• As bond ETFs continue to grow in popularity, it’s important for investors to understand all the associated costs of investing in them to help optimise their trading practices.
  
  
• The trend of declining ETF expense ratios has increased the relative importance of trading costs as a component of the total cost of ETF ownership.
  
  
• Aside from expense ratios and tracking error, an investor’s total cost of ETF ownership includes the bid/offer spread, premium/discount volatility and market impact.
   

The low-cost access to diversified portfolios that ETFs offer is one of the driving forces behind the growth in the ETF market in recent years. While expense ratios and tracking error have historically been the largest components of the UCITS ETF cost equation, the costs incurred through trading can also be significant. Indeed, as expense ratios have fallen over time, trading costs have come to play an increasingly prominent role in an investor’s total cost of ownership (TCO). 

Growth of fixed income ETFs and cost considerations

ETFs have enjoyed strong growth across Europe in the past decade. A large part of that growth has come from fixed income UCITS ETFs, which have grown as an asset class from around $120 billion in 2015 to $520 billion in 2025¹. Increased investor flows and turnover across fixed income ETFs have exerted downward pressure on the average expense ratio of UCITS ETFs (see chart below). 

In the past 10 years, the average industry ongoing charges figure (OCF) for fixed income UCITS ETFs has dropped from 28 basis points (bps) to 23 bps, while Vanguard’s average OCF decreased from 12 bps to 10 bps. As expense ratios compress, understanding the other elements of TCO becomes crucial. 

10-year UCITS fixed income ETF OCF: Vanguard versus industry

Source: Morningstar, UCITS fixed income ETFs as of 31 December 2024.

Breaking down the total cost of ownership

There are five key components of an ETF’s TCO. Looking beyond expense ratios and tracking error, we explore the other elements related to trading costs: ETF spread, premium/discount volatility and market impact.

Source: Vanguard, using data from Bloomberg to provide a hypothetical illustration.

ETF spread 

The spread is the round-trip cost of buying and selling an ETF. This reflects the difference between the bid and offer price². The narrower the difference between the bid and offer, the lower the round-trip trading cost. An ETF’s spread is directly influenced by the ETF’s traded volume and volatility as well as the liquidity of the underlying bonds of the ETF.  

What’s a bid-ask spread, and what goes into one?

Source: Vanguard. Diagram is for illustrative purposes only.

Bid-ask spreads on fixed income ETFs can vary by product type. For example, the spreads on ETFs holding US Treasuries and those holding emerging market debt can differ due to differences in the trading volume and liquidity of the respective underlying bond markets. The bid-ask spread of the underlying securities of an ETF is known as the “basket spread,” representing the round-trip cost of trading the basket, or portfolio, of bonds. 

Comparing the ETF spread and basket spread can often highlight the benefit of purchasing an ETF over buying all of the bonds in the underlying basket. The difference between a bond ETF’s spread and those of its underlying securities occurs as an ETF establishes a track record and investor trading increases. Over time, we see increased competition among market makers³ to quote prices for the ETF, ultimately causing the spread of fixed income ETFs to tighten relative to that of the bonds in their underlying basket.  

Fixed income ETFs: Cost-effective access to bond markets

Source: Bloomberg, Vanguard, big xyt, as of 31 December 2024. Reference indices are: Bloomberg MSCI Global Corporate Float-Adjusted Liquid Bond Screened Index, Bloomberg MSCI EUR Corporate Liquid Bond Screened Index, Bloomberg MSCI USD Corporate Float-Adjusted Liquid Bond Screened Index, Bloomberg Euro Corporate 500 1-3Y Index, Bloomberg Euro-Aggregate: Corporates Index, Bloomberg Global Aggregate Float Adjusted and Scaled Index, Bloomberg Global Aggregate Corporate – United States Dollar Index and Bloomberg EM USD Sovereign + Quasi-Sov Index.

Premium/discount volatility 

The second trading cost to consider is the premium or discount at which an ETF trades relative to its net asset value (NAV)⁴. If the market price of an ETF is above its NAV, then it’s considered to be trading at a premium. Conversely, if the market price of an ETF is below its NAV, it’s trading at a discount. Ideally, an investor wants to avoid purchasing ETF shares trading at a premium or selling at a discount, as doing so can erode total returns.   

Similar to the bid-ask spread, the premium/discount for fixed income ETFs is driven largely by the cost of buying and selling the underlying bonds. In certain fixed income products, the premium/discount can change quickly and frequently.  

