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Memo To Fink On iShares Fees

September 13, 2012
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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 one-fund segments?

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 approach.

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 investors.

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 vernacular.

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.

 

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