Index Strategies And ETF Fees

After categorizing all 304 ETFs by their underlying index security selection and security weighting methods, I calculated the average fee for the ETFs in each security selection strategy and security weighting strategy. Then I calculated the average fee for each of the nine Index Strategy Boxes. The results of that analysis are in Figure 3.





Figure 3 shows that U.S. equity ETFs that follow market indexes (green shade) charge on average 0.30 percent in annual fees. Thus, it can be said that basic beta exposure to various segments of the U.S. equity markets cost 0.30 percent on average. That may seem high at first observation, but recall that the 124 funds in the box include many types of market index ETFs. In addition to broad market indexes, there are many subsets, including industry sector funds; growth and value funds; and large-, mid- and small-cap funds. The fees charged for sector and style slices of a broad market index tend to be higher than the fee for a broad market index ETF. For example, iShares Dow Jones U.S. Technology Sector Index Fund (NYSE Arca: IYW) has a fee of 0.48 percent, while the iShares Dow Jones Total Market Index ETF (NYSE Arca: IYY) has a fee of only 0.20 percent.

At 0.30 percent, basic “Beta” exposure through ETF investing is relatively inexpensive, while the quest for “Alpha” through funds that follow strategy indexes is more expensive. As security selection methods and security weighting techniques become more complex, the fees charged by ETFs to manage portfolios to those indexes go up. There is a direct correlation between the complexity of the index and the cost of ETF management.

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