When Will Vanguard Top iShares On Assets?

June 28, 2010

Reports that Vanguard will launch Russell- and S&P-linked ETFs is bad news for iShares,

State Street

and other ETF competitors.

If you missed the news, Vanguard announced it will massively expand its ETF family, launching size and style indexes tied to the S&P 500, S&P MidCap 400, S&P SmallCap 600 and Russell 1000, 2000 and 3000 indexes.

Vanguard ETF head Rick Genoni said these plans show that “Vanguard is serious about this [ETF] business.”

Its competitors should be seriously worried.

Vanguard first got serious about ETFs in 2006, when it dropped the ridiculous “VIPERS” moniker and renamed its ETFs “Vanguard ETFs.” As it poured energy into marketing the funds, assets started to grow and grow and grow. Since year-end 2006, Vanguard’s ETF assets are up 388 percent, dwarfing the 66 percent growth at iShares and 117 percent GLD-driven growth at State Street Global Advisors.

2006 2007 2008 2009 April 2010 Growth % Growth $
iShares $238.3 $324.9 $252.8 $338.0 $397.1 66% $158.8
State Street Global Advisors $92.6 $143.0 $137.9 $126.6 $200.6 117% $108.0
Vanguard $22.3 $42.0 $45.2 $92.0 $108.6 388% $86.3

Note: Data from iShares, Morgan Stanley and IndexUniverse.com. All figures in billions.

On a dollar basis, iShares has dominated all its competitors over this time span, growing assets an incredible $159 billion. But Vanguard is growing much faster on a percentage basis, and it shows no signs of slowing down.

What’s most impressive about Vanguard’s growth is that it has come via plain-vanilla ETFs that were up against well-established competitors. Typically, the ETF industry is a “first come, first serve” one: The first fund to market in any particular category will gather the bulk of the assets. But Vanguard has been able to chip away by offering lower fees and consistent index-tracking performance.

Of course, other issuers have tried offering low fees and solid index tracking, and haven’t had the success Vanguard has had. Anyone remember Northern Trust’s NETS ETFs?

The difference, I think, is that Vanguard enjoys incredible brand allegiance among a certain set of investors and advisers. There are investors and advisers out there who will buy Vanguard products through thick or thin, almost without regard to what competition exists in the market. You see it in the fund-flows data, which shows steady buying month after month after month.

That’s what makes Vanguard’s decision to launch plain-vanilla S&P and Russell ETFs so dangerous to competitors. If another company were to do this, they would have difficulty attracting any assets in what would amount to me-too products. And with limited assets, the new funds would suffer from poor liquidity and wider-than-average spreads. You end up with a classic chicken-or-the-egg problem: The funds have no assets because they trade poorly, and the funds trade poorly because they have no assets.

This is the conundrum that causes so many ETF dreams die.

But Vanguard is different. Vanguard, if the pattern holds, will slowly attract assets to these new funds; month after month after month. Over time, the funds will gain sufficient liquidity to compete with established offerings from iShares and

State Street

; they’ll get above the $100 million AUM hurdle that many advisers use to screen the ETF universe. And again, over time, Vanguard’s lower-cost structure will help it chip away market share from iShares and SSgA.

Will Vanguard ever actually catch up with those two? I’m not sure. But I do think it will continue to close the gap.



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