Tradability, a liquid options market, first-mover advantage—none of that matters to some of the early investors in the iShares MSCI Emerging Markets ETF (EEM). Responding to my article from earlier this week, some investors reached out to me to share their experiences with the fund and explain why they continue to hold despite the launch of multiple lower-cost ETFs.
One reader wrote:
“Seems like you missed a very obvious point as to why EEM still retains substantial assets despite the outrageous fee it charges: speaking from personal experience, one very important reason that I have not switched the money I have in EEM is that I bought it at a low price long ago, and so have a triple in the ETF. So the capital gains tax if I sell would be very large, and it would take me decades to recover the tax via lower annual fees in VWO. I assume that a BIG chunk of the remaining EEM holdings are in taxable accounts.”
Another reader shared a very similar story:
“I am an example of someone who was an early investor in EEM and who still holds my investment there. In my case, I have not shifted my investment to a lower-cost fund because of the tax impact of liquidating my EEM position. In hindsight, I obviously should have shifted to VWO soon after it launched. At the time, however, I think I expected that EEM would lower its expense ratio to be more competitive, and maybe I was just not as attentive to the issue as I should have been.
By the time iShares introduced IEMG, my EEM position had appreciated significantly, and I estimated that it would take a couple of decades before the lower expense ratio of IEMG would compensate me for the tax liability I would incur by selling EEM. (I don’t remember the exact numbers now.) Yes, I still have the potential tax liability, but I very well may avoid ever realizing it, perhaps by donating the shares to charity or bequeathing them.”
A Real Consideration
By not mentioning the tax implications of trading out of EEM, my article from last week omitted a big element, and I’m glad these readers brought the point to my attention.
Taxes are a very real consideration for any investor sitting on hefty gains in EEM, and as the readers point out, the potential tax liabilities they face outweigh any benefit from the lower expense ratio they would get in a cheaper fund.
It’s impossible to say how many investors are holding onto EEM for similar reasons (anyone with sizable gains in a taxable account I would imagine). That likely includes a large subset of the investors who bought EEM prior to 2007 or so (those who bought into the fund after that were treading water until recently).
Inflows into EEM since the start of 2007 totaled $5.8 billion, so there’s at least some money in the fund that’s not “trapped.”
Even so, I don’t want to take away from the frustration that early investors in EEM feel, many of whom feel burned by iShares’ decision to open another low-cost emerging market ETF—the iShares Core MSCI Emerging Markets ETF (IEMG)—rather than cut the fees on EEM.
“I have always felt that iShares is taking advantage of investors in my situation by not lowering the expense ratio of EEM, which they obviously could do, and introducing IEMG instead. As a result, I have never invested in another iShares product,” one investor told me.
One can imagine that the same tax considerations that have locked many investors in to EEM have kept investors from selling other first-mover ETFs—including early stalwarts like the SPDR S&P 500 ETF Trust (SPY) and the SPDR Gold Trust (GLD).
This is a powerful aspect of being the first mover in an ETF category. An issuer has every right to wield that power and charge a higher fee, but they shouldn’t be surprised to see blowback from investors if that fee is way out of line compared with the competition.
The case of EEM is quite extreme, with a massive (by index ETF standards) 60 basis point difference in cost between the first mover and the Vanguard FTSE Emerging Markets ETF (VWO).
On the other hand, SPY’s 0.09% expense ratio, which is 6 basis points higher than the expense ratio of the Vanguard S&P 500 ETF (VOO) or the SPDR Portfolio S&P 500 ETF (SPLG), isn’t going turn investors off to nearly the same extent.