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Advisers bypass zero expense ratios for brand-name ETFs

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Fund that pays investors 5 basis points annually attracts just $6 million

Low fees might be the surest form of investment alpha, but it turns out that brand-name asset managers with longer track records still rule when it comes to exchange-traded funds. It also helps to have shelf space on high-traffic brokerage platforms.

In a somewhat surprising development, ETFs launched this year offering unprecedented zero and negative expense ratios have struggled to gain traction among financial advisers, according to an analysis of fund flows conducted by CFRA.

Three ETFs launched in March and April with zero and negative expense ratios have see combined net inflows of just $67.3 million this year through November.

That compares to three more established ETFs from brand-name providers that charge 4 basis points and have seen combined net inflows of $3.9 billion over the first 11 months of the year.

The disparity, even if it isn’t a perfect apples-to-apples comparison, is surprising to Todd Rosenbluth, director of mutual fund and ETF research at CFRA.

Unlike actively managed strategies that rely on portfolio manager skill and experience, indexed ETFs are transparent vehicles for tracking benchmarks.

But when even a fund that pays investors 5 basis points, as is the case with the Salt Low truBeta US Market ETF (LSLT), has only seen $6.1 million in net flows since March, the assumption is that investors and financial advisers are looking for a track record or a brand-name asset manager.

“It’s possible advisers want to see how it will trade, especially if a fund is tracking an index they’re not familiar with, but we don’t think investors need to wait for a three-year track record like they would with an active mutual fund,” Mr. Rosenbluth said. “There’s limited skill being [employed] by the manager of the ETF provider; they’re tracking an index and they publish their playbook, so you don’t need to see a demonstrated skill that they’re doing what they say.”

Of the three ETFs that launched in 2019 with free or negative expense ratios, the Sofi Select 500 ETF (SFY), launched in April, led the way with $58.7 million of net inflows.

The fund is understandably small, with just $65.4 million, but the performance since the April inception is a respectable 9.5%, which compares to 7.9% for the S&P 500 Index over the same period.

The $9.7 million Salt Low truBeta ETF is up 12.9% since its March launch, which compares to a 10.7% gain by the S&P 500 over the same time period. And keep in mind, with this fund you add 5 basis points per year just for owning it.

The third free ETF, the $7.8 million Sofi Next 500 ETF (SFYX), has attracted just $2.5 million in net inflows this year and is up 4.4% from its April launch.

To illustrate that the flows are probably not related to performance, the $44.8 billion Vanguard Growth ETF (VUG), which had $1.7 billion worth of net inflows this year through November, is up 9.3% since April.

The Vanguard fund, along with the $8.9 billion Schwab US Large Cap Growth ETF (SCHG) and the $5.2 billion SPDR Portfolio S&P 500 Growth ETF (SPYG), all saw net inflows this year of more than $1 billion and all have expense ratios of 4 basis points.

To be clear, the zero and negative expense ratios are temporary and admittedly a “gimmick,” said Alfred Eskandar, president and co-founder of Salt Financial.

“It’s a teaser rate that we introduced as a way to respond to the anti-competitiveness of the distribution models, because to compete in the ETF space, you need to go out to retail investors,” he said. “The hope was to get people to look at the fund, try it and stay with it because of the performance. People will see the low volume and assume it’s illiquid, but ETF liquidity is not just based on volume, it’s also based on the components of the ETF. A lot of retail investors don’t know that, and a lot of advisers feel the same way.”

Mr. Rosenbluth agreed that brokerage platforms can represent the golden goose for ETF providers but is still surprised that more independent advisers and individual investors have not jumped at the chance for free or negative-expense ETFs, even if that discount is temporary.

“I’m surprised the assets in these funds are as small as they are,” he said.