Investing in low-cost ETFs is getting cheaper — and retail investors are the winners.
BlackRock is reducing the expense ratios on it suite of 15 Core ETF products. It's a shot across the bow to its competitors, but it's also an attempt by BlackRock to get out ahead of new fiduciary rules that will likely benefit ETFs and other forms of passive investments.
It's a battle of the titans — BlackRock is the biggest provider of ETFs in the world through its ownership of the iShares franchise. They are caught in a battle for control over billions of dollars in investor money pouring into ETFs.
The winner is U.S. investors — who are going to be saving even more money by investing in low-cost ETFs that are tied to major indexes.
Here's what's going on:
1. Blackrock is reducing the expense ratio on 15 ETF products. For example, the expense ratio for their iShares Core S&P 500 ETF (IVV), is going from 0.07 percent (7 basis points) to 0.04 percent (4 basis points).
- This is a bigger deal than it sounds. That means the yearly cost of keeping $10,000 in the IVV will go from $7.00 to $4.00.
- That doesn't sound like a lot, but it is a pretty big deal in the world of ETF investing.
The S&P 500 ETFs are the biggest ETFs out there. There are three main competitors, all offering essentially the same product — exposure to the S&P 500. But the amount they are charging is now very different:
S&P 500 ETFs (Expense Ratios)
We are talking about BILLIONS of dollars here. The SPDR S&P 500 ETF is the biggest ETF in the world, with almost $200 billion in assets under management. The iSharesCore S&P 500 has roughly $80 billion under management, and the Vanguard S&P 500 has roughly $51 billion under management.
2. The immediate reason for reducing the expense ratio is the recent Department of Labor (DOL) rule that managers of retirement accounts will be held to a higher fiduciary standard than they had been held to before.
- The effect of this rule is that financial advisors are looking around to make sure they comply with these rules, and that would partly include putting investors in the lowest cost investment, all other things being equal.
- While it's doubtful that FINRA will come knocking on your door and ask if you're violating a fiduciary rule over an ETF investment, they clearly want advisors to be mindful about low-cost alternatives.
- "This is another critical milestone to help advisors as they prepare for the major shift the DOL fiduciary rule requires — providing investors with quality index exposures at great value in the center of their portfolios," said Salim Ramji, Head of BlackRock's U.S. Wealth Advisory business.
- "This is the first salvo in a race to the bottom to comply with the DOL requirements," Dave Nadig, Director of ETFs for Factset told me. "These plain vanilla products are mostly the same. Why pay nine basis points when you can get the same product for four?"
3. The ETF business is big, and getting bigger every year. We are heading toward $3 trillion in assets under management. This is another salvo in the war among ETF titans for control of billions of dollars in investor money.
Biggest ETF providers (AUM, billions)
4. It's another nail in the coffin for active investing ... not dead yet, but clearly flailing. Active investment funds are 1) more expensive than passive funds, and 2) for the most part, do not outperform.
Todd Rosenbluth, who heads up ETF and mutual fund research at S&P Capital IQ, estimates that the average net expense ratio for roughly 830 large-cap core mutual funds — which are primarily actively managed - is 1.1 percent.
That means you're paying a fee of $110 a year for every $10,000 invested in an average large-cap mutual fund. For the iShares S&P 500 ETF, you're now paying $4.00.
That's a huge difference — $110 vs.$4 a year — and you pocket the difference!
And here's the galling part — they charge more and don't outperform! Rosenbluth noted that during the five-year period ended April 5, the large-cap group had an average annualized total return of 9.4 percent. The passively managed Vanguard 500 Index Fund had a return of 11.3 percent.
Rosenbluth's conclusion: "High-cost mutual funds with poor performance records will be harder for a financial adviser to justify."
Bottom line: Low-cost ETFs are winners, but very low-cost ETFs will be the biggest winners in the business.