Fund Flows: The ETF Price War Heats Up

For investors, it’s getting easier to make money with ETFs, as issuers keep getting squeezed on costs. This is great news for ETF investors, but hard on the industry.

The October story is one of price wars in headline vanilla funds and price compression in the strategies that had once promised greater pricing power (such as “smart beta” and active management). While pockets of pricing power still exist, they are largely populated by trading vehicles or one-of-a-kind funds that have no real competitors.

The ETF price war is real and intensifying, particularly in the vanilla space. During October, we saw several major industry announcements for new or revamped cheap core funds:

• Charles Schwab launched the Schwab 1000 Index ETF (SCHK-US), a self-indexed fund that is nearly indistinguishable from the Russell 1000-based funds from SSGA, iShares, and Vanguard. Self-indexing can create cost-savings, by eliminating index licensing fees. SCHK costs 0.05% per year.
• SSGA slashed fees on 15 of its core products, and announced that they will be dropping the Russell 1000/2000/3000 indexes in favor of self-indexing, similar to Charles Schwab’s new launch.
• InvescoPowerShares launched a suite of six funds named “PureBeta.” These funds are broad-based, cap-weighted, and priced to compete. At launch on September 22, these funds were priced within one basis point of their close competitors—mostly matching iShares Core and Vanguard funds and just 0.01% more expensive than Charles Schwab’s offerings. That was before SSGA made its pricing announcement.
• This week, Franklin Templeton launched a suite of 13 plain vanilla single-country funds, two Europe-wide funds (hedged and un-hedged), and a hedged Japan fund, with expense ratios of 0.09% and 0.19%. This is a clear shot at iShares’ dominance in this space. The BlackRock direct competitors charge between 0.48% and 0.64%.
• Not to be outdone, Deutsche Bank re-purposed two country/region ETFs and cut its fees to 0.15%, while also cutting fees to the same level on its Japan JPX-Nikkei 400 Equity ETF.

Here’s how the landscape has changed over the past month. For starters, Vanguard and iShares now look overpriced in the 1000/2000/3000 space.

Ticker	Name	Focus	Expense Ratio 9-29-2017	Expense Ratio 10-31-17
SPLG	SPDR Portfolio Large Cap ETF	Large Cap	10	3
SCHK	Schwab 1000 Index ETF	Large Cap		5
VONE	Vanguard Russell 1000 ETF	Large Cap	12	12
IWB	iShares Russell 1000 ETF	Large Cap	15	15
SPSM	SPDR Portfolio Small Cap ETF	Small Cap	10	5
VTWO	Vanguard Russell 2000 ETF	Small Cap	15	15
IWM	iShares Russell 2000 ETF	Small Cap	20	20
SPTM	SPDR Portfolio Total Stock Market ETF	Total Market	10	3
VTHR	Vanguard Russell 3000 ETF	Total Market	15	15
IWV	iShares Russell 3000 ETF	Total Market	20	20

The flows have already begun to follow suit in the 1000-tracking funds. IWB lost just about $600 million in October while VONE lost $5.8 million. Meanwhile SPLG and SCHK took in $18 million and $102.8 million, respectively. Small caps have yet to follow suit, perhaps because of liquidity concerns.

As of October 31, 137 ETFs listed on U.S. exchanges carried annual expense ratios of 0.10% or less. These funds hold $1.34 trillion, or 41% of all U.S. ETF assets. Twenty-eight of these funds are now priced at 0.05% or less. That makes for tough competition in the dozen segments covered.

Let’s look at the eight segments where at least one of these nearly costless vanilla funds compete, setting aside the four value and growth segments, where differences in index construction drive the divergence in returns and make direct comparisons difficult. In these eight segments, competition is fierce.

