Less than a month ago, BlackRock aggressively cut the management fees on several of its core ETFs. The boldest move was to slash the fee to just 0.05% on its broad-market Canadian equity fund, the iShares S&P/TSX Capped Composite (XIC). That seemed to get the attention of the competition, because BMO has hit back with similar fee reductions on several of its own ETFs. (Good thing I didn’t update my model portfolios.)
On April 30, BMO will reduce the fees on the following ETFs:
| Fund name | Old fee | New fee |
| BMO S&P/TSX Capped Composite (ZCN) | 0.15% | 0.05% |
| BMO S&P 500 (ZSP) | 0.15% | 0.10% |
| BMO S&P 500 Hedged to CAD (ZUE) | 0.15% | 0.10% |
| BMO MSCI EAFE (ZEA) | 0.30% | 0.20% |
| BMO MSCI EAFE Hedged to CAD (ZDM) | 0.35% | 0.20% |
| BMO MSCI Emerging Markets (ZEM) | 0.45% | 0.25% |
| BMO Short Corporate Bond (ZCS) | 0.30% | 0.12% |
.
In the major equity asset classes, the management fees are now identical on comparable BMO and iShares products. Surprisingly, the Vanguard counterparts are now the most expensive in the group. I’m pretty sure no one saw that coming, and I would be surprised if it stayed this way for long.
| Asset class | BMO | iShares | Vanguard | |||
| Canadian | ZCN | 0.05% | XIC | 0.05% | VCN | 0.12% |
| US | ZSP | 0.10% | XUS | 0.10% | VFV | 0.15% |
| International | ZEA | 0.20% | XEF | 0.20% | VDU | 0.28% |
| Emerging markets | ZEM | 0.25% | XEC | 0.25% | VEE | 0.33% |
One of the disappointments in the BlackRock announcement last month was the iShares Canadian Universe Bond (XBB) was not among the ETFs with a fee reduction. Instead, the newly launched Core Series included the iShares High Quality Canadian Bond (CAB), which has just $65 million in assets, compared with $2 billion for XBB. That gave BMO little incentive to reduce the fee on its own core bond ETF, the BMO Aggregate Bond (ZAG). Though to be fair, ZAG’s fee was reduced in late 2012 and last year its MER was just 0.23%, identical to that of the Vanguard Canadian Aggregate Bond (VAB), and a full 10 basis points lower than XBB.
However, BMO aggressively cut the fee of the BMO Short Corporate Bond (ZCS) from 0.30% to just 0.12%: that undercuts the Vanguard Short Corporate Bond (VSC) by a few basis points and is less than half the fee of the iShares 1-5 Year Laddered Corporate Bond (CBO). (The iShares Canadian Short Term Corporate + Maple Bond is comparable at 0.12%.)
What does this mean for investors?
Let’s start by stating the obvious: the ongoing price war among Canada’s big three ETF providers has been a boon for index investors. The total MER on a balanced ETF portfolio is now about half what it was in 2011, before Vanguard arrived on the scene and shook things up. Can fees go any lower? I doubt it, but I have been wrong before.
Now to the more subtle point. Costs are always an issue, but incremental fee reductions are relatively unimportant, and even a bit distracting. Reducing your portfolio’s fees from 2% or more in actively managed mutual funds to below 0.20% with ETFs could mean the difference between investment success and failure over your lifetime. Shaving 0.10% from your fees—or $100 a year on every $100,000 invested—means you’ll be able to afford an extra dinner at a nice restaurant. A sweet bonus, to be sure, but not a game changer. For young people just starting out, increasing your savings by a couple of bucks a month would have a far more dramatic impact.
Moreover, lowering your MER a few basis points doesn’t guarantee your performance will improve accordingly: the ETFs from BMO, iShares and Vanguard don’t always track the same indexes, so their returns will vary from year to year in unpredictable ways. In a year where large caps outperform, for example, VDU will likely beat XEF, even if its fee is 0.08% higher.
It’s especially important to be aware of these differences when selecting a bond ETF. Fixed income provides the stability in a balanced portfolio, so your mix of government, corporate, short and long bonds needs to be chosen carefully. The BMO Short Corporate Bond (ZCS) isn’t a substitute for ZAG simply because it’s cheaper: the latter ETF has about 70% government bonds and a much higher duration. Similarly, CAB might be cheaper than VAB, but the former has double the amount of corporate bonds and will therefore be more volatile.
