Is A Cheaper Gold ETF A Better Gold ETF?

by on July 12, 2010 | ETFs Mentioned:

One of the most interesting developments in the ETF market over the last several years has been the extent to which investors have embraced these securities as opportunities to add commodity exposure to traditional stock-and-bond portfolios. Within the commodity space, no single fund has enjoyed a more impressive rise than the SPDR Gold Trust (GLD), which took in more than $7 billion in the first two quarters of 2010 and finished June with total assets of about $52 billion. That makes GLD the second largest U.S.-listed ETF by total assets, and it isn’t far-fetched to imaging that it will soon take over the number one spot [see Why GLD Will Overtake SPY].

GLD isn’t the only physically-backed gold ETF on the market, but it is by far the biggest; ETF Securities’ SGOL has about $600 million in assets, while the iShares COMEX Gold Trust (IAU) finished June at about $3.4 billion. Those are impressive totals, but look downright tiny next to GLD’s staggering numbers.

If iShares has its way, it might not stay that way for long. In the latest shift in the ETF industry competitive landscape, iShares announced recently that it is slashing the expense ratio on IAU from 0.40% to 0.25%, making its fund more attractive from a cost perspective than GLD. iShares appears to be giving up short-term revenue in hopes of building  a more substantial asset base behind its gold ETF [also see Five Head-To-Head ETF Matchups To Keep An Eye On].

It’s an interesting move, but it remains to be seen just how important a slightly lower expense ratio is for investors. The additional 15 basis points charged by GLD works out to about $1,500 annually on a $1 million investment, meaning that the impact for most investors will be relatively minor. It’s unlikely that existing investors in GLD will start pulling out and heading to the cheaper iShares alternative. But it’s entirely possible that investors looking to establish a position in gold will gravitate towards the ETF that will give them the highest bottom line return. That’s exactly what has happened in the emerging market space; VWO has gained ground on the otherwise similar EEM thanks largely to a lower expense ratio [ETF Moneymakers: Some Surprising Stats].

In the equity and fixed income universe, there can be material differences between even ETFs that seek to replicate the same benchmark; the use of sampling or replication strategies can affect the number of individual holdings and effective return, as can various rebalancing tactics [see Five Key Differences Between EEM and VWO]. Because gold is a commodity, however, gold ETFs tend to be homogeneous in nature; expense ratio is one of the few areas in which otherwise similar funds can differ.

Mixed Results

It’s interesting to note that iShares has had a great deal of success breaking into niches dominated by other ETF issuers. The recently launched iShares MSCI Poland Investable Market ETF (EPOL) already has about $50 million in assets, or nearly double the cash in the Market Vectors Poland ETF (PLND) that has been around since November 2009.

But it’s worth noting that other ETF issuers have attempted to implement price-slashing strategies before, with limited success. ETF Securities had previously undercut both IAU and GLD, charging 0.39%. The $600 million-plus racked up by the fund is nothing to scoff at, but it’s a drop in GLD’s bucket.

In May, GlobalShares announced that it was cutting the expense ratio on its FTSE Emerging Markets Fund (GSR) to 0.25%, making it the cheapest fund in the Emerging Markets Equities ETFdb Category. GSR saw no cash inflows last month, while the more expensive EEM and VWO took in more than $2 billion in aggregate.

Price Wars Escalate

It’s tough to tell how iShares gold ETF gamble will pay off. Perhaps the most interesting part of this story is that iShares has joined in the industry price wars. Over the last year, a number of ETF issuers have cut expense ratios on portions of their product lineups in an effort to generate new interest and grow assets [see Schwab Declares ETF Price Wars]. Even after Vanguard announced that it is preparing to launch ETFs linked to indexes underlying popular iShares funds, most in the industry had expected iShares to stand its ground, keeping its expense ratios steady and relying on the firm’s widespread recognition, efficiency in operating ETFs, and the liquidity of its funds to retain investors.

But the industry’s big dog has joined in the cost-cutting game, moving closer to the end of the expense ratio spectrum historically occupied by Vanguard and Charles Schwab. It’s still far too early to tell what all of this means for the competitive balance in the ETF industry, but it’s fairly certain that we haven’t seen the last twist or turn in this saga. Stay tuned; iShares’ decision to cut expenses on its gold ETF could have a lasting impact on the ETF industry [also see Five Bold Predictions For The ETF Industry].

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Disclosure:  No positions at time of writing.