In the last few weeks, there have been two new developments in the ETF price wars that are important to Wealthfront clients and investors in general – moves by Vanguard and BlackRock that will significantly lower ETF fees. At the same time, we’re starting to see the media raise the question that’s been on my mind lately: Why do traditional advisors charge so much when the underlying investment products (the ETFs) are getting cheaper and cheaper?
Two weeks ago, Vanguard announced it will change the indexes it uses for 22 of its index funds and ETFs. For instance, it will now use FTSE for international indexes in place of its previous index provider, MSCI.
Most people don’t realize the publishers of indexes charge fund managers like Vanguard a fee to use their indexes. License fees can range from 0.02% to 0.30% of an index fund’s assets. For Vanguard, the license fee probably represents its largest cost. By moving to new but still appropriate indexes, Vanguard is able to significantly lower its costs. As essentially a not-for-profit company (like a mutual savings bank, Vanguard is owned by the investors in its funds, not by shareholders), it can then pass along all of its savings to investors, thereby maintaining its role as cost leader.
On a side note, it was notable to us that Vanguard is able to make this switch without triggering capital gains taxes for its clients, because it’s been using tax-loss harvesting (TLH) within their ETFs. The company will reallocate $10B in its funds (see this article from Bloomberg and this piece by investment columnist Rick Ferri for more details about the changes and how they’ve affected the market). Vanguard expects basically no capital gains distributions from the transition, because it is managing the process over six months and using TLH. Wealthfront is now offering automated, continuous TLH – historically available only to institutions and clients with at least $10-$20 million in their portfolios – to our clients with accounts of $100,000 or more.
On the heels of Vanguard’s announcement, BlackRock, whose iShares unit is the largest ETF provider, said it is slashing fees on six of its iShares exchange-traded funds and introducing four new ETFs. BlackRock is responding to intense competition in the ETF market, which is basically, for fund companies, the best growth opportunity out there. BlackRock has 41% of the market, though its share has declined from 48% in 2009. Vanguard, the third-largest ETF provider behind State Street Global Advisors, has seen its market share increase to 18% from 12% during the same period. State Street’s market share has remained flat at about 25%, according to The Wall Street Journal.
Both company’s moves are good news for investors, as earlier developments in the ETF price wars have been, too.
Competition is driving down the costs of ETFs, so that many fees are below 0.15%, and some are below 0.10%. On the average portfolio chosen by Wealthfront for its clients, the ETF fees are 0.14%.
Wealthfront chooses the ETFs for its client portfolios based on fees, tracking error and liquidity, as you can see from our plan page. We’re carefully examining the iShares cuts to see if it makes sense to replace any of our currently recommended ETFs.
The financial services industry is like a whack-a-mole game: when costs fall in one place, they rise in another. While costs continue to fall on the ETFs themselves, some advisors are marketing new ways of combining ETFs, adding new fees for complexities that are of questionable value.
Last weekend, Jason Zweig of The Wall Street Journal wrote:
Exchange-traded funds have quickly become one of the cheapest and simplest investing tools in the world. They also are the raw material for an increasingly popular but potentially expensive and confusing way to invest.
He goes on to discuss the way some traditional advisors are setting up ETF portfolios for their clients and charging 1% to 3% of assets under management for them.
Wealthfront’s clients don’t need to worry about this: We’re mentioned in the article as one of a handful of low-cost online alternatives. But the way traditional advisors are layering new fees into ETF portfolios is a reminder that investors should be vigilant, always, about fees. The headlines are reassuring: ETF fees are falling. The bottom line on your account statement may not make you so happy.
About the author(s)
As Wealthfront's Vice President of Research, Jeff Rosenberger manages investment research, customer development and the Wealthfront seminar program. Prior to Wealthfront, Jeff worked in enterprise software with two startups, one of which, ProfitLogic, was acquired by Oracle in 2005. Prior to earning his PhD in Management Science & Engineering from Stanford University, Jeff worked briefly at Deloitte Consulting and Salomon Brothers. Jeff earned MS degrees in Operations Research and Statistics from Stanford University and BA from UC Berkeley. View all posts by Jeff Rosenberger, PhD