So once again, remember that risk management and strategy come first. Then you can pick the cheapest product that meets your goals. The good news is that finding cheap products is now easier than ever.
I’m probably paranoid, but the fee cuts are making me a bit nervous.
I have a good chunk of money in Vanguard Canada ETFs in a non-registered account and I’m starting to get concerned about Vanguard Canada’s long term viability.
If they don’t match the fee cuts, their total asset growth is likely going to slow down or stall. And if they do match, their path to profitability (or break even) is likely going to take quite a bit longer.
I know their parent company is willing to give them quite a while to become established. I’m just a bit worried the increased competition may have the parent reconsidering.
Awesome. That’s great news.
I agree, switching ETFs for such a small change likely isn’t worth it but it’s sure nice when you already own some of these ETFs that are lowering their fees. I’ll take that nice dinner at a restaurant that you mentioned (25 years from now!).
I love the blog. I’ve learned so much from here along with your Guide to the Perfect Portfolio book.
All in the game yo, all in the game.
@Joe: I’m not too worried about Vanguard: I expect they’re here for the long haul. They had to know that when they fired the first shot in the price war the competition would fight back.
@Lee: Thanks for the comment!
@Omar Little: A man’s got to have a code, yo.
So as a newer investor, this is good, as new money gets invested cheaper.
No real reason to sell anything yet, but I don’t want to end up with too many different versions of the same thing ..
Started with XIU (before I looked into it enough), VCN was the cheapest so new money went there, now ZCN/XIC is cheaper so new money goes there?
Thanks for the heads up, Dan. Keep us up to date on anything else coming down the wire. ;)
As a 25 year old investor looking at a 30 year period, I’m a little stuck on which bond ETF to use. What would be your recommendation for my situation considering duration, mix, and volatility?
I wonder why bond ETFs tend to be more expensive than equity ETFs? They’re supposed to be less volatile and have lower returns, yet they have higher fees than the high-growth equity ETFs. It seems counter-intuitive…
On an unrelated note… ZRE is now more than 1/3 the total cost of my portfolio, despite it comprising less than 10% of my portfolio… I think it’s time for it to have a fee cut, too. :)
Awesome news, Dan. Now only if the banks would follow suit and lower index mutual funds. I’m with RBC right now and my index mutual fund portfolio averages out to an MER of 0.70%. Still great compared to actively managed funds (2+%), but nowhere near the ETFs you refer to in this post (I’m aware of TD e-Series index funds, but have all my accounts with RBC so decided to stick with them for mutual funds). Do you think Canadian banks will take baby steps to lowering their fees or is this wishful thinking?
Dan, in a few places (eg. the 2nd sentence) you appear to be using the terms “MER” and “management fee” interchangably, when in fact the MER is normally higher than the management fee. In some cases the difference is only a couple basis points, but in others it is more significant. Unfortunately BMO does not show the (higher) MER figure on each individual ETF’s webpage, but at least a summary of both amounts for all of their ETFs can be found at http://www.etfs.bmo.com/bmo-etfs/ .
iShares used to show their MERs on the individual ETF’s webpage, but their site was recently changed so they too now show only the management fee there, while the full MER cost is now (presumably) buried elsewhere on their site. So iShares has become less transparent about their costs, not more.
I’m sure this apparant slight of hand is done deliberately by both iShares and BMO. And because these subtlties are lost on many people, they will be easily misled about the true costs.
Kudos to Vanguard because their management fee and MER (for ETFs that are at least 1 year old) are both clearly displayed on each ETF’s page. Let’s hope they too don’t go over to the “Dark Side”.
With the recent fee reductions at least we are now seeing some meaningful competition between the players. That’s a nice change.
This was announced one business day after I switched from ZCN to XIC :) It may not pay back the cost of switching any time soon. Then again I always found it a bit out of character for BMO to offer low-cost ETFs, so maybe iShares (like Vanguard) has some other advantages due to its size, track record, and less conflict with a related high-fee asset management business.
It will be very interesting to see what Vanguard does now.
