Granted, the industry is pretty flawed, however, creativity is not always a bad thing.

The reduction in variable costs associated with the MER’s might reduce the costs by a few measly basis points, but there won’t be a noticeable drop precipitated for altruistic means (on the fixed management fee portion).

But it’s possible for a new player to come in and undercut the incumbent – the ETF space is exploding (and as we have discussed before, there are advantages and disadvantages to that).

Claymore has some good products but fee creepage in the ETF market is not a positive trend for investors and, with all due respect to Preet, very rarely has a financial company cut fees except under extreme pressure from the public.

I think another point often overlooked is that FI seems to work better in less efficient markets. The backtested outperformance grows with markets that are deemed to be less and less efficient. Some may find plain vanilla indexing to be good for efficient markets and FI for emerging markets (example).

Of course, this is backtested data and as CC and MJ point out, it may not last. All the more reason to understand what the philosophy is behind FI. Certainly the benefit of hindsight is great for advocating investment strategies, for example the Dogs of the Dow. But as there are proponents of say, value investing and dividend investing, etc. who believe a performance advantage may be gained through active decision making (i.e. undertaking a particular strategy other than plain indexing), they may want to look at FI. You can get your turnkey (pseudo-) active management for almost 2% less than a mutual fund.

As mentioned before, the premiums on FI and other quant or strategy ETFs are still a bit on the high side, but hopefully they will come down as AUM increases.

http://www.canadiancapitalist.com/2007/10/22/fundamental-and-traditional-indexing-debate

Also, another disadvantage for the fundamental ETF’s are liquidity issues – there are days of thin trading since it’s still early days, so one should be sure to look at volume and perhaps place limit orders.

I particularly like the downside protection, for example due to fundamental weighting, Nortel represented only about 9% of the Fundamental Canadian Index at the time Nortel represented close to 1/3 of the TSX proper. If you look at the charts during the bubble, you’ll see that the FTSE RAFI index was flat as the TSX tanked. Since the FI’s have a value tilt, they benefit from the flight to quality as money leaves growth and flows to high yielding stocks in turbulent markets.

It would still be nicer if the costs came down.

For those looking into FI (fundamental indexing), you need to understand the philosophy behind it, so you can stick to it. For example, Rob Arnott had a great slide that showed that if you invested in the S&P490 instead of the S&P500, you would have earned a few extra percent per year since inception, simply owing to the fact that if you replicate the index, the top x stocks tend to be overvalued and growthy.

By weighting on market cap alone, you will be placing more weight on stocks that are overvalued, and you will be placing less importance on stocks that are undervalued. FI is based purely on the audited financial statements on four metrics, price is irrelevant.

There is no shortage of research and analysis on Fundamental Indexing versus plain vanilla indexing. In fact there was a great panel discussion between Jeremy Siegel (FI), Rob Arnott (FI) and Gus Sauter (Vanguard, regular indexing) that can give more insight for those interested.

http://indexuniverse.com/component/content/article/6/2995.html?Itemid=61

The debate between FI and regular indexing is intense, so I would recommend really doing some digging into it. You may agree with the philosophy, you may not – but at least you will have a more informed opinion.

Your figure for XIU is incorrect – the mer is 0.17% which is pretty good and much cheaper than the Claymore products.

Mike