Vanguard exec teases free ETFs

It was only a matter of time. The Vanguard Group Inc. has become the first U.S. ETF company to raise the possibility of funds with no expenses, according to a Financial Times report. “I would like to think the cost of investing [in ETFs] could come down to zero,” Nick Blake, head of retail at Vanguard, said at a conference in London, according to the FT. “There will always be a fixed cost in there, but if [a firm's asset] volume is big [enough], the total expense ratio can come right down.” Spokeswoman Katie Henderson clarified in an e-mail that Vanguard has no plans to waive the fixed management and operational costs that it takes to run an exchange-traded fund, so the funds will never be entirely free. That doesn't mean that an expense ratio can't fall below 0.01%, though. Vanguard's unique structure makes virtually free ETFs a possibility. When John Bogle founded Vanguard in 1974, he arranged for it to be owned by its mutual funds. That allows Vanguard to offer its funds to investors at cost. As the funds grow in size, the costs to run them shrink as a percentage of assets. “It's their mandate to operate at cost,” said Ben Johnson, director of passive-funds research at Morningstar Inc. “Certain funds could become so massive that the expense ratio would be a rounding error.” The $8.66 billion Vanguard S&P 500 ETF (VOO) is the firm's cheapest ETF, with an expense ratio of 0.05%, which some argue is already virtually free. The ETF has plenty of room to grow and for its expense ratio likewise to fall. It is only a fraction of the size of the $40 billion iShares S&P 500 ETF (IVV) even though inflows for the two products have been comparable since its launch in September 2010. The Vanguard ETF had taken in $7.4 billion of net inflows through April 1, compared with $8.8 billion for the iShares ETF, according to IndexUniverse LLC. So if it costs only 5 basis points to run the ETF at $8 billion, how much will it cost investors if the fund doubles, triples or quadruples in size? Vanguard isn't saying yet. Ms. Henderson declined to speculate on future price reductions. Given Vanguard's history of cutting costs along with rising assets — it cut fees on nine ETFs in late February for that very reason — it is a safe bet that the fee will keep on dropping even if it never technically becomes free.