CCP, no doubt, has been instrumental in adding significant AUM to TD’s e-series mutual funds, resulting in substantial additional revenue to TD. Perhaps it would be in order for TD to return the favour by reducing its MER on those funds. Dan, what do you think about the chances of that happening?
@Don: Thanks, I did use “MER” once when it should have been management fee, and have corrected it. In most cases here I have referred to management fee only, for two reasons. The first is to compare apples to apples, and the second is because the full MER can only be known in retrospect. iShares, like Vanguard, is actually good about including both on their site, but if the fee change is less than a year old they exclude the MER because it won’t be known yet. I agree BMO really should address this issue: by listing only the management fee they’re being misleading.
@Rahim and David: I don’t think the banks have any incentive to lower fees on index funds. TD, especially, has a long track record of discouraging people from using the e-Series funds. The ETF providers, on the other hand, have to be extremely price conscious or they will lose market share.
@CCP: Does the ZEM ETF hold the shares of its constituent index directly like ZEA does?
@Oldie: A bit of both: http://www.etfs.bmo.com/bmo-etfs/holdings?fundId=72052
ZEM’s costs dont reveal the actual costs. Unlike iShares and Vanguard, where a cost sharing arrangement exists when holding their parent’s US ETF, no such agreement exists for BMO holding iShares ETFs.
ZEM holds several US listed iShares and their costs creates an additional drag of 0.24% as explained below
Securities % of Assets MER Share in MER%
iShares MSCI Taiwan ETF 11.31% 0.62% 0.07012200%
iShares MSCI Brazil Cap 10.66% 0.62% 0.06609200%
Powershares India Prt ETF 6.19% 0.82% 0.05075800%
iShares MSCI Emer Mrk ETF 4.20% 0.67% 0.02814000%
iShares MSCI Poland Cap 1.81% 0.62% 0.01122200%
iShares MSCI Turkey ETF 1.71% 0.62% 0.01060200%
iShares MSCI Chile Cap 1.70% 0.62% 0.01054000%
@Ram: This is true, and it’s a reason why one needs to look at tracking errors each year. It’s impossible to check ZEM’s track record properly because it changed its index and lowered its fee last April, and both of these changes would lead to misleading comparisons. But I would definitely want to check back in a year and see if ZEM’s tracking error is very high.
“For young people just starting out, increasing your savings by a couple of bucks a month would have a far more dramatic impact.”
A great reminder that time in the market and saving when younger is critical to wealth.
I’ll continue to own XIU although I might consider switching to a broader-market product like XIC at some point. Do you think the fees will come down on XIU at some point Dan?
Mark
XBB may be expensive, but you can be pretty sure it’s not going to get wound up any time soon.
Compare to CAB at the other end of the spectrum. With 72m in assets at the present moment, it makes < 100k/year gross. Can that be worth the hassle to a firm like iShares? All you need is for a rate spike to trigger outflows and the fund to wind up and close out your position at a loss.
ZAG, VAB and others are somewhere in between. Are they at risk of the same? I can't imagine — but that's up to you to ponder. No such thing as a free lunch…
@Mark: I can’t imagine that BlackRock would reduce the fee on XIU significantly. At $12.6 billion in assets, every basis point in management fee earns them $1.26 million. XIU is a unique fund in Canada: it’s used as trading instrument as well as a long term investment.
@Human Capital: ETF closures are always a risk, but iShares Canada has never closed an ETF, except for an inverse bond fund they inherited from Claymore. I would be shocked if Vanguard did so. It’s also worth noting that if a bond ETF did happen to close the result would just be inconvenience. “Closing out your position at a loss” isn’t meaningful if your replacement ETF has similar market exposure.
Hi Dan, considering the difference in fees between VOO and ZSP now, if someone has to buy and S&P500 etf then should he still consider buying VOO as first choice or ZSP to avoid the hassle of converting CADs to USDs? Considering the fee difference is not significant anymore, is it worth shopping south of the border? Also would it matter if the ETFs is going to be in RRSP or Non Reg acct? I know XUS and VFV are ETF or ETF so there is a disadvantage of withholding taxes.
@JS: I don’t think it makes sense to a US-listed ETF to save 5 basis points in MER. So in a taxable account or a TFSA (where foreign withholding taxes are irrelevant) the Canadian-listed ETF is almost always the better choice for US equities. In an RRSP, where the withholding taxes cause an additional drag of about 0.30%, it’s at least worth a discussion.
