Gloves come off in ETF price war

The ongoing price war among providers of exchange-traded funds is heating up. The Charles Schwab Corp. last Friday unveiled…

The ongoing price war among providers of exchange-traded funds is heating up.

The Charles Schwab Corp. last Friday unveiled a round of fee cuts aimed at making its ETFs the lowest-cost funds in their categories. The move came just weeks after BlackRock Inc. said that it would implement strategic fee cuts in its iShares ETFs, the largest family of ETFs, with more than $500 billion in assets.

Both firms are following the lead of The Vanguard Group Inc., which has employed its emphasis on low-cost products to become the fastest-growing ETF firm in the industry.

The $1.13 billion Schwab U.S. Broad Market ETF (SCHB), for example, now costs 4 basis points, down from 6. It is now 2 basis points cheaper than the $23 billion Vanguard Total Stock Market ETF (VTI).

TARGETING CUTS

Schwab also is following BlackRock's lead in targeting fee cuts to the asset classes in which both companies compete with Vanguard.

Neither BlackRock nor Schwab is particularly hurting for attention. The iShares ETFs have had inflows of $63 billion over the past three years, second only to Vanguard's $73 billion, and Schwab's ETF business has grown to $7.5 billion since its launch in November 2009.

But in the core building-block-type ETFs, cost tends to matter most.

“They're commodity-type products,” said Mike Rawson, an ETF analyst at Morningstar Inc. “The disparity between one index provider and another in those categories isn't that great, so people just tend to go with the cheapest.”

Of course, because ETFs already have low fees, 1 or 2 basis points may not seem like a big difference. But without the fee cuts, BlackRock and Schwab could have risked losing investors to Vanguard because, thanks to the firm's unique structure, Vanguard can continue to lower prices.

Vanguard is owned by its funds — thus the shareholders of those funds — so expense ratios are kept at cost. As the funds grow larger, expense ratios fall because of economies of scale.

Because Vanguard's ETFs are share classes of its index funds, inflows into the index funds will allow ETF expense ratios to keep dropping.

Two-thirds of Vanguard ETFs have had fees cut over the past year, according to the company.

BlackRock hasn't been specific about its fee cuts, but Schwab seems committed to following Vanguard all the way down to the bottom.

“I'll leave it to your imagination as to how we might respond to followers who, late to the game, attempt to undercut our exceptional pricing,” said Marie Chandoha, president of Charles Schwab Investment Management Inc.

So far, Vanguard doesn't seem to be worried.

“We're happy other companies are following our lead,” said spokesman David Hoffman. “Lowering fees is something organic for us, and it will most likely happen again in the future.”

Christine Hudacko, a spokeswoman for BlackRock, declined to comment.

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