Weighing ETFs' Cost Cuts

(Dow Jones) A modest price war among some exchange-traded funds focused on emerging markets is making the arena more affordable for investors. The question they now face is whether the price cuts warrant a trade.

On Tuesday, Old Mutual lowered the expense ratio, or the cost of owning a fund, for its GlobalShares FTSE Emerging Markets ETF (GSR) to 0.25% from 0.39%. The move undercut Vanguard's Emerging Market ETF (VWO), which has an expense ratio of 0.27%. The price reduction also widened the gap between Old Mutual's fund and the iShares MSCI Emerging Markets Index Fund (EEM), which has an expense ratio of 0.72%. Old Mutual says it will not raise its fee above the 0.25% limit for at least a year.

Old Mutual's move may say more about the rapidly expanding ETF universe than it does about the lure of emerging markets. There are now 995 exchange-traded products (902 ETFs and 93 exchange-traded notes), up more than 7% since the beginning of the year, according to Seeking Alpha. (May was a rare weak month for new funds. When Rydex closed a dozen leveraged ETFs, it marked the first month in a year during which more funds closed (12) than opened (9).)

The number of ETFs has grown so large that firms are now more apt to differentiate themselves using price, says Loren Fox, senior research analyst at investment industry research firm Strategic Insight.

Competitive pricing can pay off for fund companies. Vanguard's Emerging Market ETF gained $2.9 billion in investor capital in 2010 through the end of March, while the more expensive iShares rival fund lost $4.36 billion.

Newer funds in particular have been looking at cost as a way to lure customers. Because new funds often have lower trading volume, investors typically find it more difficult to make cost-effective trades, says Legend financial adviser Jim Holtzman. Old Mutual's GlobalShares FTSE Emerging Markets ETF launched in December with a 0% expense ratio until Jan. 31.

Old Mutual's GlobalShares Emerging Markets fund has $60.7 million in assets, according to Morningstar. The Vanguard Emerging Market ETF holds $23.6 billion in assets, and the iShares MSCI Emerging Markets fund has $32.8 billion.

Tendai Musikavanhu, the chief executive of Old Mutual Global Index Trackers, says smaller firms must take extraordinary measures to get noticed among "Goliaths.'

More fund companies are shifting their focus from creating new products to distribution and attracting the retail investor, says Pete Welgoss, research analyst at the Financial Research Corp., a research firm for the investment and asset management industry. Firms like Old Mutual realize that advisers are looking to shore up clients' positions and gain access to certain markets--emerging markets, in particular--"and they want to do it at a lower cost," he says.

Musikavanhu says he sees more value for his firm in lowering customer costs than in advertising, adding that "there's quite a lot of money we're paying to make sure that those [fee] caps stay in place."

Although industry watchers anticipate more competitive pricing, the major players say they have no plans to respond to the latest cut. A spokeswoman for BlackRock (BLK) says the firm has no plans to change EEM's pricing. Vanguard says its strategy does not include "temporary fee waivers."

Fox says mutual funds and ETFs will often waive fees, sometimes for an extended period of time, in order to attract long-term investors. Fox adds because the ETF universe is still relatively young, many firms are still experimenting with fee models.

Low fees among emerging-market ETFs, for example, are important to investors and their advisers because they offer a competitive edge in a quickly growing space, says Holtzman. Last year, an "explosion of ETFs" allowed him to give his clients more exposure to specific countries they couldn't otherwise access, he says. Ameriprise financial advisor Rich Atkison says he's increased his use of emerging-market ETFs to add international exposure to his clients' portfolios after paring down more traditional international holdings in Europe and Asia.

Holtzman expects to see more competitive pricing "across the board," but cautions that with smaller and newer ETFs, investors should be mindful of trading volume to make sure the cost of trading the products doesn't offset the savings of owning them.

Fox says investors should also remember that a low expense ratio has little to do with an ETF's total net return. Investors may spend less to own the fund, but their long-term returns hinge on the performance of the ETF itself.