How The Big 3 ETF Issuers Got So Big

August 29, 2017

[This article appears in our September 2017 issue of ETF Report.]

iShares. Vanguard. State Street. The three largest ETF issuers, which together account for 82% of all assets, are so often spoken about in the same breath, you'd be forgiven for assuming they were a single (albeit awkwardly named) company.

Yes, the Big Three share many similarities: ultra-cheap "core" ETFs; rock-solid track records; and oceans of liquidity. Yet each issuer has its own particular quirks and market niche. State Street has seniority. Vanguard has low-cost diversification. iShares has the sheer, staggering weight of numbers.

Over the years, dozens of ETF issuers have come and gone, but the Big Three remain, their shadows looming large over the industry. Where iShares, Vanguard and State Street go, so too does everybody else (see Figure 1).

This is their story. 



State Street Global Advisors
Total AUM: $546B
Market Share: 18%

In the beginning, there was State Street.

State Street Global Advisors (SSGA) is the investment arm of State Street Corporation, the world's third-largest asset manager. It's also the third-largest ETF issuer, with $546 billion in assets under management (AUM) across 131 funds.

SSGA was first to market with ETFs: In 1993, it launched the very first ETF, the SPDR S&P 500 ETF (SPY), which also continues to be the world's largest. The margin isn't even close: SPY has $242 billion in assets, compared with $121 billion for its next nearest competitor, the iShares Core S&P 500 ETF (IVV).

SSGA also launched several other industry firsts: the first sector funds, the Select Sector SPDRs, in 1998; and the first physical gold ETF, the SPDR Gold Trust (GLD), in 2004.


First-mover advantage has kept State Street a significant player, even as dozens of competitors have eroded its market share over time. The funds SSGA pioneered clearly continue to drive the company's growth. SPY alone accounts for 44% of the company's total assets, and investors poured $25 billion into it last year, or fully half of the $50 billion of new net inflows into SSGA ETFs. The 10 Select Sector SPDRs accrued $12 billion in 2016, while GLD accounted for $7 billion more.

Together, that's $44 billion, or 88% of the company's total net inflows for 2016 (see Figure 2).


Fig. 2: Largest ETFs by Issuer
  Biggest ETF AUM ($B) Total Issuer AUM
SSGA SPY 242.17 44%
Vanguard VTI 81.93 11%
iShares IVV 121.84 10%




That said, Nick Good, senior managing director and co-head of SSGA's Global SPDR business, embraces the benefits first-mover advantage has provided the company.

"Liquidity draws in more liquidity. And where there's liquidity, you see big institutions making big trades," he said. "You can't be complacent. But that known brand recognition is significant."


Lowering Costs

State Street has also attracted investors by surgically slashing its prices. The Select Sector SPDRs, for example, launched with expense ratios around 40 basis points. Now, they're just 14 bps apiece. That’s helped the Select Sector SPDRs become the go-to funds for investors' sector rotation strategies: With the exception of newcomer Real Estate Select Sector SPDR Fund (XLRE), all the Select Sector SPDRs dwarf their competitors in terms of assets. (Five are more than 10 times as large as the nearest competitor.)      

SSGA leans heavily on S&P and Bloomberg Barclays indices, with a handful of MSCI and Russell benchmarks sprinkled in. (Compare that with iShares, whose lineup is almost the exact reverse.) For many core products, the distinction is mostly academic; but index provider can matter significantly for thematic plays, or even in emerging markets funds.

Last year, SSGA launched nine new funds, including three actively managed bond ETFs, three tech funds and three environmental, governance and social responsibility (ESG)-related ETFs. It also had a breakout hit in the SPDR SSGA Gender Diversity Index ETF (SHE), an ESG fund that harnesses what Good says is the company's unique position to demand strong stewardship.

"We're not active managers, so we can't just sell a stock because we don't like how it's run," he noted. But SSGA's size means "we have an obligation to challenge boards and make sure companies we invest in actually operate how we think they should."

To that point, State Street recently voted against the re-election of board members from 400 companies with all-male directorship teams. (It's unclear whether this resulted in any lost seats, however.)

Greater emphasis on governance is something SSGA hopes will help attract more institutional customers, who Good estimates already account for 40% of its assets, or slightly more than the industry average (36%).*

The firm has also enhanced its model ETF portfolio business, launching an educational blitz to guide investors through the basics of building good portfolios. "There's almost a geekiness to how we approach our business," said Good.


AUM: $757B
Market Share: 25%

Vanguard is the closest thing the ETF industry has to a rock star. Its investors aren't just clients. They're fans.

That's because the second-largest issuer, with $757 billion in assets, has demonstrated consistent—even obsessive—commitment to putting its investors first. Indexing is a big part of that.

Like hipsters the world over, Vanguard was indexing before it was cool. State Street may have beaten Vanguard to the ETF table, but Vanguard actually invented the index fund back in 1976, when the company launched its Vanguard 500 Index Mutual Fund.

Today Vanguard has cornered roughly half the market for indexed products, with combined U.S. assets of nearly $4 trillion across 300 mutual funds and ETFs, as of July 2017.

