Tom Bradley wrote:In the studies, however, mutual funds aren't measured against actual index portfolios, but rather market indexes that have no costs attached. Unfortunately, investors can't replicate these benchmark returns. ETFs have MERs too, and when they're bought or sold, trading commissions are charged and a small premium/discount to net asset value is absorbed. My indexing friends tell me it costs about 0.5 per cent (all in) to run a balanced ETF portfolio at a discount broker. Investors wanting advice would expect to pay an additional 0.75 to 1.25 per cent at a full-service firm.
FWIW when I used to post annual indexing vs. actively managed "couch potato" 15-year portfolio performance comparisons
I always subtracted 50bp from the index returns in order to simulate MERs. Nevertheless indexing won so consistently that I stopped running the numbers every year. That 50bp is a realistic average MER for TD eFunds investors. ETF portfolios incur under 20bp MERs, but then there are brokerage fees. For those who are truly passive investors, especially who have enough at their broker to get sub-$10 trades (or even free trades), then 50bp overstates their true costs.
Like mutual funds, ETFs can also miss their performance targets. A report published in May by Morgan Stanley showed that of more than 700 ETFs in the U.S., 47 per cent lagged their benchmark by more than just the fee. These shortfalls (they're rarely additive) vary depending on the type and size of fund and market conditions.
Bradley fails to mention how many of those laggards had large asset bases in broad market indexes and how many were tiny funds that concentrated in some obscure sector and/or leveraged. He also fails to point out that some of the former, especially from Vanguard (e.g. VTI), even achieved returns greater than index return less MER.
In the long run, everyone would be better served if more rigour was brought to the active-versus-passive comparisons. ETFs have a good story to tell without tilting the playing field.
The same could be said for the proponents of active management, sadly including Tom.
Sedulously eschew obfuscatory hyperverbosity and prolixity.