US ETF investors, who continued to add to their positions during the recent market correction, are very patient when it comes to maintaining their market exposure. Waiting for a market rebound is less of a pain when it’s cheap, in terms of fees.
Despite all the market chaos of the first half of 2022, one trend has remained intact: the trend of ever-decreasing ETF costs. ETF investors continue to direct their cash to the cheapest of the cheapest, as asset managers scramble to stay competitive.
Continued fee compression across all asset classes
The race to the bottom is still ongoing. At the end of June 2022, the US asset-weighted ETF expense ratio fell to 0.180% pa, from 0.183% in December 2021. This is an annualized decline of 0.006%, similar to 2020, but slightly slower than the 0.008% decline in 2021. Fee compression has saved U.S. ETF investors $90.4 million since the end of 2021, based on ETF asset levels as of 30 June.
As in previous years, fee compression is not limited to vanilla stock ETFs. It’s everywhere, in every asset class (except commodities, where SPDR Gold stocks are having a moment) and every investment strategy. Even currency ETF fees resumed their decline after absorbing expensive bitcoin futures ETF launches last year.
The chart below shows the history of ETF asset-weighted average expense ratios over time, broken down by asset class. Keep in mind that the 2022 data is for half a year, the others are full year figures.
Average bond ETF costs fell rapidly, down 0.015% in the first six months of 2022. Equity costs were less affected on average, falling just 0.001%. This relative stability could be attributed to changing preferences for investment strategies, as investors sometimes select equity ETFs with complex and therefore more expensive stock selection and weighting methodologies.
In recent years, ETF investors have become increasingly interested in active management, which has a higher expense ratio than traditional ETFs. Flows since the start of 2022 (YTD) to strategic ETFs, the so-called “smart beta” products, have increased considerably. Strategic funds also charge more than regular vanilla.
Equity ETF fees by investment strategy
To accommodate this counter-migration, it is helpful to break down equity ETF fees by investment strategy. The table below shows the history of equity ETF expense ratios for each investment strategy group. This is the same downward stair pattern we see in the Asset Class Fee History chart.
Through June, expense ratios for vanilla equity ETFs fell 0.004% on an asset-weighted basis, while costs for idiosyncratic ETFs (think equal-weighted, ESG, and exchange-specific ETFs like Invesco’s QQQ-US) fell 0.003%. On the other hand, the expenses of the strategic funds increased by 0.006%. But by far the biggest change is in actively managed equity ETFs, which have fallen 0.087% in just six months. If this trend continues through the end of the year, actively managed equity ETFs could be as low as 0.31%. That would be less than half their cost at the end of 2020.
Growth of Actively Managed Equity ETFs
Flows into the cheapest actively managed equity ETFs are responsible for this change, far more than fee reductions, as active equity ETFs are up 35.5% in the first six months of 2022 Some of this growth has been fueled by mutual funds. ETF conversions. Even excluding conversion flows, actively managed ETFs grew at a blistering 23.1% through June 2022.
To understand cost competition in active ETFs, it helps to take an example. The 156 ETFs in the U.S. total market segment include 64 actively managed funds from 39 issuers. It has attracted $5.1 billion in inflows year-to-date, excluding mutual fund conversion transfers.
These flows were very unbalanced, with Dimensional and The Capital Group capturing 54.4% and 13.9% respectively. All of Dimensional’s US market ETFs are priced very competitively, at 0.11% (the lowest in the segment, undercutting Vanguard’s active factor suite), 0.12% and 0.19 %.
Dimensional’s competitors would do well to study the left side of the graph below, which shows the percentage of segment flows captured by each asset manager, ranked by their asset-weighted expense ratios.
ETF issuers who actively manage U.S. total market ETFs that cost an average of 0.16% or less capture three out of four dollars for active management. Active ETFs that cost 0.40% or more only absorbed 11% of active flows. Against this backdrop, even Capital Group’s 0.33% charge for its dividend value and core stock ETFs doesn’t seem competitive.
