Musings on the ETF “Fee War”

Big news in the ETF space recently has come from announcements from major players: Blackrock (iShares) and Schwab announcing they are drastically reducing fees on broad-sector ETFs in an effort to keep up with Vanguard.

Here’s the backstory.  Vanguard has been gobbling up core ETF market share at a rapid pace.  Investors (and their advisors) are starting to get it: costs matter.  Vanguard’s low cost structure is putting a dent in other leaders’ market share.  According to InvestmentNews, Vanguard’s core market share has jumped to 20%, while leader Blackrock’s iShares product has seen its dominance drop from 48% to 40% since 2009.

This trend isn’t just limited to the ETF space – Vanguard’s traditional mutual funds captured about $70 billion in assets in 2012 through August.

So Blackrock and Schwab are responding in turn by making cuts to their expenses where they have competing products with Vanguard.  (This, by the way, is great news for investors.)  But what does it all mean?

Ultimately, I have a hard time believing that iShares and Schwab can compete with Vanguard on costs over the long term.  Vanguard has a tremendous advantage due to its unique ownership structure.  Vanguard is owned by its funds, and in turn its shareholders.  Thus all economies of scale are returned to the shareholders via lower expenses.  As assets continue to increase at Vanguard, this advantage continues to work in their favor.  Blackrock and Schwab will have to take a loss-leader mentality with their core ETF products if they hope to keep pace with Vanguard’s falling expenses.


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