As the exchange traded fund industry continues to attract
investment money, fund companies have pushed fees on passive,
index-based strategies closer and closer to zero.
In an attempt to achieve scale and maintain market share,
large ETF sponsors have slashed fees on a number of products,
with big players like Vanguard Group, BlackRock's iShares and
fighting in a perpetual ETF fee-war that has pushed expense
ratios on some popular ETFs down to a 0.03%.
Last year, iShares reduced the fees on a number of its
products, with the
Shares Core S&P Total US Stock Market ETF (NYSEArca:
now showing an expense ratio of 0.03%. ITOT was the cheapest on
the block for a brief moment.
Trending on ETF Trends
Competitive Pricing Helps Smaller ETF
July ETF Flows Show Investors Turned
Shining a Bright Light on the High Costs of
How One Financial Planner Saves for
Cash-Strapped in Retirement? Time to Research
Not to be outdone, Charles Schwab lowered fees by one basis
point on four of its large-cap ETFs in response to iShares, with
Schwab U.S. Large-Cap ETF (NYSEArca:
Schwab U.S. Broad Market ETF (NYSEArca:
both coming in at a low 0.03% expense ratio.
"For traditional market-cap weighted index funds - the return
of two funds covering the same market should be equivalent,
resulting in beta being commoditized and fund managers left
competing only for price," writes Angana Jacob, Global Research
& Design at S&P Dow Jones Indices, in a research note.
"Thus, the entry barrier becomes the scale, and is no longer
about the product. If a fund has USD 100 million AUM and the cost
of replicating the market for an additional USD 100,000 is close
to zero, in order to maximize profit, the eventual price target
should also trend toward that point."
Consequently, Jacob argued that as margins approach zero,
larger firms might consider a so-called loss leader approach or
waiving fees in an attempt to attract investors, retain
accumulated assets and build scale in higher-priced products.
ETF Industry Could Expand Almost Threefold by
The sponsors have been able to slash the fees largely because
of the rapid growth of the funds as the ETF industry has
accumulated $2.3 trillion in assets under management.. Looking
ahead, the industry may continue to find more opportunities to
reduce fees as scale increases. According to a recent PwC survey,
global ETF assets are likely heading to $8.2 trillion, with the
U.S. portion going up to at least $6.2 trillion by 2021.
"This pricing strategy would be to offer their core pure
passive range for free in order to retain their scale benefits
and make their margin on smart beta or active products and other
business lines, such as multi-asset solutions," Jacob added.
"Many investors also seek to complement their passive low-cost
beta with active management using a core-satellite approach."
Moreover, fund sponsors that opt to go with the ETF fee
waiver, loss leader approach may still be able to earning revenue
from securities lending. Securities lending is a practice where
mutual funds and ETFs pay agents to lend out shares in their
portfolios - funds are created with exposure to an underlying
basket of securities - to other traders and thereby earn
interest. Typically, ETFs lend securities to investors who want
to short a stock.
"We show that exchange traded funds can earn significant
revenue from securities lending, on order of the size of the
ETF's expense ratio," according to a research paper,
Passive Investing: The Role of Securities Lending
, by Jesse Blocher and Robert E. Whaley. "We also show that ETF
managers respond to the securities lending incentives by slanting
their holdings toward stocks with higher lending fees."
The research revealed that ETFs could make 23 basis points to
28 basis points per year from securities lending, and if firms
are more aggressive with their lending program, securities
lending could net as high as 55 basis points to 114 basis points
Important Trends Impacting the ETF Industry
To put this in perspective, there are currently 1,948
U.S.-listed exchange traded products with an average expense
ratio of 0.58%, or 58 basis points.
As ETF sponsors enjoy increased scale and alternative avenues
of turning a profit, such as steering people toward higher
costing strategies and securities lending, the industry might
witness fees go closer to zero. ETF investors will be the
ultimate winners, tracking major benchmarks at potentially no
to read the full story on ETF Trends.
The opinions and forecasts expressed herein are solely those
of Tom Lydon, and may not actually come to pass. Information on
this site should not be used or construed as an offer to sell, a
solicitation of an offer to buy, or a recommendation for any