Managers waging battle over fees on several fronts

The competitive pressure on ETF fees climbed (or dropped) to a new plateau this fall as several asset managers revealed products or pricing designed to attract assets and attention.

This race to the bottom in expense ratios will ultimately benefit the largest issuers — BlackRock's iShares and Vanguard — and those with significant brokerage or custody platforms that are most able to weather a commoditized product market.

For institutional investors and financial intermediaries, differentiation will boil down to index choice and construction, secondary market volume, and platform incentives. Yet, according to the recently released Brown Brothers Harriman ETF.com 2017 U.S. Investor Survey, 64% of those surveyed deemed expense ratio as "very important" in choosing an exchange-traded fund, ranking highest among 10 factors institutional investors and advisers were asked to consider.

According to XTF, 150 U.S.-listed ETFs had expense ratios of 0.1% or lower through Nov. 30, accounting for $1.39 trillion in assets (of which 83% is invested in equities.) Five have published expense ratios of 0.03% — the $12.8 billion iSharesCore S&P Total Market, two products from Charles Schwab with $11 billion each, and two competing products from State Street Global Advisors with $1 billion in assets combined.

SSGA's expense ratio reductions for a suite of 15 "plain-vanilla" products in October marked that issuer's most aggressive salvo in the ongoing fee war. The Boston-based manager coordinated its move with an index shift for three products from the Russell 1000, Russell 2000 and Russell 3000 to self-indexing.

Simultaneously, brokerage firm and custodian TD Ameritrade introduced those 15 products to its commission-free ETF program while shifting all products from Vanguard and several ETFs from Blackrock out of the program.

(In response to pushback from financial advisers, TD extended to mid-January from mid-November a grace period for advisers to make commission-free portfolio changes.)

Although asset growth for new products can be slow, expense waivers or reductions can signify new competitive fronts and often spur incumbents to respond by matching or undercutting the pricing of similar products.

One recent move shined a spotlight on the market for single-country exposures, now dominated by BlackRock products tracking MSCI indexes. In early November, Franklin Templeton Investments launched 16 single-country and regional ETFs tracking FTSE indexes, many with 0.09% expense ratios compared to 0.48% for most iShares country funds.

Although assets in those new funds are still small and trading volume insignificant, the cost will garner attention from competitors quickly. According to BBH, 50% of investors and advisers are willing to adopt a new product within its first year of trading.

"While iShares has a significant leg up in reputation when it comes to ETFs, Franklin does have brand awareness stemming from its legacy mutual fund business," said Brendan Powers, a product development analyst with Cerulli Associates in Boston. "Given the focus on cost when selecting pure beta products, it would be hard to imagine the Franklin products not being considered by clients looking at single-country exposure."

Other areas where fee pressure is increasing and product choice is expanding include core "smart beta" factor exposures (momentum, quality, size, etc) with the expected launch of new Vanguard active equity ETFs in the first quarter of 2018 to be priced at 0.13%; commodities with this year's launch of low-priced GraniteShares exposures for gold and broad-based commodities; and even "pure beta" exposures where Invesco PowerShares, long a proponent of smart beta and factor-based indexing, has launched low-priced plain-vanilla ETFs.

"Certain marquee funds will maintain an audience because of trading volume but will likely cease to grow," said Dave Nadig, president of ETF.com, a fully owned, editorially independent subsidiary of Cboe Global Markets.

He points to the significant trading in the SPDR S&P 500 ETF, or SPY, while assets have flowed to competing S&P 500 products from BlackRock and Vanguard, which are lower priced and have a structural advantage as mutual funds relative to SPY as a unit investment trust.

Mr. Nadig also cited as an example iShares' introduction of its Core lineup several years ago, which featured a few ETFs in direct competition with its own legacy products, but with expanded exposures and lower fees.

Yet, Mr. Nadig said the "fee war" discussion misses the larger point about the mispricing of asset management generally. "How much money in dollars should it take to run a certain portfolio?" asked Mr. Nadig. "The variable cost for an institutional S&P 500 portfolio is probably one basis point at best. What we should be asking ourselves is whether a certain product is really worth the total amount the manager is charging to run it."

Kathleen Moriarty, partner at Chapman and Cutler LLP in New York, noted a fund adviser can lower expense ratios on its own accord but can't raise fees without approval from the majority of the fund's board members.