Are ETFs cheaper than Passive Funds

Mike Turner, Assistant Research Manager (Funds and DFM)

We hear in the press about how cheap ETFs are compared with traditional passive funds, often comparisons are made using Ongoing Charge Figures (OCFs). The comparisons are usually made using fund populations containing dirty share classes (share classes loaded with trail commission). But if we remove the dirty share classes and compare OCFs using clean share classes only, is it still the case that OCFs are lower on ETFs? 

The below graph compares the OCFs of ETFs to the OCFs of passive funds (OEICs & Unit Trusts) by asset class but only including clean share classes in the data population. 

So we can see from the graph above that in most cases OCFs are cheaper on average for clean share classes of passive funds when compared with ETFs, so why bother with ETFs? Let’s examine how ETFs compare with passive funds (OEICs & Unit Trusts) in terms of tracking. To measure how closely a fund tracks its benchmark we can use R-Squared. A figure of 100% would mean the fund’s returns are 100% correlated with the benchmark. 

From the above graph we can see that the 12 month R-Squared is on average higher than the R-Squared of passive funds across all asset classes, however it is only significantly different for Global ex UK Fixed Interest.  

The table below shows the same data used for the above graph but allows you to see the exact numbers clearly. 

In this article we have looked at OCF in isolation. It is also important, however, to consider other costs involved with both types of investment vehicle. In conclusion, although OCFs are lower on average for clean share classes of passive funds when compared with ETFs, we have seen that there can be a trade off in that ETFs can offer better tracking potential on average.