By Christian Magoon
CEO, Magoon Capital
The ETF industry is increasingly becoming a brutal battleground for asset management firms to compete in. Just last month, over two dozen ETFs were closed by firms like Russell Investments, Scottrade and IndexIQ due to low demand. This week leading ETF Sponsor Blackrock / iShares announced upcoming expense ratio cuts are on the way. The battle being fought by ETF firms is a fantastic development for investors. They reap worthwhile benefits like lower expense ratios, more selection and less costly access to ETFs. This is all happening due to the appeal of ETFs - to asset managers and ultimately to investors. In order to understand this battle ground one must step back and examine the opportunity ETF offers asset managers, the characteristics of the ETF industry and the unique tactics some ETF Sponsor are employing to remain competitive.
The ETF industry continues to become more competitive as its growth becomes more impressive. A quick look at July equity inflows into ETFs and mutual funds illustrates why many asset managers want to be in the ETF space. According to Morningstar data, stock ETFs took in $12 billion of assets while stock mutual funds lost $8.5 billion in assets in July. That is an incredible swing. Also showing promise is the fixed income space, which is a ETF product set in its infancy. In July ETFs took in $1.5 billion compared to mutual funds' haul of $29 billion. The potential for increased market share for fixed income ETFs is immense. These asset gathering opportunities cause firms that were primarily focused on areas like mutual funds, separately managed accounts, brokerage services and even research to become active in the ETF business. So how will they compete? Most will focus on two elements: the strength of their investment expertise and cost. These elements benefit ETF investors.
The assets in the ETF industry are very concentrated by product and by ETF Sponsor. On the product front, the top 10 ETFs make about about $410 billion of the $1.2 trillion in ETF assets. These large scale products are faced with aggressive price competition in a battle to take assets away from. As an example, a well publicized battle between Vanguard and iShares in the emerging market ETF segment has resulted in Vanguard's ultra low priced VWO catching and now leading iShares EEM in asset size. Here's a chart of the top 10 largest ETFs as of the end of June via ETF Industry Association data.
The concentration issue is even greater on the ETF Sponsor side. Just three firms - iShares, SSGA and Vanguard - account for 81% of all ETF assets ($980 billion of the $1.2 trillion in assets according to end of June ETF Industry Association data) This concentration has lead to aggressive pricing tactics by both new entrants and large sponsors able to generate economic scale. This focus on expense ratio competition is consistently reducing the costs investors pay for the most popular ETFs in the market place.
Beyond Expense Ratios
While the expense ratio of ETFs is often the primary way to compete, there are firms that are thinking outside the box. Some of these firms include Charles Schwab, Vanguard, PIMCO, Market Vectors and WisdomTree. Both Schwab and Vanguard are using their own distribution to offer proprietary ETFs to clients without charging a commission to buy or sell the ETF. This can translate to a significant amount of expense savings for a round trip purchase, especially for smaller investors. PIMCO is using its blue chip reputation in the actively managed fixed income mutual fund space to aggressively launch actively managed fixed income ETFs. Several of these ETFs - BOND and MINT - have climbed well over a billion dollars as they successfully combined the advantages of an ETF with the well know mutual fund brand of PIMCO. Finally several enterprising firms including WisdomTree and Market vectors are increasingly using indexes they create in house rather than licensing them from outside providers. This helps to reduce costs and ensure exclusivity. Ultimately all these tactics allow the overall ownership costs of ETFs to fall.
Unlike most other packaged investment products, ETFs continues to see meaningful advances for investors in cost of ownership, selection of product and ease of access. Should this progress continue, ETFs will accelerate their asset levels and benefits to investors at the same time. Now that's what I call a win - win scenario.