A week ago, Bernstein Research put out a note predicting fee
cuts for a host of iShares products in the coming months. Bernstein
argued-and I think rightfully so-that comprehensive cuts would be
both unlikely and foolhardy.
After all, why apply a wholesale cut to your product line when
you have hugely popular funds-the iShares MSCI Hong Kong Index Fund
(NYSEArca:EWH) and the iShares MSCI Taiwan Index Fund
(NYSEArca:EWT) come to mind-are operating in what are essentially
A massively strong brand could clearly be diluted with such a
"bargain basement" campaign.
A more measured response that leverages the firm's massive
pipeline of market knowledge, research and customer feedback to
forecast the expected impact of fee cuts is a much more reasonable
Then, almost on cue, after hinting at it during July's quarterly
earnings call, BlackRock Chief Executive Officer Larry Fink said on
Monday that iShares would be cutting fees on some of its
core-strategy funds in the next three months.
Nobody but Larry and the good folks at BlackRock know what those
"core funds" are, but I think three obvious funds stick out.
EEM, A Clear Candidate
The iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM) is
the Intel of the ETF market. Much like the tech giant, EEM broke on
the scene with a revolutionary product that opened the world to
Like Intel, competitors came along with products that eventually
commoditized the groundbreaking iShares fund. What was once exotic
exposure-emerging markets-is now in every investor's daily
When Vanguard had the gall to move into the emerging space with
a fully replicated fund tracking the same index as EEM-and at less
than half the cost to boot-the multibillion-dollar behemoth began
losing out to Vanguard in the asset-gathering war. For the record,
EEM now costs 0.67 percent, while VWO costs 0.20 percent.
Articles were written, poor tracking was highlighted and
eventually the Vanguard MSCI Emerging Markets ETF (NYSEArca:VWO)
surpassed EEM in assets, and hasn't looked back since.
To its credit, iShares evolved, eliminating its optimization
strategy and decreasing fees. The problem was Vanguard's fees were
also falling. Now, with eight different emerging markets funds with
cheaper expense ratios-including the iShares MSCI EMEA Index Fund
(NYSEArca:EEME), a more narrowly focused iShares product-it's
getting harder and harder to justify EEM's lofty 0.67 percent
annual expense ratio, especially with the fund's volatile tracking.
The pressure is on for a fee cut on EEM.
Bond Funds Like AGG As Well
The iShares Barclays Aggregate Bond Fund (NYSEArca:AGG) is a
massively popular fixed-income product for iShares that actually
carries tighter average spreads than its competitor, the Vanguard
Total Bond Market ETF (NYSEArca:BND). It's less than a basis point
lower than BND's spread, but it is nonetheless lower.
The problem is BND's portfolio is half the price of AGG-10 basis
points vs. 20 basis points-meaning the round-trip cost is roughly
half the cost of AGG. Once again, iShares is charging twice as much
as Vanguard to track the exact same index.
Sure, AGG has been less volatile in tracking the Barclays
Capital U.S. Aggregate Bond Index by a wide margin in the past two
years, but many investors who aren't privy to the high-level
presentations of BlackRock representatives explaining tracking
error will see the higher headline expense ratio, calculate the
higher round-trip cost for AGG, and simply choose BND.
Sector Funds Too
Sector funds are another category where iShares should be
looking to cut prices, though this one is a bit more complicated
because different classification systems can cause differences in
exposure that allows firms to position their products as
Unlike EEM and AGG, which have become commoditized, the sector
products still have points of differentiation.
Take IYM, the iShares Dow Jones U.S. Basic Materials Index Fund
(NYSEArca:IYM). Since it tracks the Dow Jones U.S. Basic Materials
Index, which is based on the Industry Classification Benchmark (
) as opposed to, say, the Vanguard Materials ETF (NYSEArca:VAW),
which tracks the Global Industry Classification System (GICS)-based
MSCI U.S. IMI Materials Index, the iShares fund includes coal
firms, which GICS classifies as energy.
Then there are funds like the SSGA Select Sector SPDRs, which
only pull from the S&P 500 Index. These portfolios have
narrower coverage than the iShares Dow Jones sector funds.
Distinctions like these cause exposure differences, which lead to
differences in returns, which ultimately lead to selling
The problem is, despite the fact that these exposure differences
are not trivial, they're not enough to justify the 29 basis point
difference between the iShares suite of funds and those on offer
In the end, I don't claim to know the intimate details of the
cost structure of running each iShares ETF.
What I do know is that fee cuts are coming, and these funds are
the obvious candidates. Either way, this is good news for
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