More here:
https://canadiancouchpotato.com/2013/12/09/ask-the-spud-when-should-i-use-us-listed-etfs/
https://canadiancouchpotato.com/2014/02/20/the-true-cost-of-foreign-withholding-taxes/
ZSP and XUS now charge the same fee. However, ZSP holds the stocks of the S&P500 index while XUS holds IVV. In this case, is there any advantage to use either ETF over the other?
@John: Nope, no difference. The withholding tax issues are the same: in both cases they are lost in RRSP and TFSA and recoverable in a non-registered account.
What do you suggest for those who will be buying US equity ETF in the near future? Which ETF (ZSP or VUN) to choose as the management fees are same?
Thanks!
Another thing to consider is given the returns of the last few years some equity ETFs people hold may have considerable capital gains and selling to switch to a lower cost alternative may have big tax consequences that far outweigh the benefit of the lower fee even over long periods of time.
Hi Dan,
I am not sure if this is an appropriate post to ask re-balancing question but I just wanted to know if you have written about re-balancing with currency fluctuation affect on portfolio in the past and if you could redirect me there. I am realizing all of a sudden my US ETF holding are higher then target (VTI and VEA) because of CAD decline. How should we deal with re balancing in such case?
JS,
For any rebalancing decision, the value of all assets must be denominated in the same currency. Period. Anything else will leave you with gibberish.
The fee cuts, both at BlackRock and at BMO, look very opportunistic to me. They are as likely, opportunistically, to raise the fees. Me, I’m sticking with Vanguard!!
Ram – the website for BMOs ETFs (including ZEM) say this:
In addition, as ZEM may hold other underlying ETFs, the management fees charged are reduced by the management fees paid on the underlying ETFs.
(Source: http://www.etfs.bmo.com/bmo-etfs/glance?fundId=72052 )
@JS: As Kiss suggests, rebalancing should always be done after converting any US holdings to their market value in Canadian dollars.
Dan, I bank at TD and use TD Discount Brokerage. I was pleasantly surprised over the last year or so to hear TD Bank and Brokerage representatives pushing e-series.
As a check, I took a look at the annual report for ZEM. There is no reference in the annual report about management fees charged being deducted for management fees paid to underlying ETFs. That’s somewhat concerning.
I note that the 2013 management fees charged are $229,000. Assuming average fund assets of $71,000,000, this represents a management fee of approximately 0.32%. This compares to the published average 2013 management fee of approximately 0.48%. I note that the difference here is 0.16%, which is less than the 0.24% underlying ETF MER fees that Ram calculates.
Give the market a couple years and i am sure that we will see ETF with a POSITIVE MER. (think +0.01%).
Anyone want to take the bet ? ;)
For the Complete Couch Potato will you be making any changes or upgrades based on the fee changes?
@Richard: I think this latest move is a good example of why I don’t rush to change my model portfolio recommendations with every new announcement. I could have changed them after iShares dropped their fees, and within a couple of weeks that would have been hard to justify.
You have to be careful with low-fee ETFs. The sponsors have to make money – or achieve savings elsewhere in their operations – somehow, and there have been a lot of worries in Europe about the effect of derivatives (primarily total return swaps) in ETFs when they go that route. See http://www.bis.org/publ/work343.pdf
I haven’t checked to see if there are any holdings in the highlighted funds at present, but I do know that BMO has the ability to hold derivatives in their ETFs (some of them, anyway).
@James: Thanks for the comment. There are very few swap-based ETFs in Canada, and all of them are from a single provider (Horizons). Some iShares ETFs formerly used forward contracts to get tax-efficient exposure, but these were changed after the 2013 budget crackdown. iShares, Vanguard and BMO are quite plain-vanilla in this respect, even though the prospectus of most ETFs mentions the ability to hold derivatives. (Sometimes these derivatives are just index futures, for example.)
Except the difference in management fees, are there any fundamental difference between these broad market ETFs? For example, ZCN, XIC, v.s. VCN; ZEA, XEF, v.s. VDU? Particularly, for the international broad market, ZEA seems to be a more tax-friendly one. But does it make sense to invest in an ETF with a small asset under its management (for example, ZEA), only for enjoying its more effective tax measure? How can a novice investor tell the fundamental difference, if any, among these very similar broad market ETFs?
