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Increase in no-fee offerings boosts appeal of ETFs

Richard Powers said Vanguard doesn’t want commissions to be ‘a barrier to customer choice.’

Over the past few years, exchange-traded fund issuers have continuously reduced expense ratios on so-called core offerings, as they look to attract retail clients, financial advisers and other asset allocators to broad-based, market-cap-weighted index exposures in both debt and equity.

More recently, however, this competition has extended beyond the core, as the largest financial services firms look to make splashy market entries or press their advantages on both brand and reach.

The most surprising, but perhaps inevitable, recent shift was Vanguard Group Inc.'s elimination of online retail trading commissions for all U.S.-listed ETFs, with the exception of approximately 250 leveraged and inverse exchange-traded funds.

"We are simplifying the fee schedule so that commissions are not a barrier to customer choice," said Richard Powers, Malvern, Pa.-based head of ETF product management for Vanguard of the August move. "There are several different levers for lowering the cost of investing. And, most of the time, it's actually the expense ratio, but there are also trading costs, tracking error, taxes and market exposure."

Although couched as bringing the "Vanguard effect" to retail trading commissions, the seeds of this move likely were sown last October. Then, brokerage and custody platform TD Ameritrade adjusted a long-praised commission-free ETF list to exclude many core Vanguard and BlackRock (BLK) Inc. (BLK) iShares ETF offerings.

Instead, the Omaha, Neb.-based company offered a rebranded line of 15 SPDR Portfolio ETFs from State Street Global Advisors with expense ratios ranging from 0.03% to 0.11%. Although some advisers were upset about the shift, those SSGA funds experienced $16.5 billion in net assets flows over the past year, for approximately $26.5 billion in total assets, according to research firm XTF Inc., a unit of the London Stock Exchange Group.

On Aug. 1, as Vanguard's commission structure was being implemented, Fidelity Investments trumped the rest of the industry in the race to a zero-fee fund. The Boston-based firm announced the debut of two no expense ratio mutual funds, cut fees on other index funds, and expanded to 240 the number of iShares ETFs offered commission-free to Fidelity brokerage customers. Late last week, Fidelity said it would launch two more no-expense-ratio funds Sept. 18.

Although not ETFs, Fidelity's ability to attract nearly $1 billion to self-indexed total market and total international mutual funds, according to Fidelity, has captured the fascination of the ETF industry, which had been expecting one of its own to break the tape in the race toward zero.

While equity and ETF trading commissions, and even fund structures, might have less relevance for large institutional investors, zero-fee commissions and rock-bottom expense ratios on so-called core exposures have become the price of entry to attract retail clients and many financial intermediaries.

Yet, ETF sponsors with affiliated brokerage and wealth management platforms also are flexing their muscles by introducing competitively priced products beyond the core.

Leveraging the parent company brand, several ETFs from issuers such as Northern Trust, Goldman Sachs and J.P, Morgan have catapulted to billions in assets under management in a relatively short period of time, continuing to bury the adage that investors should wait for a three-year track record prior to investing.

Goldman Sachs Asset Management brought its marketing muscle to lowering the cost of smart beta and factor-based investing in September 2015, launching the now $3.9 Goldman Sachs ActiveBeta U.S. Large-Cap Equity ETF at a 0.09% expense ratio.

More recently, four BetaBuilders ETFs launched in June and August by JPMAM already have accrued $5.2 billion in assets collectively with low expense ratio exposure to Canada, Europe, Japan and developed Asia Ex-Japan. However, even lower cost access to similar exposures from Franklin Templeton (BEN) Investments (BEN) have attracted a fraction of the assets, despite their November 2017 launch.

No 13-F institutional holding data is available for the JPMAM products yet, but Jillian DelSignore, head of ETF distribution for J.P. Morgan Asset Management (JPM) in New York, said the firm is looking "to provide choice to advisors and institutions across asset classes."

"After decades of price competition in asset management, it's getting more difficult to see where price savings can be eked out," said Elisabeth Kashner, San Francisco-based director of ETF research and analytics for FactSet Research. However, she does highlight other avenues that fund and ETF providers can use to reduce cost beyond the headline expense ratio, which for about 25% of existing ETFs includes an upfront and explicit fee waiver, according to FactSet.

Moving more into fund operations, Ms. Kashner sees asset managers driving efficiency through international dividend withholding recapture and the management of index-rebalance trades, facilitated by market-makers, which help to wash out low basis stock.

While tax efficiency within the ETF structure and low barriers to entry on reduced trading commissions do not directly impact large tax-free investors, they are part of the gravitational pull that is attracting significant assets to ETFs and making them cheaper and easier products to use.

New kids on the block
The largest new ETFs since Jan. 1, 2017. Assets are in millions.
ETFInceptionExpense ratio (basis points) Total assets
J.P. Morgan Ultra-Short Income5/17/1718$2,287.8
J.P. Morgan BetaBuilders Japan6/15/1819$1,820.4
Principal U.S. Mega-Cap Multi-Factor Index10/12/1712$1,784.7
Barclays ETN+ FI Enh. Global High Yield Series B3/15/1893$1,593.8
J.P. Morgan BetaBuilders Canada8/7/1819$1,458.7
J.P. Morgan BetaBuilders Europe6/15/189$1,316.8
iShares Core MSCI Int’l Developed Markets3/21/175$846.7
Principal Active Global Dividend Income5/9/1758$705.9
Barclays ETN+ FI Enhanced Europe 50 Series C3/15/18105$682.5
J.P. Morgan BetaBuilders Developed Asia ex-Japan8/7/1819$608.1
As of Sept. 7, 2018. Source: FactSet Research Systems Inc.