Bernstein: ETF Fee War Fuels Competition

Olly Ludwig
November 13, 2012

The ETF fee war is good for competition, but a few basis points in price difference isn’t a big deal, Bill Bernstein says.


The fee war everybody is talking about in the world of ETFs these days between Schwab, iShares and Vanguard is certainly good for competition, money manager and former neurologist Bill Bernstein says. But Bernstein, author of fun and readable books such as “The Investor’s Manifesto,” also argued that the price differences in question—sometimes just a few basis points—are hardly worth getting excited about.

When Managing Editor Olly Ludwig caught up with Bernstein recently, they talked about everything from the validity of enhanced indexing methodologies to the possibility that the popularity of products such as dividend-rich ETFs could cause correlations to rise at exactly the wrong time.


Ludwig: There's been a lot of change in the world of indexing recently. Many people call it a fee war between Schwab, Vanguard and iShares. Do you have some general observations about this?

Bernstein: It’s much to do about nothing.

Ludwig: When you say that, are you talking about the expense ratio? Are you talking about the different indexing methodologies?

Bernstein: All of the above. There are a few big mistakes you can make in indexing, and they’re not even big mistakes. They're just mistakes that will cost you a dozen basis points a year: investing, for example, in the S&P 500 Index vs. some other large-cap index. And the reason is, because everybody in the world indexes the S&P 500, and when it reconstitutes, you're going to incur some transactional costs following that reconstitution. Everybody is trying to get in and out of the same little narrow door at the same time.

Ludwig: So all this hoopla about Schwab bragging about what they’re doing is just drops in the bucket? On the emerging markets funds, for example—we’re talking about a 5 basis point difference a year, 15 for Schwab, 20 for Vanguard. And it’s 18 basis points for that new iShares product.

Bernstein: Yes. But the competition is obviously very healthy. Remember Vanguard’s first emerging markets index fund. I think it had a 60 basis point expense ratio. And now, it’s down to a third of that. That’s extremely healthy.

Ludwig: Yes. So, at the very least, all this maneuvering and posturing is keeping that downward pressure on funds.

Bernstein: Yes. I’ll tell you what's sort of the bigger societal issue about this that I really find absolutely fascinating. You look at Vanguard, and it’s quite obvious that it’s going to basically, in the long run, blow all of these companies out of the water. Why? Because it doesn’t have to make a profit. And because it doesn’t have to make a profit, it will continuously accumulate market share. People come to that. And so you’ve got a nonprofit, if you think about it, which is providing a financial good, which is blowing away for-profit companies.

Ludwig: So let's talk about BlackRock's iShares, which just launched this new lineup of 10 core funds. They look pretty credible. But in this competitive landscape that you describe, where Vanguard would prevail over the long haul, these 10 funds are just sitting behind a moat, sort of “deck chairs on the Titanic,” as you had once told me with regard to something else, in terms of Black Rock’s ultimate competitive challenge here against Vanguard?

Bernstein: Yes—I mean, are you ordering the sausage pizza or the pepperoni pizza? It’s usually not a difference.

In other words, if somebody told me, “You can't invest in Vanguard and DFA [Dimensional Fund Advisors] funds anymore. You can only invest in BlackRock and WisdomTree,” I would say, “All right.” I don’t think I’d be able to do quite as good a job, but it wouldn’t be the end of the world.



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