You might have caught some very interesting news recently.

Not in the actual news of course. But in the world of investments, and specifically, the options available to us in Australia.

What happened? ETF manager Betashares just launched a direct rival to Vanguard’s international share fund VGS. The new fund is called the Betashares Global Shares ETF, and it has the ticker code BGBL.

Not only is it a direct competitor, but it’s come out the gate with a much lower management fee than VGS (0.08% versus 0.18%). Side note: this is an impressive offering and Betashares deserves big applause for continuing to innovate and deliver low-cost options to compete with (and even undercut!) the big dogs in the room.

A whole bunch of investors have taken notice and are now considering BGBL for their international shares exposure. But despite what you might have heard, there’s more to consider than fees, even for funds which invest in the same companies. That might sound strange, because what I’m about to discuss is not widely known, yet important to understand.

VGS versus BGBL

This article is not intended as a head-to-head comparison of the two funds. Instead, I’m fleshing out the bigger picture reasons why a lower fee fund is not automatically better than a higher fee fund. That can be true even if they look the same on the surface.

Both VGS and BGBL invest in around 1,500 global companies from developed markets. Each has basically the same portfolio of stocks and breakdown between countries. OK, so what’s the difference between VGS and BGBL? How is Betashares able to offer the fund at a much cheaper fee?

While I can’t speak to their pricing strategy, the first obvious difference is that Betahsares is using a different index provider. They’re working with a firm called Solactive, just as they have with their fund A200 (which also became a strong competitor to Vanguard’s Aussie index fund VAS), whereas I believe Vanguard uses Standard & Poor’s as their index provider.

The point here is that Betashares is able to provide the fund at a lower cost, likely because of their different index provider. Judging from A200’s performance, that has worked out just fine. But you might be thinking: “if the companies are the same, then surely the fund will have the same performance, making the lower fee fund better?”

Why fees don’t tell the whole story

Lower is better makes perfect sense on the surface. But we also need to consider something very important: how well does that fund manager track the index?

Because you don’t automatically get index performance. That’s what you’re paying the fund manager for - to manage a portfolio of stocks which resembles the index to get as close as it possibly can. So the real question is: does Betashares track its index just as well as Vanguard? And is there anything else that could affect performance?

Let’s take a look at the Australian index ETFs for comparison to answer this question, using performance data up to May 31, 2023. I’m highlighting the net returns after fees for both funds.

Here’s VAS, managed by Vanguard:

BMK stands for Benchmark, essentially referring to the index the fund is aiming to track. ETF Total means the net returns to investors in the fund. Now here’s A200, managed by Betashares:

The 3-5 year view gives us the most relevant picture since Betrahsares hasn’t been running for 10 years yet. And remember, index performance is slightly different in that VAS tracks the top 300 Aussie companies and A200 tracks the top 200. Those extra 100 small companies will sometimes outperform and sometimes underperform, so that part is irrelevant here.

What we really want to know is how these funds performed relative to their own index.

A200 seems to lag its index by around 0.10%, which is slightly more than the fee charged during most of that time (0.07%). Not perfect, but not bad at all.

VAS, on the other hand, seems to have only lagged its index by less than 0.05% per annum on average, and only 0.01% over 5 years. Which is somehow much less than the average fee it charged during that time (0.10%). So, Vanguard charges higher fees, but seems to track its index better. What’s going on here?

There could be two reasons for this. Vanguard has been managing index funds for almost 50 years, so it could simply be better at doing so. Another important reason, though, and likely more impactful, is that Vanguard does something with its funds that Betashares doesn’t do. That something is securities lending.

Securities lending

I’ll do my best to simplify this into layperson's terms (for myself as much as you!), as it’s not something 99.9% of investors are ever involved in.

Essentially, securities lending is where Vanguard lets institutional investors borrow parcels of stock, for which they’re paid a fee. The people doing this are short-sellers in the market, who aim to profit from borrowing a stock, selling it in the market and buying it back later at a lower price, then returning the stock to its original owner (in this case Vanguard on our behalf).

What if something goes wrong? This appears to be managed carefully, as Vanguard has engaged in securities lending for 30 years. Vanguard only undertakes this activity when it’s reasonably profitable to do so (depending on the fee), and all income earned goes straight back into the fund to improve returns for investors. As the lender, Vanguard is also protected from default by the ‘lending agent’ JP Morgan, which I recently learned from this interesting Reddit summary. Vanguard has also discussed securities lending in a short video here.

