ETF production line gets leaner

Deborah Fuhr, partner at exchange-traded fund (ETF) consultancy ETFGI, calculates that the average European ETF has an annual total expense ratio of 38 basis points (0.38%). That's much cheaper than the average actively run European equity fund, which charges 1.7% a year, according to research group Lipper. Those charges add up.

Let's say you start with a portfolio of £10,000, which grows at 5% a year for the next 25 years. If you take a 1.7% hit each year for expenses, your portfolio will grow to £22,218. If you suffer only 0.38% a year in costs, you'll have £30,800 in 25 years' time.

So what can you do about it? Mutually owned US fund giant Vanguard points out that while it's impossible to invest cost-free, keeping expenses down helps to narrow the inevitable gap between what the markets return, and what an investor actually earns. Lower-cost funds have tended to beat higher-cost funds over time. And index-tracking funds, including ETFs, can be a useful tool for cost control.

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Last week Vanguard launched four new ETFs in Britain, taking its fund range to nine in total. The firm's FTSE Developed Europe (LSE: VEUR), FTSE Developed Asia Pacific ex-Japan (LSE: VAPX), FTSE Japan (LSE: VJPN) and FTSE All-World High Dividend Yield (LSE: VHYL) ETFs each have annual expense ratios of between 0.15% and 0.29%, well below the European average.

Japanese ETFs in particular have seen huge investor interest in recent months, and it's worth noting that Vanguard's new FTSE Japan ETF carries less than a third of the fee on iShares' MSCI Japan fund, currently the most popular fund in this category. With that sort of fee differential, I'd expect to see Vanguard take business from its main rival in the coming months.

Of course, headline fund fees don't tell the whole story. You should always check a fund's past performance against its index, in case there are hidden extra costs or the fund manager has had problems tracking the benchmark.

It's also important to see how liquid an ETF is in secondary market trading, as that's where you'll be buying and selling the fund. Check the London Stock Exchange website for the average bid-to-offer spread (the gap between the buying and the selling price).

That said, Vanguard's new launch is a sure sign that Europe's ETF market is getting more competitive something that can only be good for private investors.

Paul Amery is a freelance financial journalist, formerly a fund manager and trader. His website is Paulamery.net.