As ETFs are priced continuously, pinpointing an optimal premium or discount can be challenging. Instead, investors should assess the volatility of the premium/discount figure, which provides more insight than the daily average. Comparing this volatility between ETFs with similar underlying exposures can help investors understand market dynamics for a given fund or category. 

Execution in the real world and market impact 

When assessing an ETF's liquidity, investors should consider the resources available to minimise the potential market impact of a trade⁵. An ETF issuer’s capital markets team can help investors understand and manage the potential impact, guiding them to a strategy that balances trade timing and urgency with available liquidity. 

ETFs have multiple layers of liquidity⁶ – accessing them can reduce market impact. As an illustration, we can consider a recently launched ETF with low assets under management, where some listings have traded under $10,000 USD daily⁷. Despite the example trade being 28x the ETF’s average daily volume (ADV)⁸, we can see that the trade was executed inside the bid-ask spread. Such a result would qualify as a successful transaction. 

Example of ETF multi-layered liquidity

Past performance is not a reliable indicator of future results.

The above chart is a real trading example of a Vanguard UCITS ETF and is provided for illustrative purposes only.

Source: Bloomberg, the trade example took place on 13 June 2022. 

It’s important for investors to appreciate that an ETF’s ADV reflects only historic secondary market liquidity, not underlying liquidity. Market makers regularly access this underlying liquidity to enable larger bilateral trades, often on request-for-quote (RFQ) trading venues⁹. In the above example, execution was successful due to the underlying liquidity. 

When trading volume of an ETF exceeds its ADV, market makers, collaborating with Vanguard as authorised participants (APs)¹⁰, purchase ETF shares via the primary market in exchange for benchmark-eligible bonds. This method efficiently enables further ETF liquidity, effectively making the ETF interchangeable with the underlying bonds. 

Newer ETFs may rely more on the primary market for liquidity compared with more established ETFs that have deeper secondary market liquidity pools. This doesn't necessarily lead to poor trading outcomes but aligns costs with trading the bond basket. Investors should understand these liquidity mechanisms to assess the TCO for larger trades and seek guidance from the ETF issuer’s ETF capital markets team. 

The importance of each individual cost component will depend heavily on the investor’s objectives, notably their holding period and the size of the trade (outlined in the diagram below). For any questions regarding UCITS ETFs, we invite investors to contact Vanguard’s ETF Capital Markets team at capitalmarkets@vanguard.co.uk.   

Importance of cost factors by holding period and trade size

Source: Vanguard. For illustrative purposes only.

¹ Source: Bloomberg, as at 31 March 2025.

² The bid is the price at which an investor can sell ETF shares and the offer is the price at which an investor can purchase ETF shares.

³ A market maker is a financial institution that provides liquidity to the market by continuously buying and selling securities, including ETFs. The market maker’s primary role is to ensure that there is always a buyer for a seller and a seller for a buyer, which helps to maintain a stable and efficient market.

⁴ Net asset value is the total value of a fund's assets minus its liabilities, divided by the number of outstanding shares.

⁵ In the context of ETF trading, "market impact" refers to the effect that a trade has on the price of an ETF. When a large trade is executed, it can move the price of the ETF, either up or down, depending on the direction and size of the trade.

⁶ An ETF having multiple layers of liquidity means that there are various mechanisms and participants that contribute to the ETF's overall liquidity. This multi-layered liquidity can help ensure that the ETF trades efficiently and that investors can buy or sell shares without significant price impact.

⁷ When an ETF is relatively new it may not have amassed a large amount of assets – which would mean that a large trade (relative to the total assets) could potentially move the price of the ETF. An ETF listing with less than $10,000 trading daily (a relatively low amount) could present challenges related to liquidity, price stability and execution. ETFs can have multiple listings whereby they are available on multiple stock exchanges.

⁸ Average daily volume refers to the average number of shares or units of an ETF that are traded over a given period. ADV is a useful metric for investors and traders because it provides insight into the liquidity and trading activity of an ETF.

⁹ Request for quote is a process used in financial markets, including ETF investing, where an investor or trader requests price quotes from one or more market participants, such as market makers or liquidity providers, before executing a trade.

¹⁰ APs are large financial institutions that have special agreements with ETF issuers to create and redeem ETF shares. APs play a crucial role in maintaining the liquidity and price stability of ETFs.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results. The performance data does not take account of the commissions and costs incurred in the issue and redemption of shares.

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