The net result is that Vanguard has been able to generate some small additional returns through this activity. This higher net performance has the same effect as a lower fee. As we can see from the return table earlier, the net fee to investors has been almost zero over the last 5 years (0.01%). And over the last three years, net performance was actually above the index.

So through a combination of what seems like better index tracking and securities lending, VAS has been able to track its index much more closely. Investors are arguably getting a good deal here despite paying slightly higher fees. This means I wouldn’t rush out and buy BGBL solely because it has a lower management fee - it’s clearly not that cut and dry.

What else people forget about fees

In all of the discussion about fees, I think there’s another thing which goes overlooked.

Management fees on broadly diversified index funds are all heading towards zero anyway. They’ve been trending that way since the beginning. So, the direction is overwhelmingly down for large passive funds like those popular in the Pearler Community.

“But shouldn’t I still save on fees now, isn’t that better?”

Perhaps. But how many times will you switch from one fund to another based on fees? First VAS is cheaper so you buy that. Then A200 is cheaper so you switch. Soon, maybe another fund is cheaper (IOZ, or something else), so you go for that one. You do the same with your global shares too.

Sooner or later you’ve got six funds in your portfolio when you only need two. Or do you sell the old one when you switch? And what about capital gains tax? Or, if you keep them, you’ve got extra payments and holdings to keep track of, and tax info to check.

Lots of potential extra decisions and mental energy. What is that extra portfolio admin (or simplicity) worth to you? Again, not so simple when we stop and think about the bigger picture. There’s always more to consider, not just one metric.

Higher fee funds can lead to better investor performance

Wait, what? In some cases, this is absolutely true. Let me explain.

If you’re somebody who can’t help but tinker with their investments, and you tend to overthink things, it’s likely this ‘tinkering’ is actually detracting from your returns. This habit often causes people to sell things which are underperforming, as they convince themselves it’s not a good investment anymore (just as it's about to outperform).

So, it’s possible for an investor to be better off paying higher fees (funds like VDHG and DHHF come to mind as examples of higher fee funds), if it helps improve your behaviour as an investor. It can help you stop overthinking your portfolio, which funds to choose, and how much to have in each. With an all-in-one fund, these decisions are taken care of for you.

Now, back to our low-fee options. Some people worry whether these super low fees can be sustained. I answered a question like this recently, so let’s cover that now.

Are ultra low fees sustainable?

Some index funds have fees which are, let’s be honest, not far off being completely free. For example, 0.04% for A200, 0.07% for VAS, and 0.04% for IVV.

Can fees this low continue? Yes, I think so. Fees have been steadily dropping over the years to get to current levels. And remember, funds like this typically attract lots of new money each year, so even if the fund isn’t profitable for the fund manager initially, it wouldn’t take long to become so.

My view is fees will continue to head towards zero across the board, so it probably doesn't matter too much which you go with. You’re not crazy for wanting to keep the fund you’ve already got, given the reasons we mentioned. That’s despite the excitement over newer cheaper options and the enthusiasts declaring “time to dump X and go for Y!”.

To be clear, I’m not saying you shouldn’t switch funds or choose the one with the lowest fee. I’m simply saying you might want to consider more than that, before you get too excited and jump on the new fund. Regardless of which you choose, most widely diversified low-cost index funds are perfectly sensible long-term options.

Final thoughts

I hope this article helped you think about fees from another angle you maybe hadn’t considered before. Let’s sum it up briefly for the skimmers…

BGBL is an attractive new option for investing in international shares as an Aussie. But we need to remember that fees aren’t everything. A higher fee fund can be a better option in some cases, for reasons like investor behaviour and different practices (such as securities lending) which can create slightly better returns for shareholders.

We also covered the potential issues of always chasing the cheapest fund available, including taxes, decisions, and portfolio management.

What do you think of the BGBL, the new kid on the block? Will you be investing in BGBL? Or will you be sticking with one of the current options for your global share exposure?

Regardless of your choice, we should be celebrating this offering from Betashares. It’s incredible to be in an environment where fees continue to fall, because ultimately, it means more wealth for investors.

Until next time, happy long-term investing!

Dave