Is the ETF fee war nearing a cease-fire?
Over the past several years, the primary trend in the fund industry has been a massive shift into not just passive products, but also low-fee ones. Exchange-traded funds, which on average charge less than their mutual-fund equivalents, have been among the primary beneficiaries of this shift.
But now, after multiple rounds of fee cuts by the major providers, expense ratios have gotten so low in the most popular fund categories, with many rivals separated by as little as one basis point, that they are no longer the primary metric that investors use in selecting among similar investments. Instead, market participants increasingly look to the fund’s liquidity and ability to track its index in making their deciding factor.
“What matters is cost holistically, and that will vary based on holding costs and transaction costs. The shorter the holding period, the more transaction costs matter,” said Ben Johnson, director of global ETF research at Morningstar. “You have to take into account the flexibility of the package — a larger fund may be less costly to short; there’s a whole ecosystem of associated derivatives.”
This “holistic” approach to measuring the total cost of funds explains one of the curiosities of the current market, where low-fee funds otherwise have reigned supreme: For funds tracking major benchmarks or asset classes, the most popular fund doesn’t have the lowest fees, as seen in the following table, which uses data from FactSet.
|Index/Asset class||Assets Under Management||Expense Ratio||30-day Average Trading Volume (shares)|
| S&P 500
|SPDR S&P 500 ETF Trust
|$245 billion||0.09%||60.6 million|
|iShares Core S&P 500 ETF
|$130.25 billion||0.04%||3.5 million|
|Vanguard S&P500 ETF
|$75.6 billion||0.04%||1.5 million|
| Russell 2000
|iShares Russell 2000 ETF
|$42 billion||0.2%||23.3 million|
|Vanguard Russell 2000 ETF
|SPDR Gold Shares
|$35.58 billion||0.4%||8 million|
|iShares Gold Trust
|$9.5 billion||0.25%||9.8 million|
|GraniteShares Gold Trust
|iShares Core U.S. Aggregate Bond ETF
|$50.35 billion||0.05%||2.4 million|
|Schwab US Aggregate Bond ETF
In part, this reflects the role these products serve in many portfolios, as investors utilize them as short-term holdings or as vehicles to short the market. For those purposes, high liquidity and narrow spreads will be of greater value than an annual expense ratio.
“The SPY still delivers incredible value as a trading vehicle; it has traded with a penny spread every day for years,” said Nick Good, senior managing director and the global co-head of the Global SPDR Business at State Street Global Advisors. High liquidity allows investors to quickly get in and out of a security without a major impact on the price, even if they are making large trades.
The SPDR S&P 500 fund, which is often referred to as “SPY” for its ticker symbol, was the first ETF ever launched, and it remains the largest on the market by a wide margin.
“Buy-and-hold investors will worry less about these aspects, but for many traders and investors, who are considering the total cost of ownership, high liquidity will be valued more than an expense ratio,” Good said.
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Of course, even though the SPDR S&P 500 fund charges more than twice what its rivals do, an expense ratio of 0.09% still qualifies as rock-bottom by any reasonable standard. A single basis point amounts to an additional penny for every $100 invested, which barely counts as a rounding error.
“As expense ratios drop to near zero, there is less relative benefit now to an investor who chooses the cheapest option in the category based on price alone,” wrote Rich Powers, head of ETF Product Management at Vanguard, in a blog post. “That certainly raises the question of how important that last basis point is when considering an index fund or ETF.”
He added that the difference between a 0.8% fee and a 0.12% one remained sizable, and “in that case, the expense ratio should be near the top of the due diligence checklist. When the differences in expense ratio among competing products are only a few basis points, cost should probably fall further down the checklist.”
Beyond fees, Powers added, “It should be apparent that other factors, such as strategy or portfolio manager execution, have a longer-term impact on an investor’s ability to reach his or her long-term goals.”
Overall, the average fee for an equity ETF is 0.49%, according to August data from Morningstar Direct. For bonds, the average is 0.33%, while it is 0.71% for commodity-tracking funds.
Average fees have been dropping rapidly, and there have been several major moves in the ETF fee war over the past few weeks alone. In early September, the GraniteShares Gold Trust was launched with an expense ratio of 0.2%, half the fee charged by the SPDR Gold Shares ETF, by far the biggest gold fund on the market. Separately, Goldman Sachs filed for a fund that tracks an equally weighted index of large-cap stocks. The ETF will only cost 0.09%, dramatically lower than the similar Guggenheim S&P 500 Equal Weight ETF.
On Monday, State Street Global Advisors cut expense ratios on more than 15 funds in an aggressive bid for retail investors and advisors. While some of the cuts were relatively minor, with the fees dropping by just a few basis points, others represented massive changes. The SPDR Portfolio Emerging Markets ETF
(previously the SPDR S&P Emerging Markets ETF) had its fee cut from 0.59% to 0.11%. Another, the SPDR Portfolio World ex-US ETF
, is seeing its fee go to 0.04% from 0.34%, a cut of nearly 90%.
Read more: ETF fee war expands, bringing more pain to active managers
Also: Here’s how much ETF fees have dropped since the financial crisis
The degree to which investors favor low-fee products has been pronounced. According to Vanguard, which cited May data from Morningstar, there is nearly $8 trillion in funds that charge between 1 and 47 basis points. The next cheapest category — charging between 0.48% and 0.65% of assets — has about $2.5 trillion, a downward slope that continues the more expensive the fund is.
The fee war has sometimes been deemed “the Vanguard effect,” in reflection of how the asset-managing giant — which has also been sucking up massive inflows — has pioneered passive vehicles and made low costs a cornerstone of its offerings. The median Vanguard ETF charges 0.1%, according to Morningstar Direct. For iShares, the median is 0.36%, while it is 0.3% for State Street, which sponsors the SPDR family of funds. The data is from the end of August, before the latest round of SPDR fee cuts were announced.
In June, Morgan Stanley forecast that ETF and mutual-fund fees would fall an additional 10%-15% over the coming years. Morningstar’s Ben Johnson speculated that the gravity of falling fees would even impact the higher-priced category leaders, like SPY.
“There’s a multitude of different users and use cases [for investors], which isn’t to say that the differences in expense ratios are sustainable or justifiable,” he said. “I imagine that the iShares and Vanguard S&P 500 ETFs will chip away at SPY’s market share, and at some point it will hit a tipping point and the math will change.”
— Ben Johnson, CFA (@MStarETFUS) October 16, 2017
SPDR’s Nick Good said the company was “always evaluating” whether its fees were appropriate, but that it had no plans to change the SPY’s expense ratio.