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Under Pressure: ETF Expense Ratios Have Been Falling for Close to Two Decades

ETF fee reductions have been with us since close to the beginning. A look back at how the price war started, what it's meant for investors, and what's ahead.

Robert Goldsborough, 01/16/2013

One of the hottest topics in the exchange-traded fund world has been the ongoing price war that has continued driving costs down for investors.

The fee war has intensified in the last several years, as the ETF market has become more crowded. Some me-too products have come along with an eye toward undercutting a popular incumbent product, fee-wise. Offering the lowest fees in a product category has been a strategy for several entrants, with some incumbents responding with price cuts. Still other ETF providers have introduced other strategies or sought other ways of differentiating their products, such as asking investors to look at other indirect costs of holding an ETF beyond simply a stated expense ratio. And in recent years, brokerage platforms have partnered with ETF issuers to offer commission-free trading of select ETFs.

Outside the price wars, ETF fees can also change as assets under management rise and fall, and sometimes these changes are disclosed only in SEC filings.

In late December, Vanguard announced lower fees on 24 ETFs and higher fees on two funds. But because Vanguard has taken the position that it runs all of its ETFs (and mutual funds) at cost, the firm does not communicate lower expense ratios as price cuts per se. Instead, it simply notes that funds' expense ratios now are lower (or higher) because of changes in asset levels.

In iShares' case, about 40 ETFs saw their prospectus expense ratios rise by a few basis points each several weeks ago, which was also driven by changes in asset levels. This fee change was disclosed only in prospectuses filed with the SEC.

We would classify the more active cuts as outright industry warfare, aimed at growing market share, while one could view the smaller fee changes as more of a matter of scale and reflective of the industry's growth.

Even so, we don't believe that these ETF pricing decisions, proactive or not, occur in a vacuum. They unquestionably are being made with an eye toward the competitive set. What's more, it's pretty clear to us that the ETF fee war isn't going to be abating anytime soon. As the new year has begun, we thought it would be an appropriate time to review key points in the ETF price war.

State Street SPDRs: the Pioneers
The pioneer in the ETF space is State Street, which brought out the first-ever ETF, SPDR S&P 500 SPY, in January 1993 at a price tag of 0.20%. Over the next eight years, the firm rounded out its early product portfolio with a host of ETFs, including more broad index ETFs, funds devoted to specific assets classes such as REITs, and the first-ever suite of U.S. equity sector ETFs. Expense-ratio reductions appeared almost immediately, and on a near-annual basis for some funds. For example, SPY cost 0.19% in 1995, 0.18% in 1996, and 0.17% in 1999. By 2004, its price tag was down to just 0.11%. Meanwhile, the Select Sector SPDR ETFs devoted to U.S. equities first charged what, by today's standards, seems excessive: 0.57%. Within two years, those equity sector ETFs' fees fell to 0.28%. By 2010, their price tags dropped to 0.20%.

Robert Goldsborough is an ETF Analyst at Morningstar.
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