Price of Success
In many ways, passive funds have become the victims of their own success. During the longest bull run for U.S. stocks on record, ETFs more than quadrupled their assets under management. That rapid proliferation has come at a very literal price. On an asset-weighted basis, the average fee fell 38 percent to $2.10 per $1,000 in that span, according to the most recent data available from the Investment Company Institute.
BlackRock, Vanguard Group and State Street -- the three dominant firms which together oversee over 80 percent of the $3.8 trillion in U.S. ETFs -- have led the way. More than 97 percent of flows into index funds last year went to those charging $2 or less. Vanguard, for example, attracted more than $4 billion to a stock ETF last week after making it the lowest-cost S&P 500 strategy.
As profit margins have shrunk, both BlackRock, the world’s largest asset manager, and State Street announced plans this year to dismiss workers to redirect resources and cut costs, respectively. Vanguard recently dropped its investment minimums to fend off rivals.
It hasn’t been any easier for the minnows in the ETF world. Financial advisers are often prohibited from buying funds that don’t meet minimum asset thresholds. To compete with the big boys, you need to climb over that bar. Increasingly, that means charging nothing or even paying investors outright.
‘Anti-Competitive Hurdles’
“There are anti-competitive hurdles that we’re trying to jump over,” says Alfred Eskandar, president and co-founder of Salt Financial.
Eskandar’s Salt and SoFi are gambling that investors stick with them if they start charging fees. In general, issuers can minimize the roughly $200,000 a year it costs to run an ETF by using an in-house index rather than licensing a more popular one. They could also lend out securities for extra income. Yet there are limits when the product itself generates no revenue.
A decade ago, Deutsche Bank’s European asset management unit started a pioneering no-cost stock ETF, but ultimately raised its price five years later. Now, much of the debate is over how sustainable the ultra-low cost model will be when the bull market finally ends.
“It does still cost something to manage the funds and to service the funds and distribute the funds,” says Noel Archard, global head of product for State Street’s ETF business. When it comes to the fee war, “there’s a logical bottoming-out point. We’re getting pretty close to that threshold.”
This article was provided by Bloomberg News.