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Why iShares Changed Course

October 15, 2012
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iShares' new pricing strategy is an ingenious solution to a seemingly intractable problem: how to compete with Vanguard without destroying its core business.

That's good for BlackRock.

But it's also good for investors, offering them some interesting new choices.

For years, iShares has had a problem. While its overall business has grown, it's been losing share—not assets, just market share—in its "core beta" products—the plain-vanilla ETFs in categories where investors and advisors put most of their money: size-bucketed equities, broad bond portfolios, multicountry international funds.

The best-known example is the iShares Emerging Markets ETF (NYSEArca: EEM). A few years ago, EEM dominated emerging markets ETFs. As of July, 31, 2007, EEM had $17.5 billion in assets under management, while it closest competitor—the Vanguard Emerging Markets ETF (NYSEArca: VWO)—had just $2.2 billion in AUM.

But iShares had a problem. While EEM and VWO tracked the exact same index, EEM charged significantly more: 0.75 percent per year at that time compared with just 0.35 percent for VWO. VWO also better tracked its index, using a full replication strategy versus iShares' optimized approach. Once investors figured this out, money flows strongly favored the Vanguard product. As of Oct. 11, 2012, VWO had $57 billion in AUM compared with "just" $37 billion for EEM.

Many called on iShares to slash fees on EEM to compete, but that was a nonstarter for obvious financial reasons. Instead, it lowered fees on EEM incrementally over the years, from 0.75 percent in 2007 to 0.67 percent today, but to slash fees to Vanguard levels would have been too costly. With its 0.67 percent expense ratio, EEM currently generates $250 million in annual fees. Reducing its expense ratio to match VWO's (now just 0.20 percent) would have cost the firm $175 million a year.

Try getting that past the board of directors.

So instead, iShares has chosen to thread the needle.

Early today, it announced the launch of a new "Core" brand of ETFs within iShares. To do so, it did two things: First, it cut fees on six ETFs, bringing those fees down to industry-leading or industry-competitive levels. Then, it announced plans to launch brand-new ETFs in four other "core" areas of the market, including areas where it already had large, established funds.

The six funds it directly cuts fees on are listed below.

New Ticker

Old Ticker

New ER

Old ER

AUM

Loss In Expense

Ratio Revenue

ITOT

ISI

0.07

0.2

$363,780,000

$472,914

IVV

0.07

0.09

$32,753,550,000

$6,550,710

IJH

0.15

0.21

$11,291,540,000

$6,774,924

IJR

0.16

0.22

$7,890,870,000

$4,734,522

AGG

0.08

0.2

$15,713,620,000

$18,856,344

ILTB

GLJ

0.12

0.2

$199,210,000

$159,368

$37,548,782

 

Generally, these are ETFs that were already low-cost, and have now just become a little cheaper. While the fee cuts do impact BlackRock's revenue, at current asset levels, the impact is modest: You're "only" talking about losing $37.5 million in annual fees.

Now consider the ETFs where iShares launched competing products:

 

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