TER reporting needs to reflect true ETF cost

The reporting of total expense ratios (TERs) needs to reflect the true cost of ETFs to gain traction among IFAs, according to industry players.

Evercore Pan-Asset Management chief executive Christopher Aldous says there is a "foible" in the way ETFs report TERs. He says an equity based ETF, for example, could have a stated TER of 0.4%, which represents the annual management charge and should reflect the tracking error of the fund.

However, he says the tracking error is often less than this, due to revenue from securities lending and other methods going back into the fund.

Aldous says: "But providers haven't found a way of stating the true cost yet." He explains IFAs have to report the TER as stated, even if it does not account for the true cost net of any benefits added back into the fund.

He adds: "This will be an issue for the IFA market. I hope that providers will address it by bringing down the stated fees but it's worth bearing in mind when making comparisons - it's definitely a foible of the ETF world."

Spencer-Churchill Miller Private highlights this is an issue affecting all UK equity fund investors. The firm is calling for the TER to be replaced by a new calculation that includes all costs, which it terms the Total Cost of Investment Ratio.

In July, db x-trackers offered its DJ Euro Stoxx 50 ETF at 0% TER, which it reduced from 15 basis points. Head of db x-trackers UK says Manooj Mistry explains the ETF has an index swap with Deutsche Bank to guarantee perfect index performance.

In order to hedge the swap exposure, Deutsche buys the underlying components of the relevant index, from which it generates revenues through activities such as securities lending.

Mistry says the revenue can be passed on to the ETF, to offset the impact of fees and further improve the tracking of the fund. In the case of the Euro Stoxx 50 ETF, an outperformance of 45 basis points was generated, meaning Deutsche could reduce the TER to zero.