Investors’ preference for low-cost active equity ETFs covering the entire US market shows the challenge the current competitive landscape poses to asset managers. While differentiated strategies can be launched at higher costs, competition will erode initial profit margins until investors have captured nearly all of the surplus. The only question is, how long will it take?
Case Study: International High Dividend Yield ETFs
A time-series example allows us to see how ETF fee compression has reshaped the asset management industry over time. International high dividend yield ETFs are an excellent case study due to the limited size of the segment (only six competitors) and high investor interest at $1.6 billion in inflows since inception of the year. From February 2016 to present, the segment has grown from $790 million to $5 billion, half of that in 2021 and 2022.
On February 25, 2016, the first SPDR S&P International Dividend ETF (DWX-US) was well established, having launched in 2008. DWX held a 97% market share with $766 million in assets under management and charged 0 .45% per year. . DWX’s existing competitors, launched in 2013 and 2015, had struggled to gather assets. The newcomers’ woes were understandable – First Trust charged 0.78% per annum; DWS XTrackers chose to match, but not undercut, SSGA’s fees in its FX Hedged International Dividend ETF. By 2015, currency hedging had already passed its peak of popularity.
On that day, the Vanguard International High Dividend Yield ETF (VYMI-US) launched with a price of 0.30%. Since then, SSGA’s DWX has lost assets and market share. As of June 2022, its assets under management were $561 million, representing an 11% market share. VYMI, on the other hand, ended June 2022 with $3.95 billion in assets under management, or a market share of 79%. Eight percent of the remaining market share now belongs to the Schwab International Dividend Equity ETF (SCHY-US), launched last April. SCHY’s spend rate is 0.14%.
First Trust and DWS never gained popularity, nor did newcomer Virtus. First Trust’s reduction in expense ratio in 2018, from 0.78% to 0.60%, left it in the same position, the most expensive in the segment. DWS cut HDAW-US fees in 2018 to just 0.20% and dropped currency hedging. A 0.20% fee should have been attractive to first-time buyers, but the change in strategy may have made investors nervous. Virtus WMC International Dividend ETF, launched in 2017, is priced unattractively at 0.49%.
The chart below, which combines historical FactSet expense ratio data with data on assets under management and fund classifications, shows how fee compression has reshaped this segment of ETFs. Underage competitors have been excluded for readability.
Today, Vanguard and Schwab are the only real competitors in the international high dividend yield segment. Low-cost leader Schwab has taken on the task of consuming SSGA’s market share, while Vanguard remains stable. Will Vanguard announce a competitive fee reduction for VYMI this year?
These examples of fee compression at work in the total US market and in the international high-dividend-yielding segments are not anomalies. They make the headlines. Many asset management companies relied heavily on rising markets to offset the organic contraction, while preserving profit margins.
The combination of a bear market and fee compression leaves nowhere to hide. Companies like Vanguard, Charles Schwab, and Dimensional ETFs have figured out how to compete in a low-fee environment and have reshaped the competitive landscape on their terms. It’s no small feat to rack up entries during a bear market and even more impressive to gain market share during a selling frenzy.
Through June, Vanguard attracted 45.7% of ETF flows (excluding conversions) despite an initial 28.8% market share of US ETFs. Schwab drained 6.9% of flows on a basis of 3.8%. Dimensional ETFs started 2022 with just 1.3% of all ETF assets and continued to capture 4.8% of ETF flows (again, excluding conversions, even his own).
As of June 30, 2022, Vanguard’s asset-weighted ETF annual expense ratio was 0.05%, Schwab’s was 0.08%, and Dimensional’s was 0.23%. Blackrock and State Street/SSGA, which compete with Vanguard and Schwab, lost ground, contributing 23.5% and 0.3% of YTD streams against starting market shares of 34.2% and 14.5%. Blackrock’s asset-weighted average expense ratio in June was 0.18%; The SSGAs were 0.13%. The calculation is relentless.
For investors, saving on fees is extremely useful in a tough market environment. For asset managers, bear market fee compression can be a severe test. The low-cost, high-throughput quadrant can be an attractive environment for those who can adapt. Good luck there.
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