ETF Inflows Set a Record in July. The Fee Mix Moved at the Same Time.

In July, exchange-traded funds (ETFs) took in $193 billion. That pushed the year-to-date total to $1.23 trillion, a record for that seven-month period. But there was an important underlying shift taking place that investors need to be aware of. It's good news for companies like BlackRock (NYSE: BLK), but it could be bad news for individual investors who keep buying ETFs. Here's what you need to know.

Exchange-traded funds are cheap to own, right?

The first exchange-traded fund ever created tracked the S&P 500 index . It made total sense to use the S&P 500 index (SNPINDEX: ^GSPC), since it is basically considered "the market" by most investors. The unique structure of ETFs allowed the fund, SPDR S&P 500 ETF (NYSEMKT: SPY), to offer a shockingly low expense ratio of just 0.09%.

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Most mutual funds at the time had expense ratios that were far higher than that. Even index-based mutual funds tended to be more expensive to own.

Early on, all of the ETFs created tracked large, well-known indexes. And the goal was to have low expense ratios. In fact, there was a race to have the lowest costs, with Vanguard S&P 500 ETF (NYSEMKT: VOO) eventually offering access to the S&P 500 index for a tiny 0.03% expense ratio. On an absolute basis, that's not much different from the 0.09% of SPDR S&P 500 ETF, but on a percentage basis, the difference is huge.

Wall Street gives the market what it wants

The problem is that there are only so many big indexes to copy. So Wall Street, seeing an opportunity to sell a new product, began creating bespoke indexes around which it could build new ETFs. All sorts of sector-specific ETFs were launched, and ETFs based on "factors" too. There was a Herculean effort among finance giants to slice and dice the market just to create new ETFs.

But those ETFs often require more "work" to operate. So, expense ratios were higher. For example, Vanguard Utilities Index ETF (NYSEMKT: VPU) has an expense ratio of 0.09%. But it's just an index of utility stocks , so how much extra work is really needed to create it compared to an S&P 500 index ETF? The answer doesn't matter; investors have to pay more for it either way. And Wall Street generates more fee income.

The next obvious step was for Wall Street to create actively managed ETFs. Basically, these are mutual funds with an ETF structure, but they charge higher fees than index-based ETFs. For example, the recently launched iShares Systematic Alternatives Active ETF (NASDAQ: IALT) has an expense ratio of 0.99%. That's basically what an actively managed mutual fund would charge, meaning BlackRock, one of the largest ETF sponsors, has found a way to materially increase its fee income through the ETF structure. To be fair, iShares Systematic Alternatives Active ETF is a pretty complex ETF, but investors shouldn't ignore the trajectory that expense ratios have taken.