ETFs were not intentionally created to lower investment costs for shareholders. This may be surprising news, but the thought process for creating an exchange-traded basket of securities actually came from an exchange.
Offering a pool of securities—and identifying how mutual funds developed into a multi-trillion dollar industry—changed the game for an exchange. Yes, it delivered an innovative investment vehicle with enhanced efficiency and accessibility, but another driving force existed: to create more revenue for an exchange itself.
The creators certainly recognized the potential benefits for shareholders of these products. Thankfully, one can look to the original exemptive relief filed with the SEC to understand the features and benefits designed for ETFs. None of those features mandated any type of pricing, with the exception that the first ETFs would be passive in their investment strategies.
As any advisor understands, if a manager does not add investment value, there should not be much of a fee charged, if any at all. In fact, the first ETF was structured as a unit investment trust (UIT), which does not charge a management fee. A UIT instead charges a trustee fee for the oversight that trustees provide in ensuring the ETF maintains its investment mandate and operates appropriately.
Among the greatest features intentionally designed for ETFs is the operational efficiency. The ingenuity of the ETF structure ensures that investors who buy and hold can do so cost effectively and are only charged the total expense ratio for holding an ETF over time, plus the commission. Investors who actively trade are charged the same and also pay for commissions and spreads for each transaction made with a market maker. The commission and spreads help offset a market maker’s cost of holding inventory. Therefore, the cost friction from active traders does not impact the long-term shareholders.