@Jim: The broad market ETFs you’ve listed are very similar, and their returns should not vary significantly over the long term. The index methodologies, country and sector breakdowns, and even the individual holdings are all published on each ETF’s web page, so comparisons are actually quite easy.
As for investing in an ETF with low assets under management or low trading volume, that’s generally not a big concern, especially if you are not trading it frequently:
https://canadiancouchpotato.com/2012/09/10/etf-liquidity-and-trading-volume/
Dan “I’m not too worried about Vanguard: I expect they’re here for the long haul. They had to know that when they fired the first shot in the price war the competition would fight back.”
As a relative newcomer to Canada then it’s simply wonderful to witness a leading international new entrant disrupting a concentrated, uncompetitive Canadian market. ETF pricing will, in time I think, cause positive change to the lamentable Canadian mutual fund industry too. Hurrah for the Canadian consumer. I hope that Vanguard has a few similarly troublesome corporate friends to encourage to enter Canada – say its international peers in banking, telecoms, perhaps supermarkets, perhaps quite a few more …. :)
Thank you Vanguard.
If Vanguard comes back with some retail mutual funds that would be a huge step forward for the market… let’s hope they do!
When would you consider switching ETFs to obtain a lower MER? I’m a young investor and a couple basis points could mean a lot in the long run.
By the way, I’m using a TFSA as an investment vehicle, so I wouldn’t have to worry about capital gains.
@Keith: Maybe the next time you are adding a significant amount to the portfolio. If you are going to be making a purchase anyway, selling the old ETF would cost just one extra trading commission.
I do not know if it is a right place for me to ask questions on the tracking errors. When I checked the tracking errors for the ETFs issued by Vanguard Canada, iShares and BMO, I found that the tracking errors were quite small for the Canadian and US equity ETFs, such as ZCN, XIC, VCN, ZSP, XUS, VFV. However, for international and emerging market ETFs, the tracking errors were quite large. For example, ZEA and XEF. Since its inception, the annualized performance difference between the fund and the index was 6.76%. I could not find the information for VDU. Did I read something wrong? Why was the tracking error for the international and emerging market ETFs so large?
@Jim: The tracking error on international equity ETFs is likely to be larger for several reasons, including withholding taxes. There can also be an issue with differences between the finds’ net asset value (NAV) and price, which can make tracking error look large over the short term. But 6.76% annualized makes no sense: that must be an error. What source are you using?
I got the tracking error for the XEF from Tracking Error Chart on ca.ishares.com. Here was the quote:
Period 10/04/2013
to
16/05/2014
Annualized performance difference Performance Difference is the difference between the fund and index returns. 6.76%
Fund return25.28%
Index return17.72%
Management fee*0.20%
A similar ETF issued by BMO (ZEA) also showed a significantly difference from the index (visually checked from the Tracking Error Chart from BMO’s ETF website).
Did I read it in a wrong way or did I miss something?
The similar ETF issued by Vanguard (VDU) did not have this kind of information available from its website.
For XEC, here was the quote about its tracking error (6.11%) (again from the tracking error chart on ca.ishares.com)
Period 10/04/2013
to
16/05/2014
Annualized performance difference Performance Difference is the difference between the fund and index returns. 6.11%
Fund return10.28%
Index return3.53%
Management fee*0.25%
@Jim: There must be an error in those charts. There’s no way those two ETFs could have outperformed their indexes by more than 6%. ETFs are not permitted to publish their returns until they have a full year under their belt. That should happen for XEC and XEF at the end of May. But if you go to Morningstar you can check the 12-month returns on XEC, XEM and ZEM, all of which track similar emerging markets indexes. Their returns were 6.44%, 6.02% and 6.02% respectively. The MSCI Emerging Markets Index returned 6.78% over that same period. After fees and withholding taxes that’s pretty much would you would expect.
Vanguard has the same issue with VDU: they can’t publish returns until there’s a full year. But again, Morningstar gives its 6-month return as 9.15%, compared with 9.93% for XEF. The indexes are different, so that gap is not surprising. The MSCI EAFE Index returned 9.77%.
So nothing seems worrisome here. I suspect it will all be resolved when the funds have a longer track record.