ETF Segment	# Vanilla Core Competitors	Lowest Core ER	Highest Core ER
Equity: U.S.  -  Large Cap	13	3	20
Equity: U.S.  -  Total Market	8	3	20
Equity: Developed Markets Ex-U.S.  -  Total Market	8	4	33
Fixed Income: U.S.  - Broad Market Investment Grade	4	4	5
Equity: U.S.  -  Small Cap	9	5	20
Equity: U.S.  -  Mid Cap	6	5	25
Fixed Income: U.S. Government TIPS	4	5	20
Equity: U.S.  -  Extended Market	3	5	15

As expected, flows are following expenses. In October, 13 funds garnered 50% of all net inflows; their median expense ratio was 0.14%. Twelve took market share from competitors, 10 of which had expense ratios below the asset-weighted segment average.

In market segments where funds compete by strategy, market share increased for cheaper funds, and decreased for pricier ones over 96.8% of the asset base in October. While it is true that strategic fixed income funds that captured market share within their segment charged an asset-weighted average expense ratio of .38% (against losers charging only .29%), this happened in a tiny corner of the ETF market—a segment with only 0.03% of the asset base strategy-competitive segments. Overall, October’s market share gainers cost only 0.19% on an asset-weighted basis, while October losers cost 0.25%.

An expense ratio of 0.20% is now expensive in the U.S. ETF landscape. In the vanilla equity space, margins are even tighter; funds that gained market share cost 0.15%, while losers cost 0.19%, both on an asset-weighted basis. In the vanilla fixed income segments, market share gainers cost 0.17% on average, while the losers cost 0.28%.

While non-vanilla strategies still bear higher price tags than their simplest brethren, costs are shrinking there, too, as market share flows from richer funds to cheaper ones. Should current trends continue, within a few years most strategies will be offered at cost, or close to it, in most asset classes.

Below are some of the market share shifts we saw in October.

GLD (expenses 0.40%) to IAU (expenses 0.25%).

EFA (expenses 0.33%) to IEFA (expenses 0.08%).

ACWI (0.33%) to VT (0.11%).

IYR (0.44%) to VNQ (0.12%).

SPY (0.0945%) to IVV and VOO (both 0.04%).  While SPY took in $5.8 billion in October, it lost market share because of its relative size.  VOO began October at 30.7% the size of SPY, but it took in 35.7% as many dollars.  VOO’s growth rate is faster than SPY’s.  Ditto IVV.

These screenshots were taken on November 6, with October flows shown in the far right.

Fee compression is not limited to plain vanilla funds; it’s happening across all strategies, especially in segments where more than two funds compete within a strategy. For the 14 non-vanilla strategies that saw net October inflows of $50 million or more, the median monthly cost for market share gainers was 0.075% lower than it was for the losers.

Strategy	Strategy Group	Asset-weighted ER Winners	Asset-weighted ER Losers	Investor savings from changes in market share
Active	Active	0.65%	0.50%	-0.15%
Equal	Idiosyncratic	0.44%	0.28%	-0.16%
Price-weighted	Idiosyncratic	0.95%	0.18%	-0.77%
Exchange-specific	Idiosyncratic	0.21%	0.57%	0.36%
ESG	Idiosyncratic	0.41%	0.36%	-0.05%
Currency Hedged Fundamental	Strategic	0.48%	0.58%	0.10%
Dividends	Strategic	0.65%	0.47%	-0.19%
Fundamental	Strategic	0.32%	0.44%	0.12%
Growth	Strategic	0.14%	0.19%	0.05%
Multi-factor	Strategic	0.47%	0.54%	0.07%
High Beta	Strategic	0.25%	0.57%	0.32%
Momentum	Strategic	0.22%	0.65%	0.44%
Volatility Hedged	Strategic	0.63%	0.75%	0.12%
Bullet Maturity	Vanilla	0.20%	0.28%	0.08%
Vanilla	Vanilla	0.16%	0.21%	0.05%

Trendwise, while pricing power remains for some of the active and idiosyncratic funds, the strategics have joined the vanilla funds in a race to trim expenses. The strategic funds have also been losing market share all year, with the exception of September.

Diving into the data, we find less cause for optimism on the persistence of pricing power. Let’s look at a few examples of pricing power and its demise outside of the vanilla space.

