The low-cost debate

Scott Longley

a group of scissors are laying on a table

As befits a move to cut the cost of fees to their lowest level in Europe, the Lyxor explanation for their move is disarmingly simple.

"We launched these products after a lot of conversations with investors, and they told us they want low costs, but without compromising on quality," says Adam Laird, head of ETF strategy for Northern Europe at the provider.

"It was essential to us that we made these as simple and as straightforward as possible. Here that means physical replication without securities lending. There's no hidden surprises."

He is talking about the standout fees of 0.04% - just four basis points - that apply to two new funds within Lyxor's Core range, the Lyxor Core Morningstar UK NT ETF and the Lyxor Core Morningstar US Equity ETF. The rest of the range, meanwhile, have also priced competitively with fees ranging from 0.07% to 0.12%.

The straightforwardness of the offer is an important point. ETFs are clearly gaining in popularity in Europe - according to the latest figures from Lipper European ETF assets under management was up slightly in February to €648.3bn.

Yet in terms of total AUM Europe is still some way behind the US and partly this is down to greater understanding but also the fact of the generally lower fees being offered in the US must also play a part.

The message on compounding, in particular, has a certain resonance when allied to what the investor sees as being costs that have been pared to almost zero.

Such is the view of James McManus, investment manager at UK-facing robo-adviser Nutmeg.

"Lowering the cost of investing is great for all investors," he says. "However, while it may initially be headline-grabbing, for many investors, including retail customers, the true benefits are not felt just over one year, but when returns are compounded over many years."

Getting MiFID

To an extent, Europe's financial watchdogs can take some of the credit for the focus on fees. As part of MFID II, greater transparency is one of the watchwords of the new regime. "Particularly today after MiFID II rules have come into place, there's a real focus on cost of investment," says Laird.

McManus points out that though the Lyxor move is timely, other providers can still do more to fully explain the mechanics of fees and charges.

"Fee cuts alone don't necessarily help investors understand the long-term impact of all the costs and charges that are applied to their investments," he says.

"The MiFID II regulation was designed to bring clarity around costs and charges, making it easier for investors to see exactly how much they're paying in both a percentage term and pounds and pence. However, it's still early days and we've seen varying degrees of transparency on costs and charges from providers in the industry - there's still work to do."

Still, Lyxor clearly gets plaudits for the overall message its two 'four bip' funds send out to investors.

"We like seeing ETF providers competing to reduce their costs," says Johan Hellman, the co-founder at another robo-adviser ETFmatic. "Unlike other criteria that ETF providers like to compete on (for instance tracking error/difference) reducing cost is both easy to explain and more likely to be true in the future."

His view is echoed by Oliver Smith, portfolio manager at IG Group. "It is certainly a good thing to have price competition in the ETF market," he says. "It also piles pressure on the market leaders to maintain their market share by potentially matching them."

But Smith also notes one interesting aspect of the 'fees war' - the fact that it is actually a battle between the index providers as much as it is between fund providers.

"In one sense, this is an index provider price war," he says. "Morningstar are trying to gain a foothold by undercutting MSCI and FTSE."

The Zero challenge

Smith points out these funds at four bips are almost being run as loss-leaders as it is but he believes that eventually we will see what is also currently being forecast for the US market - the launch of a zero-cost ETF.

Yet there are issues for some of the robo-advisers about the apparent gift horse. We don't expect to see zero-fee ETFs in the near future," says Hellman. "We're also not convinced zero-fee ETFs would necessarily be a good thing for our clients. The ETF providers do after all need to make a living and in general we prefer that they do so directly from the ETF management fee rather than through finding other, less transparent or riskier, ways."

McManus at Nutmeg says he finds it difficult to believe that we will see zero-fee funds any time soon.

"ETF providers are commercial enterprises, with shareholders and costs, and there is a base level of revenue or profit margin for which businesses are willing to engage in activities," he says. "The economic rent can be reduced to zero, but it's highly unlikely that the industry will ever have appetite for managing products that are only breaking even or loss making."

Laird at Lyxor suggests that on the provider side there is also little appetite - or reason - to go for zero. "I don't think we'll have loss leader products this side of the Atlantic," he says. "To do so you need to have cross-subsidy with higher fee funds, and European investors will pick and choose to get the right deal in the right area.

"When we were developing these funds, we were insistent that our funds shouldn't be loss making. We're launching this range for the long run. Lyxor's been running ETFs for over 17 years and we want investors to know that we will be around in decades to come."

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