Late To The Party

Yet Vanguard is still primarily a mutual fund company, and it was slower than State Street or BlackRock to embrace ETFs. In 2001, Vanguard launched its first two ETFs, the Vanguard Total Stock Market ETF (VTI) and the Extended Market ETF (VXF). By that time, State Street had already launched 20 funds and  iShares had launched 58. 

A slower start doesn't seem to have hurt Vanguard long term, however. Of the 70 ETFs the firm has launched, not a single one has ever closed, nor are any currently below $100 million in AUM. Indeed, 55 ETFs hold above $1 billion.

Diversification & Rock-Bottom Pricing
Vanguard's secret sauce is diversification. The company may not offer the broadest range of ETFs, but those it does sell have comprehensive portfolios that hold hundreds, sometimes even thousands of securities. Yet Vanguard's ETFs also exhibit extremely low tracking error and spreads; the widest Vanguard ETF spread is just 0.17%.

"We're big advocates for diversification; it's the only real free lunch in investing," says Rich Powers, head of ETF Product Management for Vanguard's Portfolio Department.

The other big reason for Vanguard's dominance is low cost. The company's ETFs carry bargain-basement prices, with an average expense ratio of just 0.11%, compared with 0.31 for SSGA and 0.36 for iShares.  





Such rock-bottom prices are possible because the company is client-owned; meaning, Vanguard's funds own Vanguard-the-company, rather than the other way around. As such, Vanguard-the-company must operate at-cost, and the resultant savings translate to lower expenses for Vanguard-the-funds.

"We're gratified fees have come down so meaningfully across the industry, and we feel we had a large role in that change," noted Powers. "The end winner, though, is the investor." 

Perhaps the biggest downside of Vanguard, however, is that its portfolio disclosure is lagged, with ETF holdings reported on a monthly instead of daily basis. That's within the guidelines of Vanguard's exemptive relief from the SEC, and the firm says that daily disclosures is not in the best interests of shareholders in index funds due to the possibility of frontrunning. That said, Vanguard's ETFs are extremely good at tracking their underlying indices, and the indices themselves—usually FTSE, MSCI or CRSP benchmarks – are easy enough to look up.

Now that iShares and State Street are aggressively matching—even undercutting—Vanguard on price, good benchmarks with low tracking error may be the firm's next biggest selling point, says Powers.

"Cost was a huge differentiator when you were comparing products at 5 bps versus 50. Now that it's more like 5 bps versus 6, investors should expand their focus beyond cost to the tracking skill of the underlying strategy, or the strategy itself," Powers added.


AUM: $1.21T
Market Share : 40%

In this industry, big begets big. At $1.2 trillion in AUM, iShares is the biggest of the big. No other issuer even comes close.

As the ETF division of BlackRock, the world's largest asset manager, iShares started out of the gate with massive resources and economies of scale at its disposal.

Starting in 1996, iShares launched ETFs early and often, sometimes bringing dozens of funds to market in a given year. Today there are 343 iShares ETFs, or more than double the number offered by State Street and almost five times that offered by Vanguard (see Figure 4).




The relentless release cycle continues through today: Last year, iShares launched 23 funds; so far in 2017, it’s launched nine more.  And there are many more in various stages of registration.

iShares's lineup spans a vast breadth of investment objectives. Like State Street and Vanguard, iShares sells several extremely cheap "core" ETFs, like IVV and AGG. But it also offers hundreds of strategic and thematic plays, ranging from single-country funds to niche sector twists; from rate-hedged bond ETFs to smart-beta strategies. With apologies to Apple, the iShares motto could be: “There's an ETF for that.”

"Our scale allows us to deliver a wide range of products that help people invest in things they normally wouldn't be able to invest in on their own," said Ruth Weiss, head of the U.S. iShares Product Team at BlackRock. "We're constantly evaluating where we think investors, and the market, are going next."


Fixed-Income Advantage
Just as with State Street, iShares continues to ride the benefit of first-mover advantage for the funds it launched first, especially in the bond market. In 2002, the company launched the first fixed-income funds: the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), the 1-3 Year Treasury Bond ETF (SHY), the 7-10 Year Treasury Bond ETF (IEF) and the 20+ Year Treasury Bond ETF (TLT). All four remain heavy hitters, perennially appearing in the top 25 largest bond ETFs. (In fact, of those top 25 bond ETFs, 16 carry the iShares name.)

That sets up iShares well to address the needs of what many industry experts predict is the next big ETF market: insurance companies looking to build out their fixed-income portfolios with active and smart-beta strategies.    

"Fixed income is going to be transformational," Weiss predicted. 

Of course, the downside to playing the numbers game is that not every iShares ETF is a megastar. Of its 343 funds, 99 (or 29%) fall below $100 million in AUM. To an extent, successful funds are subsidizing the stinkers.

The issuer has also closed 66 funds, or almost as many as Vanguard has ever launched. Most of these closures occurred in the last three years.

"We're constantly evaluating whether clients are using our products the way we expected them to, and whether they still have a role in the market," noted Weiss. "That said, one of the benefits of scale is that we can afford to be patient."

The idea of an issuer as large as iShares lying in wait and biding its time seems funny. But with a record $74 billion in net inflows in the last quarter alone, for iShares, the sky really may be the limit.

*McCollum, Andrew. "Institutional Investment in ETFs: Versatility Fuels Growth." Greenwich Associates. Q1 2016. PDF available here


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