iShares, the ETF behemoth that has steadily been losing market
share to low-cost provider Vanguard over the past few years, may
find that cutting prices on its funds is the most direct way to
combat the Vanguard challenge, but don't expect anything too
dramatic or comprehensive, according to Bernstein Research.
An aggressive, across the board, price-cutting campaign is
likely to be too risky to undertake, as the efficacy of competing
on price alone is questionable, Bernstein ETF researchers wrote in
a report published Wednesday.
"The nature of competition is multi-dimensional and depends on
the user segment and the specific product," the report said. "Thus,
an across the board price cut would seem unjustified, as it could
fail to generate market share gains and would simply damage the
firm's earning power."
In the past few years, retail investors in particular have
turned increasingly to Vanguard ETFs instead of similar-and more
expensive-funds offered by San Francisco-based iShares. While the
trend extends to numerous competing and similar funds, the
asset-gathering battle of the two firms' huge emerging markets ETFs
became the ultimate metaphor for the broader story.
We closely documented the slow and steady way that the Vanguard
MSCI Emerging Markets ETF (NYSEArca:VWO) was catching up to the
iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM). In January
2011, VWO finally became the biggest developing markets fund, and
VWO now has $53 billion in assets, while EEM has $34 billion.
While the reasons behind the slippage for EEM relative to VWO
are, as Bernstein wrote, more complex than just price alone, the
researchers argued in the note that "in our view the only
immediately actionable change in strategy would be price cuts."
While many examples aren't quite as stark, VWO has an annual
expense ratio of 0.20 percent compared with 0.67 percent for EEM-a
significant difference over time for long-term investors.
Officials at iShares and its parent BlackRock (
) have been reluctant to openly acknowledge the competitive
significance of price disparities of its products relative to
Valley Forge, Pa.-based Vanguard's.
But at the end of the second quarter on a call to discuss the
company's earnings, BlackRock Chief Executive Officer Larry Fink
said the Vanguard threat was serious, and said his firm had a plan
to address the problem. Bernstein noted that no further details
A Rock And A Hard Place
Serious and "tangible" as the Vanguard threat is, the Bernstein
note seemed to suggest that iShares can perhaps be forgiven for
delaying any action on the question, as there is indeed more than
price to this story.
For one, iShares has origins as a company more focused than
Vanguard on the institutional space. In that world, where a large
fund like EEM may be used for hedging other positions, price is
For example, institutions looking to hedge other exposure might
have relatively short holding periods, in which case a bigger price
tag is less important than, say, liquidity.
Superior liquidity is precisely what iShares has argued its
funds had over just about any other competitors' ETFs.
But Bernstein argued that even that advantage is more complex
than meets the eye. For one, Vanguard funds like VWO are big enough
to be quite liquid by now and, moreover, liquidity of an ETF can
have more to do with the tradability of its underlying stocks than
with the liquidity of the actual ETF shares.
What also hurt iShares was the fact that EEM for quite some time
was tracking its index less closely than VWO-and both funds use the
exact same index. While iShares rectified the problem, it
wasn't lost on some investors, which contributed to EEM's relative
Underdeveloped Retail Arm
While the VWO vs. EEM story and a number of other similar
stories involving distinct pairs of similar funds with similar
shifts in asset gathering, a broader slippage in market share
involving less commoditized "non-substitutable" funds suggests a
bigger problem for BlackRock and iShares.
"The faster organic growth of the rest of Vanguard's ETF suite
(the 'non-substitutable' ETFs) implies the share shift
encompasses more than direct competition," the Bernstein note
"The best that can be interpreted from this outcome is that
BlackRock has missed an opportunity by ceding the retail segment to
Whatever BlackRock chooses to do, Bernstein's analysis suggests,
as noted, that the firm won't cut prices across the board, which
limits any immediate dramatic effects on the firm's stock
"Based on our assessment of a likely outcome, we conclude this
risk is probably not significant enough by itself to justify a
large discount in the stock. We maintain our Market-Perform rating
and $205 price target."
BlackRock's shares closed on Wednesday at $176, down 93 cents,
or 0.53 percent.
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