With more than 1,400 exchange-traded products listed in the United States, fund providers need to differentiate their new fund launches to pique an investor's interest. So ETF providers have brought to market new and innovative funds to attract new investors, but they have also actively slashed expenses on many of their older fund products, in what appears to be an ETF price war.
Before advisors take on any positions in an ETF, they must consider the explicit costs they incur by trading and holding a fund. Every ETF tries to reflect the performance of a benchmark index, minus fees.
Specifically, advisors want to look at the expense ratio. This is the fee every ETF investor will have to pay to compensate the provider for operating the fund, and it is determined through an annual calculation. (The management expense ratio is calculated by dividing the fund's operating expense by the average dollar value of assets under management.)
A lot of investors may even overlook the expense ratio when investing in funds, focusing on other factors, and asking, "Really, how much is a 1% management fee in the grand scheme of things?" However, they have to consider overall expected returns because that 1% can turn into a large chunk of the nominal annual return.
Nevertheless, ETF investors generally enjoy lower costs. Since the beginning, the ETF product has been touted as an efficient, low-cost investment vehicle, with an industry average expense ratio of about 0.55%. According to Morningstar Inc., investors cite the cost factor as "very important" to "important" when they select a product. The low cost of ETFs continues to resonate; 89% of current ETF investors and 96% of prospective users cite ETFs' costs as a deciding factor. Since most ETFs will passively reflect the performance of an underlying benchmark, there is no real need for a manager to babysit the fund. That gives the products inherent cost savings, without all the excess pork. Additionally, with the industry growing and bringing in more investors, fund providers are beginning to cut fees.
Additionally, there is a "Vanguard Effect." The company has kept fees low in its investor-owned funds and attracted market share in turn. That has allowed it to adapt its low cost mutual fund business into low-cost ETF products.
Slashed Fees? I'm Not Complaining.
This year alone, we've seen the top three ETF providers, BlackRock, State Street Global Advisors and Vanguard, who together hold $1 trillion of the total $1.2 trillion ETF industry, reduce the expense ratios on a number of their fund products as well as launch new low-cost vehicles.
In December, Vanguard lowered the expense ratio on its suite of sector ETFs to 0.19%. A few months later, SSgA responded and reduced the expense ratios on all its sector ETFs to 0.18% in what appeared to be a growing competition for a piece of the market pie. Previously, the title for the cheapest sector ETFs went to the FocusShares Morningstar suite of ETFs, whose expense ratio was 0.19%.
iShares, meanwhile, launched a slew of new ETFs in the first two months of this year that are remarkably inexpensive for their categories. In any maturing industry, it is only natural that firms slash their prices to undercut the competition and suffer squeezed margins as a result, since it's the price of a fund that may very well be the deciding factor for an investor looking to place money.
The firms themselves say it's the inflow of money that allows them to cut their prices, not the competition. That may be a logical argument, since they calculate their expense ratio by dividing a fund's operating expense by the average dollar value of assets under management. If the assets under management have grown, it seems plausible the expense ratio would fall to accommodate the growing economies of scale. We are nearing market saturation, and the lower fees are a reflection of this growing trend.
Nevertheless, the fund companies' actions, no matter what their reasoning, will ultimately benefit the ETF investor. Since the start of the year, more than 100 products have been launched, with an average expense ratio around 0.6%.