ETF FEE WARS CHANGING SHAPE
In October, we witnessed the latest skirmish in the ETF fee wars as iShares abruptly announced that it had cut fees on 15 of the ETFs in its “Core” family by 2-5 basis points. The move was a swipe at Vanguard, Charles Schwab and even State Street Global Advisors, as it lowered the price on the iShares S&P 500 ETF (IVV) by 3 basis points to 0.04%, nearly half the cost of the SPDR S&P 500 ETF (SPY).
However, just days later, Schwab responded to the volley of price cuts with its own, cutting the expense ratio on five of its key ETFs by 1 basis point each, reclaiming the No. 1 low-cost spot for at least those ETFs’ respective asset classes.
Now that fees on key asset classes are well into the single digits, this raises the question of how much lower costs can actually go. There are actually three ETFs with expense ratios of 0.03%, two from Schwab and one from iShares. Where do you go from there?
‘I Don’t Think We Go To Zero’
Dave Nadig, managing director of exchange-traded funds at FactSet Research, doesn’t think things are going to get too crazy.
“I think there’s a point of diminishing returns. I don’t think we go to zero, where the investment management is free and the issuers live off SEC lending revenue,” he said.
Really though, the fee cuts are sort of cosmetic on the core funds at this point because, as Nadig puts it, nobody is making money on those products. The purpose of such low fees for the Schwabs, Vanguard and iShares of the world is just to knock down sales barriers, Nadig says.
Goldman Sachs certainly did something similar in 2015 when it launched the Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC). The fund costs just 0.09%, the same as SPY, despite being a smart-beta fund. It was considered a shrewd move that garnered a lot of attention, not least because it was a way to draw investors into Goldman’s entire family of smart-beta ETFs.
5-40 Basis Point Range
Nadig thinks the fee compression will continue in the ETF space, but in a very different way.
“What I think we see is funds pressed into a narrow range of 5-40 basis points, where products over that range really have to fight to prove they’re worth it,” he said.
No longer will it be a battle of core asset classes, but of funds representing subsets of those asset classes or the strategies that target them. Currently, there are more than 1,300 ETFs with expense ratios of 0.40% or more; that means the battlefield is slowly shifting to a much broader field.
“The real fee war will continue up-hill from those lower-cost products. You’ll start seeing products priced at 0.70% getting repriced down into the area of 0.40% and so on,” Nadig said. “I predict a rash of fee compression at the top.”