In a little over four years, exchange traded funds in the US have grown to $40bn with more than 30 different funds available.

Globally, exchange traded funds are now worth more than $50bn. This figure is expected to grow rapidly as banks and financial institutions launch a range of new funds on stock exchanges throughout Europe.

Investors have been attracted by much lower costs than conventional tracker funds, and by the liquidity of ETFs. Although the US ETF market is worth close to $40bn, around two-thirds of this value is traded every day, making the buying and selling of ETFs a painless process.

Getting in and out of ETFs is also relatively inexpensive as the spreads on these instruments are tight. For investors keen to tinker with their exposure to particular markets and sectors on a regular basis, ETFs are a better alternative than index-tracking funds where buying and selling can incur much greater costs.

But one of the biggest benefits of ETFs, particularly for private investors who may find it difficult to access many markets without paying over the odds, are their annual costs.

In the US, well-established ETFs are now cheaper than their cousins, the index tracking mutual funds. The largest ETF in the US, the $20bn Standard & Poor's Depositary Receipt which tracks the S&P 500 - affectionately known as the Spider - now dramatically undercuts the lowest cost index tracking mutual funds.

The annual charges on this S&P 500 Spider managed by State Street are just 0.12 per cent, compared to the cheapest S&P 500 index tracker mutual funds in the US which charge 0.18 per cent a year.

The Dow Diamonds ETF, which tracks the 30 stocks which make up the Dow Jones Industrial Average, charges a competitive 0.18 per cent a year and the Nasdaq 100 ETF, which tracks the 100 largest stocks listed on Nasdaq, charges a similar figure.

In the US, State Street offers a range of Spiders investing in nine different sectors, from financials to technology companies, where annual charges are less than 0.5 per cent.

Webs, managed by Barclays Global Investors, allow US investors to access 18 overseas markets from Malaysia to Holland. Annual charges on these funds are 0.75 per cent.

But competition for ETFs is different in different markets. Canada will soon enjoy the world's lowest cost ETF when State Street launches the Dow Jones Canada 40. This will track Canada's 40 largest companies on annual charges of 0.08 per cent.

BGI manages an ETF listed on the Toronto stock exchange which tracks the 60 largest Canadian companies and which charges 0.17 per cent a year. And in Hong Kong, an ETF tracking the Hang Seng index charges just 0.12 per cent a year.

These competitive charges make the 0.35 per cent annual charge on BGI's recently launched London-listed FTSE 100 ETF look relatively expensive. Although this ETF has lower costs than the vast majority of index tracking unit trusts in the UK, a small handful of fund managers charge lower fees.




BGI argues that it may reduce charges further as the size of its ETF grows. Annual charges are an important consideration when buying ETFs, as over the longer-term high annual charges can amount to a significant drag on performance. But it is important not to ignore the other costs of buying and selling ETFs.

Spreads on many ETFs tend be low, often little more than 0.1 per cent, making them relatively inexpensive to buy and sell.

But some ETFs, such as those investing on the more volatile Nasdaq exchange or in illiquid overseas markets, will have much larger spreads. The cost of these spreads should be taken into account when assessing the overall costs of ETFs.

Stockbroker commissions hike up overall transaction costs for private investors, particularly on smaller sales and purchases. ETFs should prove a good deal for most investors and in many cases will prove more cost effective than more conventional index tracking funds.

But do not ignore pooled funds altogether. Not only do some have lower annual management charges than ETFs, but for investors with only small sums to invest or who are keen on making monthly contributions, pooled funds such as unit trusts are still likely to be the best bet.


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