ETFs Not Always Cheaper Than Mutual Funds

It’s no secret that exchange trade funds have perceived cost and tax advantages over index mutual funds.

Since ETF managers do not have to maintain accounts for individual investors like index mutual funds, Morningstar says this helps reduce ETFs’ administrative expenses.

But does that correlate with a lower-cost exposure than index mutual funds? Not necessarily so, says a new research report from Morningstar released Wednesday.

“ETFs do not incur some of the administrative costs that their index mutual fund counterparts face, but they are not always cheaper,” write Morningstar analysts Alex Bryan and Michael Rawson in the report, “The Cost of Owning ETFs and Index Mutual Funds.”

Morningstar evaluated the cost comparison by matching ETFs and index mutual funds that track the same indexes within several Morningstar categories and comparing these funds’ reported net expense ratios, which “often represent the largest and most predictable component of the total cost of owning a fund.”

Morningstar limited its data set to broad market-cap-weighted stock and bond indexes tracked by both ETFs and index mutual funds and then examined the asset- and equal-weighted net expense ratios for each category of ETFs and index mutual funds, based on their 2013 annual reports.

Here’s what Morningstar found:

“We find that ETFs in most categories do not have lower asset-weighted average expense ratios than index mutual funds that track the same benchmarks,” write Bryan and Rawson. “The difference in the asset-weighted expense ratios between the two vehicles is small in most categories.”

According to Morningstar, only three of the 14 ETF categories had a lower asset-weighted expense ratio than their mutual fund counterparts, and ETFs looked more expensive in eight of the categories.

However, the equal-weighted expense ratios suggest that ETFs do offer substantial cost savings.

Bryan and Rawson explain this in their report, “Although ETFs carry lower equal-weighted expense ratios in most categories, the most expensive mutual funds do not attract significant assets. … As a result, comparing expense ratios on an equal-weighted basis paints an inaccurate picture of the average investor’s experience.”

Morningstar is quick to point out that there are other variables that affect the results of this analysis as well, such as whether Vanguard funds are included.