ETF Managers not sunk by fee wars

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While much of ETF discussion last year focused on record flows, Fed Support, and the dominance of Vanguard’s low-fee funds, I think an interesting story that has emerged is that many ETF issuers have found innovative ways to survive the fee pressure among the commodity beta providers, and have succeeded in launching funds and raising assets at attractive margins.

While in a previous article, I showed a correlation between flows and lower fees among similar index funds, this article aims to show that many ETF managers have not allowed themselves to be drawn into this race-to-the-bottom cage match, and have successfully launched reasonably-priced innovative and interesting products which have attracted assets, showing either they are providing value to the customer, or they have an excellent marketing program (or both, not for me to judge).

New Launches

While the AUM-weighted fee of the top 20 funds is just 0.10% (representing nearly 40% of total ETF assets), the chart below illustrates that new launches over the past 10 years have maintained a consistent range between 0.50% and 0.60%. With the exception of BNY and Schwab, few new folks are launching into the pure market-weighted beta category.

Chart 1: Fees of funds launched over the last 10 years:

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And while there is no denying that larger, low-fee funds are getting the bulk of total flows, it is important to note that many funds launched in the last few years with fees in the 0.40-0.60% range have successfully raised assets. And the last time I checked my Algebra I textbook, you need quite “a bit” more AUM at 0.03% than at 0.50% to grow profitability.

Chart 2: Flows of ETFs launched 2017-2019, grouped by Fee:

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ESG:

I don’t have to tell anyone reading this article that ESG funds hit an inflection point in 2020, with over $25B in U.S. ETF inflows, more than tripling the previous year. Funds like ESGU and ESGV are multi-$billion instruments, routinely used in ETF models, and exhibit solid liquidity. However, a less-publicized aspect of the shift into ESG funds is that the higher fees also drive profitability at ETF managers. So while you may “feel good” by moving assets from SPY and IVV to ESGU or EFIV, you’re also making the earning statement of BLK and STT “feel good.”

Chart 3: Comparative fees of ESG & non-ESG Funds:

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Thematics:

I am convinced that thematics are a perfect segment for the ETF wrapper, enabling daily trading & performance, usually clear disclosure, and providing investors diversification AND the ability to invest in their investment hypotheses. As with ESG, thematics have also been an excellent way for providers to maintain fees. But to be fair, if my “theme” returns 20% better than the S&P, I’m not sure I care about the extra 0.50% in fees.

Chart 4: Several thematic ETFs that “Earned their keep” in 2020:

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Fixed Income & Commodities

Whether due to actual or perceived complexity, Fixed Income and Commodity ETFs typically command a premium over core equity ETFs. With the risk-off flight to bonds and gold in early 2020, better options for cash in short-duration ETFs, and the increasing popularity of the ETF structure for fixed income by advisors and institutions, average fees have not suffered in this regard.

Chart 5: Average fees for core Equity vs. Fixed Income & Commodity ETFs:

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Active and NQFT funds:

Finally, with the passage of rule 6c-11, simplifying the path for Active funds, as well as the SEC approval of several NQFT (“not quite fully transparent”) structures, several attractive avenues were opened in 2020 for managers to offer value-added products that can command higher fees, while still saving investors significant money over previous Mutual Funds options. Given their expected higher returns and possibly higher cost structures, most active funds (transparent or non) charge 0.50-0.80%. As I have posted previously, the 19 NQFT funds launched in 2020 have behaved impressively, gathering nearly $1.0B in assets, trading smoothly, and have an average fee of over 0.50%.

Conclusion:

While the biggest ETFs slug it out for pennies, I have been encouraged to see the creativity and innovation from the ETF industry’s product and marketing teams in the last few years. With $5T in assets, compared to over $20T in traditional mutual funds, ETFs still have much room to run. They will continue to save investors significant capital as they realize the full benefits of the structure and available investment options. This study has highlighted that while low fees and market beta are an important segment of the ETF landscape, there is still room for success and profits with the right strategic plan.

“Let’s be careful out there”   – Sgt. Esterhaus, Hill Street Blues.

Elya

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ADDENDUM EXHIBITS:

Table A1: Record 2020 ETF flows; huge gain in bonds; capping off a $5.4 T industry:

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Chart A2: A decade of nonstop ETF growth:

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Table A3: Vanguard crushed it in 2020; but encouraging to see more breadth of flows, with issuers outside the top 10 comprising 14% of inflows.

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A great independent article from Morningstar discussing 2020 flows: Link.

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Data Sources: ETFlogic.ioetfdb.comMorningstar.com, and issuer websites. Any data errors are my own. PDFs of all articles available upon request.

Elya Schwartzman is the founder and president of ESIC LLC, an independent advisory firm specializing in ETFs, indexing, fixed income portfolio management, and investment infrastructure and technology. ESIC also provides independent research on these topics. Over the past 15 years, Mr. Schwartzman has played a key role in the growth of the ETF and indexing industry, having managed teams, portfolios, and investment process initiatives for BlackRock and SSGA.  

Disclaimers:  ESIC provides paid advisory services to companies in the ETF ecosystem, including but not limited to issuers, index providers, analytics and data vendors, and market makers. Any views expressed are solely of the author and should not be construed as investment advice.

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