Zero-Fee ETFs: A Good Bargain?

December 11, 2009

Everyone expected lower prices when big names like Charles Schwab and Pimco entered the ETF playground. But now, it's just getting nuts.

In the past few months, we've seen several new funds launch (particularly in the commodities space) that undercut the existing competition. And, of course, Charles Schwab came out swinging last month with its commission-free funds.

Now there's newcomer Old Mutual, which announced it would waive expenses on its new GlobalShares FTSE Emerging Markets Fund (NYSEArca: GSR) until Jan. 31, 2010, or until its assets hit $1 billion, whichever comes first. The fund launches soon.

After the deadline, GSR's expense ratio bumps back up to 0.39 percent, a figure that still undercuts many (but not all—see below) of the existing emerging markets funds, like the SPDR S&P Emerging Markets ETF (0.59 percent) or the iShares MSCI Emerging Markets Index Fund (0.72 percent).

The offer also extends to four additional GlobalShares ETFs focusing on the All World, All World ex-US, Developed Countries ex-US and All-Cap Asia Pacific ex-Japan markets. Once the deadline expires, these funds' expense ratios will climb to 0.35 to 0.50 percent.

While I welcome competition into the industry (and the lower fees it inherently brings), I question whether Old Mutual's offer is really as good as it seems.

For starters, GSR would still be more expensive than Vanguard's Emerging Markets ETF (NYSEArca: VWO), which lately has emerged as the surprise rock star of the ETF industry. Not only has VWO returned 71.8 percent year-to-date, but in November, the fund led all other ETFs in net inflows for the second straight month. (Its main competitor, the iShares MSCI Emerging Markets Fund (NYSEArca: EEM), attracted only $369 million.) VWO is a great bargain, and investors are clearly starting to realize it.

What's more, as yet another emerging markets ETF, GSR enters a space where, at last count, more than 40 funds currently vie for investor dollars. Old Mutual's "zero fee" offer is an obvious ploy for attention in an increasingly crowded market, but I'm not sure a discount that expires in seven weeks can attract enough investors to the new fund—or, at least, enough who will stick around once fees increase.

And it's the same story for Old Mutual's other proposed funds, which cover already well-trodden sectors. Another developed equities ex-U.S. index fund? Really?

That's not to say that I think GSR is a bad option for investors—in fact, I think the fund's composition is rather interesting. It's the first ETF based off the FTSE Emerging Markets Index, which has outperformed the MSCI Emerging Markets Index by more than 5 percent over the past year. The fund also invests both in individual companies and other ETFs, like the iShares MSCI Taiwan Index Fund (NYSEArca: EWT) and PowerShares India Portfolio (NYSEArca: PIN) (which make up 4.0 percent and 3.0 percent of the portfolio, respectively). The fund was also aggressively seeded, with more than $60 million plopped into the fund on day 1.

Still, this "zero fee" marketing gimmick tears focus away from GSR's attractive points and places it all on cost—a game that Old Mutual is destined to lose, if not to Vanguard, then to the next cost-slashing ETF that comes out later down the line.


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