What’s the lowest expense ratio you’d be willing to pay for an exchange-traded fund? How about zero?
All-out price wars are bringing that day ever closer. And while that might benefit a select group of major ETF providers, the rest of the industry needs to come up with a response to remain relevant.
Of course, the ETF industry doesn’t operate in a vacuum. Its fortunes are closely tied to the misfortunes of the mutual fund industry. And 2017 brought an unwelcome sense of déjà vu for mutual fund firms. Continuing a trend that has been in place for a half decade, $195 billion flowed out of mutual funds and $475 billion flowed into ETFs through the first 11 months of 2017, according to FactSet Research. (Year-end data for 2017 was not available at the time of publication.)
“ETFs are two to three times cheaper than actively managed mutual funds. It’s not hard to understand how cost savings are driving flows to ETFs,” says Elisabeth Kashner, director of ETF research at FactSet.
Even within the mutual fund segment, higher-cost funds are losing market share. In recent periods, funds with above-average fees have continued to see an exodus of investor funds while low-cost mutual funds have largely seen stable asset bases.
That same trend is playing out within the ETF sector as well. Through this year’s third quarter, 75% of ETF industry inflows have gone toward funds that sport an expense ratio of 0.20% or lower. In fact, cut that expense ratio by half to see where the real action is these days. There are currently 123 ETFs listed on U.S. exchanges carrying annual expense ratios of 0.10% or less, according to XTF Research, and they collectively hold more than 40% of all U.S. ETF assets.
That’s not good news for the more than 2,200 other ETFs that charge higher fees. (The median net expense ratio for U.S.-listed exchange-traded products was 0.46% in 2017, according to Morningstar.) The trend is pumping up market share at top firms—and trimming the share of second-tier firms.
Right now, the big three—BlackRock’s iShares unit, Vanguard and State Street Global Advisors—control roughly 82% of ETF assets under management, and they run 49 of the industry’s 50 largest funds. The PowerShares QQQ ETF is the lone outsider in that club.
That’s not to say the roughly 90 other ETF firms shouldn’t bother to pursue success with ETFs. “It’s possible for fund firms to be gaining assets while still losing market share [as the overall pie grows larger],” says Kashner.
Indeed, it’s already hard enough to stand out in the increasingly crowded ETF field. Of the 616 ETFs that have been launched since 2015, 240 have accrued less than $10 million in assets under management, according to exchange-traded product research firm XTF.