Fees, indexes take center stage in ETF competition

Liquidity and cost trump all other benefits of exchange-traded funds for institutional investors. Yet the basic attributes of this rapidly growing category of products also have large investors shying away from most areas of index and asset class innovation — where costs are higher and trading is lower.

But those areas are where ETF sponsors have focused in recent years.

In 2012, that divergence became clear as the pace of ETF closures accelerated despite a net 5% increase in the number of exchange-traded products to 1,443 in the $1.34 trillion U.S. market, according to research firm XTF Inc. Net new flows into ETFs were $169 billion through Dec. 17.

Maturation of the U.S. exchange-traded-product market has turned into a battle over indexes and basis points, largely between The Vanguard Group Inc., the iShares unit of BlackRock Inc., and State Street Global Advisors, which collectively control 84% of assets. Exchange-traded products include exchange-traded funds, exchange-traded notes and exchange-traded commodities.

In October, iShares significantly decreased expense ratios on 10 products it considers core portfolio building blocks. Vanguard countered with a cost-reduction measure that shifted several products to FTSE international indexes and to domestic indexes from the Center for Research in Securities Prices. It had been using MSCI indexes.

STATE STREET

State Street Global Advisors, which manages or markets the two largest exchange-traded products in the world — SPDR S&P 500 and SPDR Gold Shares — has been steadfast in its fees.

The battle among the largest ETF sponsors is a response to what Benjamin Fulton, managing director of Invesco PowerShares Capital Management LLC, describes as a marked shift from “product development” to “product management” throughout the ETF universe. Nearly 100 offerings left the market last year, including broad-based and low-cost funds from Scottrade Inc. and all but one fund from Russell Investments.

Last month, PowerShares announced plans to liquidate 13 funds by March 7, representing less than 1% of its exchange-traded product assets.

Against the backdrop of departures, established asset managers are exploring ETFs as another distribution channel for well-known brands and strategies. Launched in March, Pacific Investment Management Co. LLC's Pimco Total Return ETF, priced slightly above the institutional share class of the Pimco Total Return Fund, grew to $3.9 billion through mid-December.

Ari I. Weinberg is a contributor to sister publication Pensions & Investments.

Related Topics: Exchange Traded Notes (ETNs)