iShares’ troubles with EEM have just started; here’s what it can do to save the franchise.
When the Vanguard Emerging Markets ETF (NYSEArca: VWO) topped the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) as the largest emerging markets fund last week, ETF sites on the Web celebrated. Dave Nadig called it the triumph of sensibility: Vanguard’s low cost wins, iShares’ high cost loses and investors come home the victors.
Lost amid the shuffle is that iShares has been doing quite well with EEM. Here is its total AUM at the end of each year for the past six years:
2005: $10.3 billion
2006: $15.7 billion
2007: $29.9 billion
2008: $19.2 billion
2009: $39.4 billion
2010: $47.6 billion
It’s only in the hypercharged world of ETFs that a 36 percent compound annual growth rate can be considered a problem. Or, to be more precise, it’s only in a world where your top competitor is growing at a rate of 140 percent a year that a 36 percent compounding growth rate is a problem.
On revenue, though, iShares is doing just fine. Based on current expense ratios and assets, EEM is generating about $310 million a year in revenue; nearly three times that of VWO, which churns out just over $120 million a year.
That’s actually iShares’ problem. I have seen suggestions that iShares cut its fee on EEM to compete with VWO, but with VWO priced at 0.27 percent versus 0.69 percent for EEM—that’s a fantasy. iShares would have to cut its expense ratio by 61 percent to match Vanguard’s low cost. That would cut nearly $200 million in fees from its bottom line, just to level the playing field with VWO.
A smaller fee cut—say, to 0.50 percent—would do almost nothing.
Apart from extolling its superior service, iShares’ response to the competition from VWO has been to emphasize the liquidity of EEM, arguing that it is designed for institutional-sized liquidity that is not available in VWO.
This has limited attraction. Both funds trade at 1 penny spreads, according to Arcavision, and while BlackRock can spin a yarn about how EEM is easier to trade at institutional size, that’s a difficult message to convey to the average investor.
So what can iShares do to “save” its emerging markets franchise from further incursions by Vanguard? It’s an important question, because ever since VWO became the largest emerging markets ETF, EEM has been hemorrhaging assets: $1.5 billion has flowed out of EEM in the past week alone.