In the world of actively managed ETFs, we would expect competition to drive fees lower. In general, this seems to be true, as most segments with more than two actively managed ETFs are seeing investors access cost savings by moving market share from expensive funds to cheap ones. But the table below shows that this is not uniform.

Active funds per segment	Average Investor Savings
17	-0.08%
14	0.14%
13	0.06%
11	0.20%
10	0.16%
8	-0.15%
5	0.10%
3	0.39%
2	-0.09%

 

There was a particular willingness to pay within the eight funds of the “Equity: Global Total Market” segment. This segment offers several different flavors of active management, including income, long-term capital growth, and outperformance, along with one-off themes of disruptive innovation and copying famous investors. In October, only four had inflows; no dollars went to the income funds or the copycat. The flows to the outperformance-oriented funds were minimal (just $5 million). The bulk of the money went to three funds: Davis Select Worldwide ETF, Innovator IBD 50 Fund, and ARK Innovation ETF.

Ticker	Name	Expense Ratio	October Flows ($ Millions)	Objective
ARKK	ARK Innovation ETF	75	38	Benefit from disruptive innovation
VALX	Validea Market Legends ETF	79	0	Copy famous investors
GDVD	Principal Active Global Dividend Income ETF	58	0	Income and long-term capital and income growth
YLDE	ClearBridge Dividend Strategy ESG ETF	59	0	Income and long-term capital and income growth with ESG focus
DWLD	Davis Select Worldwide ETF	65	25	Long-term growth of capital
FFTY	Innovator IBD 50 Fund	80	82	Long-term growth of capital
VGFO	Virtus WMC Global Factor Opportunities ETF	49	5	Outperform Global Equity Market
HECO	EcoLogical Strategy ETF	95	0	Outperform Global Equity Market with ecological focus

 

The ARK Innovation ETF (ARKK-US) is the only broad-based fund with an innovation focus. It has a monopoly at the moment. Any investor who wants to access innovation broadly must agree to the 0.75% annual expense ratio.

Nearly all the pricing power in actively managed funds is attributable to highly specialized funds that have no direct competition. Where funds compete within the same strategy and segment, investors have been flocking to the cheaper option.

This is even truer for the strategic (smart beta) ETFs that many issuers hoped would warrant a premium over basic vanilla. In October, not only did strategic funds lose market share by taking in three percent less, dollar-wise, per starting market share, than their vanilla, active, and idiosyncratic counterparts in competitive segments, but they also experienced severe cost pressure. The U.S. High Dividend Yield segment is an excellent example.

	Ticker Symbol	Proper Name	Expense Ratio	October 2017 Net Flows
1	SCHD	Schwab US Dividend Equity ETF	0.07%	114,825,388
2	HDV	iShares Core High Dividend ETF	0.08%	17,219,685
3	VYM	Vanguard High Dividend Yield Yield Index Fund	0.08%	181,488,640
4	SDY	SPDR S&P Dividend ETF	0.35%	46,167,713
5	DHS	WisdomTree U.S. High Dividend Fund	0.38%	-24,918,575
6	DVY	iShares Select Dividend ETF	0.39%	-147,102,035
7	RDIV	Oppenheimer Ultra Dividend ETF	0.39%	-3,444,675
8	DIV	Global X SuperDividend US ETF	0.45%	5,140,526
9	FDL	First Trust Morningstar Dividend Leaders Index Fund	0.45%	-5,805,200
10	PEY	PowerShares ?High Yield Equity Dividend Achiever Portfolio	0.54%	-15,539,350
11	FVD	First Trust Value Line Dividend Index Fund	0.70%	90,185,850
12	WBIY	WBI Power Factor High Dividend ETF	0.70%	1,234,500

The largest flows went into the funds that cost 0.07% or 0.08%, while funds costing more than that experienced outflows, on the whole.

Asset managers may have reason to hope that October’s growth in market share for active and idiosyncratic funds will allow them some breathing room—and pricing power—for new launches. But October’s cost migration suggests that pricing power will be fleeting, as competition can come to challenge any successful fund.

Article By Elisabeth Kashner, FactSet