Free ETFs Don’t Work

March 05, 2012

In the ETF world, it’s no secret that the early bird gets the AUM, leaving latecomers to battle it out.

Recently, PowerShares tried to penetrate a crowded fund space by temporarily waiving all management fees for its KBW series of financial sector ETFs, launched in November.

The result? Although an expense ratio of zero was eye-catching at first, the effect wore off quickly.

These funds are:

  • PowerShares KBW Insurance Portfolio (NYSEArca: KBWI)
  • PowerShares KBW Capital Markets Portfolio (NYSEArca: KBWC)
  • PowerShares KBW Regional Bank (NYSEArca: KBWR)
  • PowerShares KBW Bank Portfolio (NYSEArca: KBWB)

 

On Feb. 1, PowerShares ended the freebie and raised fees on each of the four ETFs to 35 bps, at which point, assets in three of the four funds collapsed. That happened even though the new fees were on par with those of competitors.

KBW Fund Assets

Fund assets for KBWR, KBWI and KBWC have dropped by 89.7 percent, 88 percent and 66.1 percent, respectively; and most of these drops occurred a few days after the expense ratios were raised.

What Happened?

The PowerShares KBW funds launched with above-average amounts of seed capital because of market makers—who gathered inventories, at no cost, in anticipation of the funds doing well. The sudden collapse in assets happened when market makers exited the fund after PowerShares began charging management fees.

PowerShares may have assumed that by the time providers of seed capital left, the ETFs would have gathered significant assets from other market players. After all, KBW indexes were popular as underlying indexes for the SPDR financial sector funds, which switched index providers a week before PowerShares’ KBW ETFs launched.

But, the no-fee ploy clearly didn’t work, nor did it make a difference that when expense ratios did kick in that the PowerShares funds cost exactly the same as the competing SPDR funds.

 

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