There's more than $5 trillion invested in exchange-traded funds worldwide, and millions of investors love the flexibility and diversification that ETFs offer. One of the biggest benefits of ETFs has been the way in which they've helped investors reduce the costs of investing, as some of the largest funds in the business have such low expenses that their shareholders pay very little to invest in them.
Earlier this year, some industry watchers predicted that zero-fee ETFs were right around the corner. However, one fund provider has gone beyond that threshold, proposing to become the first ETF to offer negative fees -- meaning that the fund will pay you to invest in its shares. To many, that sounds too good to be true, and they're wondering whether negative-fee ETFs are just a marketing gimmick or something that will gain traction across the industry and put a lot of money in fund shareholders' pockets. It's too early to be sure, but there are good reasons for investors to be skeptical.
What Salt Financial wants to do
Upstart ETF manager Salt Financial announced that it would breach the zero-fee barrier with its new Salt Low TruBeta U.S. Market ETF. The fund will concentrate on stocks that have relatively low levels of volatility compared to the overall market, hoping to give conservative investors a smoother ride than they'd get with a market-tracking fund like the SPDR S&P 500 ETF (NYSEMKT:SPY).
That's a niche that other ETFs, including the iShares MSCI Minimum Volatility ETF (NYSEMKT:USMV), have attacked before with success. The iShares fund has accumulated more than $23 billion in assets, and with an expense ratio of 0.15%, investors are paying almost $35 million annually in total fees for the fund.
Salt wants to reverse that. Instead of charging shareholders for the fund's expense, Salt will actually pay its shareholders to purchase shares of the ETF, with a negative expense ratio of 0.05%. Put another way, for every $10,000 an investor put into the fund, Salt would pay an extra $5 out of its own pocket to boost the value of the fund shares.
However, there's a limit to Salt Financial's benevolence. The company said that it's only willing to provide this negative-fee incentive for the first $100 million in assets that it attracts. That'll limit the fund company's overall potential liability to $500,000 per year, which makes sense for a small fund just getting started.
The more troubling provision, however, is the fact that the incentive is only temporary. As of April 2020, the negative fee will go away. In its place, Salt will start charging a traditional positive expense ratio of 0.29% annually to shareholders.
A race to viability
The particular tack that Salt Financial is taking makes it clear what the ETF company's objective is: to try to attract $100 million in assets as quickly as possible. The reason for that is that in order to be economically viable, $100 million in assets is just about the bare minimum an ETF must raise. Even at that level, a 0.29% expense ratio generates just $290,000 in fee revenue for Salt -- an amount that likely doesn't come close to covering all of its expenses.
Yet with thousands of ETFs in the market, it's tough for new funds to get to even $50 million in assets, let alone $100 million or more. Just one out of five ETFs launched in 2018 hit the $50 million mark during their first year of operations. Looking back over the past decade, almost three-quarters of ETFs that failed to reach $50 million in assets remained under $50 million through the present.
Don't fall for negative expense ratios
The temporary nature of its negative expense ratio makes it clear that, at least for Salt Financial, the idea of paying investors to invest is a gimmick designed to attract assets. ETF investors who don't read the fine print might get a nasty shock when money starts coming out of their pockets come mid-2020.
Lower expenses are a boon for investors, and it'll be interesting to see whether any ETFs that pledge to keep expenses below zero permanently come to market. That hasn't happened yet, but Salt's offering suggests that it could happen at some point soon -- especially if investors pile into Salt's new ETF.