State Street, facing historic redemptions, slashes ETF prices

A storied ETF firm aggressively cuts expense ratios on funds

Feb 3, 2015 @ 12:29 pm

By Trevor Hunnicutt

State Street Corp., whose ETF lineup saw the largest redemptions in history last month, on Tuesday aggressively cut its prices on nearly a third of its funds.

The Boston-based custody bank is one of the early pioneers in building exchange-traded funds, having backed in 1993 one of the first and largest such funds to trade in the U.S., the $185 billion SPDR S&P 500 ETF (SPY), which it now runs.

But as the ETF has become the fastest-growing product in asset management, passing $2 trillion in assets for the first time late last year, State Street's $420 billion U.S. ETF business has faced tough competition from nimble, often low-cost competitors, especially BlackRock Inc.'s iShares and the Vanguard Group Inc., both which enjoy abiding support from financial advisers and their affiliated brokerages.

State Street's asset management division, State Street Global Advisors, said it would cut by up to 23 basis points, or 0.23% per year, the management expenses on 41 ETFs. The average index-based ETF charged 56 basis points in 2013, the most recent year for which data is available, but investors continued to prefer the cheaper funds, paying just 29 basis points on average, according to Lipper.

Conspicuously absent from the list of funds seeing cost reductions is SPY, which remains 9.45 basis points.

“Some of these are pretty aggressive and surprising price cuts,” said Morningstar Inc. analyst Michael Rawson. “They need to undercut iShares if they want to attract assets.”

State Street's move accelerates competition on fees among top players in the investment management business, a trend that may have positive implications for investors — costs erode investment returns — even as it frustrates industry executives. An expense ratio is just one of the many costs of investing in an ETF, but it is the easiest for an investor to control.

“We saw this as an opportunity to continue to showcase the indexing expertise of State Street Global Advisors,” said James Ross, global head of SPDR Exchange Traded Funds. “We're in a very competitive business, and we have have some very strong competitors across from the largest to the small players that have made great headway. I think we all offer different value propositions.”

In recent years, State Street has been working to build a traditional distribution network through broker-dealers by bringing in former wirehouse executives, and it's been filling its wholesalers' briefcases with brochures touting a wider range of products, from strategic beta to actively managed mutual funds. Mr. Ross said the firm also has “one of the best capital-markets teams on the Street.”

Those efforts may have come too late, according to Mr. Rawson, as other firms amp up their ETF businesses and outreach to advisers.

“State Street is well known as a custody bank, not as an asset manager,” he said. “They're trying to get big in this space but so is every other fund company.”

State Street's core, passive ETF products focused on equity markets continue to account for the lion's share of its fund flows. Those products, in general, have benefited from a search for lower fees and index-based investments by financial advisers.

Vanguard and iShares have been beneficiaries.

iShares is the largest distributor of the funds, with $760 billion in assets.

And Vanguard, a favorite of a fee-based, index-investing financial advisers, has for the first time surpassed SSGA to become the No. 2 U.S. ETF business, with $434 billion.

Both of those firms offer newer alternatives to SPY, the iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO), organized under a less-restrictive legal structure that some investors believe allows it to better match the returns of its benchmark. SPY investors say that fund offers other benefits, including ease of trading.

SPY took in $21.9 billion last year, an amount wiped out entirely by its $26.7 billion in investor redemptions last month, according to estimates by Morningstar. The iShares product took in $9.6 billion last year, while Vanguard's fund saw $10.3 billion in inflows.

Meanwhile, another popular and groundbreaking product offered by State Street, the SPDR Gold Shares (GLD), lost $3 billion to redemptions last year after the safe-haven asset lost its luster in 2013, when the fund sank by 28%, Morningstar said.

Mr. Ross, who was part of the team that brought SPY to market, said the flows into and out of the large fund are largely cyclical.

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