Unpacking ETF Fees, Part 4: iShares

In the last of this series of posts on ETF fees, let’s take a closer look at iShares, the largest ETF provider in Canada and the only one that discloses its funds’ entire management expense ratio (MER) on its website.

I spoke with a representative at iShares to ask whether an investor should expect any other operating costs above and beyond the MER. In most cases, the answer is no: the management expense ratio includes GST, and the fees payable to the independent review committee (IRC) are “a fraction of a basis point.”

iShares ETFs will still incur trading costs that are not included in the MER, but with an index fund these are typically very low. Brokerage costs are itemized in the footnotes of the funds’ financial statements and they appear to be negligible: the S&P 500 Index Fund (XSP) and the MSCI EAFE Index Fund (XIN) have the highest brokerage costs at about $25,000 to $35,000 annually, but these funds each hold a billion dollars in assets.

iShares estimates that currency hedging (used by both XSP and XIN) costs about 0.15% annually, and this won’t be included in the MER either. That’s not a trivial cost, especially when the benefits of currency hedging are dubious. Consider that XSP simply holds the US-listed iShares S&P 500 Index Fund (IVV), which costs a mere 0.09% annually. The Canadian version tacks on 0.15% in management fees, and the hedging adds another 0.15%. That makes XSP four times more expensive than its US counterpart. Unless you expect the US dollar to plummet during the period you hold the fund, think hard about whether that higher fee makes sense.

At the end of the day, what really matters is how closely an ETF tracks its index. If the index returns 10% and your ETF returns 9.5%, your bottom-line cost is 0.5%, whether that drag is a result of management fees, trading costs, currency hedging, or anything else. iShares ETFs are generally excellent on this front: their tracking errors are very low, and sometimes a fund will even return a bit more than the index, either because of a lucky accident or a shrewd bit of arbitrage.

You can learn exactly how well any ETF (not just iShares funds) tracks its index by looking in the Management Report of Fund Performance, which is released twice a year and available on SEDAR. Just follow this link, type the fund company’s name in the search box, then choose “Management Report of Fund Performance” from the pull-down menu. Each report will include a line like this:

For the year ended December 31, the Fund returned 9.5% versus the Index return of 10%. The main reasons for the difference in performance of -0.5% between the Fund and the Index were management fees (-0.30%) and other miscellaneous factors (-0.20%).

As long as those miscellaneous factors are kept low, you’re accomplishing the ultimate Couch Potato goal of tracking the index as closely as possible.

Part 1: Unpacking ETF Fees

Part 2: Claymore

Part 3: BMO

10 Responses to Unpacking ETF Fees, Part 4: iShares

  1. brad February 25, 2010 at 11:29 am #

    Thank you for this excellent series, it was a real eye-opener.

  2. mcmatterson February 26, 2010 at 8:00 am #

    My thoughts exactly. Thanks.

  3. Vaan February 27, 2010 at 11:13 am #

    I still have about 12 years of investing. i am interested in living off of dividends when the time comes. I am interested in putting more money into CDZ and CYH because of their dividend payout. However, I think I can get equal or better performance with XIC, VTI and VEA over the next 12 years with a much lower MER. Then I would consider getting the dividend payers at retirement. Any thoughts on which approach to take at this point?

    Vaan

  4. David February 23, 2011 at 12:21 pm #

    What about “ETFs of ETFs” – like XTR or CBD – are we paying 2 levels of fees? In iShares Prospectus they specifically rule this out (saying they’ll adjust the fees on the underlying ETFs to ensure investors pay only once) but I can’t find that from BMO and Claymore…

  5. Canadian Couch Potato February 23, 2011 at 12:31 pm #

    @David: No, you’re not double-paying management fees when you hold “ETFs of ETFs.” Claymore’s CBD and CBN add up the fees of all the underlying ETFs and then add an additional 0.25% for the index licensing, rebalancing etc. But the fee you see quoted on the website is all you pay.

  6. David February 23, 2011 at 12:52 pm #

    Wow – fast response!
    I’m trying to compare
    iShares XTR: MER of 0.55, and prospectus explicitly states the fees on underlying are adjusted to ensure you pay max 55bps
    Claymore’s CBD: “Management Fee: 0.25% – Total Management fee does not include management fees of the underlying ETFs”
    ZMI: MER of 0.55, BMO has written to assure me that is the max fee but I’m awaiting a citation from official fund documents to ensure the underlying ETFs don’t also pay BMO Asset Management their fees too.
    These funds are very comparable, but CBD charges an extra 25bps on top of all the charges below – hard to calculate which would come out worse but I suspect Claymore would be a bit more, since the three largest holdings are charge .58 and .25 and .60, plus the allocation +.25%…

  7. Canadian Couch Potato February 23, 2011 at 1:11 pm #

    @David: The total cost of CBD is 68 basis points: 0.43% for the underlying ETFs, plus the 0.25% management fee. I’ve had many discussions with Claymore about this and have it on good authority.

    Differences in MER of 10 basis points or so are negligible unless the funds track identical indexes. The main driver of your decision should be the asset mix and strategy that each ETF uses. This will have a much greater effect on risk and performance.

    Have you seen this post on the Claymore CorePortfolios?
    http://canadiancouchpotato.com/2010/07/26/under-the-hood-claymore-coreportfolios/

  8. sleepydoc August 29, 2011 at 2:26 pm #

    I just stumbled upon this and thought I would check the true cost of the ZRR fund. The fund’s listed MER is .25%. the Sedar website you direct readers to says:

    “The ETF returned 6.97% versus the Index return of 7.16%. The difference in the performance of the ETF relative to the Index during the Period (-0.19%) resulted from the payment of management fees (-0.17%) and certain other factors
    (-0.01%).”

    Why is the true lag of this ETF (0.19%) even less than its MER (0.25%)? Is the cost to me the 0.25% MER PLUS the 0.19%?

  9. David August 29, 2011 at 2:36 pm #

    Hi sleepydoc,
    this can happen for a number of reasons:
    – most likely it’s securities lending. The Sponsor (iShares) rents out the securities in the fund. Let’s say someone needs to some Royal Bank shares for a couple of weeks, they pay the fund (and iShares) to borrow the funds’ (your) shares. These revenues partly offset the various costs (like management fees). I’m not sure about Canada but iShares in Europe is a massive securities lender (so they might lend a good part of your shares to an investment bank against some collateral. If that IB goes broke you’d better hope you like the collateral. No reward without risk).
    – sometimes there are unintentional gains (and losses) on forex.
    – I’m not sure if this is a fully replicating fund or if it uses optimised sampling. A fund that uses optimised sampling sometimes outperforms its benchmark since it doesn’t have the exact same portfolio and might get lucky in the parts it holds.

  10. Canadian Couch Potato August 29, 2011 at 10:08 pm #

    @sleepydoc: Has ZRR been active for a full year? I think in this case what probably happened is that the reporting period is less than 12 months, which is why the MER is given as 0.19% instead of 0.25%.

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