28/06/2015 10:10Vanguard Hong Kong - The case for indexing

Page 1 of 2https://www.vanguard.com.hk/portal/resources/case-for-indexing.htm##cost-advantage

A passive investment strategy seeks to track the performance of an index by mimicking its holdings. Primarily because of their low-cost structure, well-managed index investments such as an index-based mutual fund or ETFs have generally outperformed higher-cost investments over the long term. When advisers index a solid portion of their clients portfolios, their clients often benefit fromlower costs, broader diversification and minimal cash drag. These elements can translate to a long-term performance edge.

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The case for indexing

The indexing cost advantage

The role of costs is so critical to investment success that it merits a closer look. The return from a mutual fund or ETF reflects thereturns of its underlying holdings less transaction costs and expenses charged by the fund.

Compared with index funds and ETFs, active funds typically have higher expense ratios. As at 31 December 2012, investors inactively managed Asia ex-Japan equity funds were paying an average annual expense ratio of 1.77%, and those in actively managed

global equity funds were paying 1.58% annually, versus 0.55% and 0.46% for the corresponding index-based ETFs.1

While the expense ratio is easy to measure, many other fees are harder to estimate. Turnover, or the trading within a fund, results in

transaction costs including commissions, bid-ask spreads, market impact2 and opportunity cost. These costs are incurred by everyfund and detract from net returns, but they are difficult to measure. Active funds often have higher transaction costs, due to thegenerally higher turnover associated with active managements attempt to outperform the market.

1 Source: Vanguard analysis, based on data obtained from Morningstar on 17 June 2013.

2 In this context, market impact refers to the effect of a market participants actions that is, buying or selling on a stocks price.

Indexing cost advantage

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28/06/2015 10:10Vanguard Hong Kong - The case for indexing

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