By Elisabeth Kashner, CFA, VP, Director of Global Fund Analytics, FactSet Research Systems
U.S. ETF investors, who continued to add to their positions during the recent market correction, are a patient lot when it comes to maintaining market exposure. Waiting for a market bounce feels less awful when it doesn’t cost much, fee-wise.
For all the market chaos of the first half of 2022, one trend remained intact: the drive towards ever-lower ETF costs. ETF investors continue to direct their cash to the cheapest of the cheap, as asset managers scramble to stay competitive.
Continued Fee Compression Across Asset Classes
The race to the bottom is still on. At the end of June 2022, the asset-weighted U.S. ETF expense ratio dropped to 0.180% per year, down from 0.183% in December 2021. That’s a 0.006% annualized decline, like 2020’s, but slightly slower than 2021’s 0.008% drop. Fee compression saved U.S. ETF investors $90.4 million since the end of 2021, based on June 30 ETF asset levels.
As in past years, fee compression is not limited to vanilla equity ETFs. It’s everywhere, in every asset class (except commodities, where SPDR Gold Shares are having a moment) and every investment strategy. Even currency ETF fees have resumed their decline after absorbing pricey bitcoin futures ETF launches last year.
The chart below shows the history of asset-weighted average ETF expense ratios over time, broken down by asset class. Bear in mind that the 2022 data is for a half year—the others are full-year figures.
Average fixed income ETF costs fell rapidly, down 0.015% in the first six months of 2022. Equity fees were less affected on average, dropping just 0.001%. This relative flatness might be attributable to shifting preferences for investment strategies, as investors sometimes select equity ETFs with complex, and therefore more expensive security selection and weighting methodologies.
For a few years, ETF investors have been increasingly interested in active management, which carries a higher expense ratio than plain vanilla ETFs. 2022 year-to-date (YTD) flows into strategic ETFs, the so-called “smart beta” products, picked up significantly. Strategic funds also charge more than plain vanilla.
Equity ETF Fees by Investment Strategy
To adjust for this counter-migration, it’s helpful to break out equity ETF fees by investment strategy. The chart below shows the history of equity ETF expense ratios for each investment strategy group. It’s the same downward stair-step pattern we see in the asset class fee history chart.
Through June, vanilla equity ETF expense ratios fell 0.004% on an asset-weighted basis, while idiosyncratic ETF (think equal weight, ESG, and exchange-specific ETFs like Invesco’s QQQ-US) costs dropped by 0.003%. Contrarily, strategic fund costs ticked up by 0.006%. But the biggest change by far was in actively managed equity ETFs, which fell by 0.087% in just six months. Should this trend continue through year-end, actively managed equity ETFs might cost just 0.31%. That would be less than half their cost at the end of 2020.
Growth in Actively Management Equity ETFs
Inflows to the cheapest actively managed equity ETFs are responsible for this shift, far more than fee cuts, as the active equity ETFs grew by 35.5% in the first six months of 2022. Some of that growth was powered by mutual-fund-to-ETF conversions. Even excluding the conversion flows, actively managed ETFs grew at a blistering 23.1% pace through June 2022.
To understand cost competition in active ETFs, it’s helpful to look at an example. The U.S. total market segment’s 156 ETFs include 64 actively managed funds from 39 issuers. It attracted $5.1 billion of inflows YTD, aside from mutual fund conversion transfers.
Those flows were highly lopsided, with Dimensional and The Capital Group capturing 54.4% and 13.9%, respectively. Dimensional’s total U.S. market ETFs are priced super 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-hand side of the chart below, which shows the percent of segment flows captured by each asset manager, arranged by their asset-weighted expense ratios.
ETF issuers with actively managed U.S. total market ETFs that cost on average 0.16% or less captured three out of every four dollars directed to active management. Active ETFs that cost 0.40% or more took in just 11% of the active flows. In that context, even Capital Group’s 0.33% charge for their dividend value and core equity ETFs seems uncompetitive.
Investor preferences for low-cost active equity ETFs covering the U.S. total market show the challenge that today’s competitive landscape poses for asset managers. While differentiated strategies may launch at higher costs, competition will erode initial profit margins until the investors have captured virtually all the surplus. The only question is, how long will it take?
Case Study: International High Dividend Yield ETFs
A time series-based example allows us to see how ETF fee compression has reshaped the asset management industry over time. International high dividend yield ETFs make for a great case study because of the limited segment size (just six competitors) and high investor interest, namely $1.6 billion in YTD inflows. From February 2016 to the present, the segment grew from $790 million to $5 billion, with half of that coming in 2021 and 2022.
On February 25, 2016, the first-to-market SPDR S&P International Dividend ETF (DWX-US) was well-established, having launched in 2008. DWX had a 97% market share with $766 million in AUM and charged 0.45% per year. DWX’s existing competitors, launched in 2013 and 2015, had struggled to gather assets. The newcomers’ misfortunes were understandable—First Trust charged 0.78% per year; DWS XTrackers chose to match, but not undercut, SSGA’s fee in its currency-hedged international dividend ETF. By 2015, currency hedging had already passed its peak popularity.
That day, the Vanguard International High Dividend Yield ETF (VYMI-US) launched with a 0.30% price tag. Since then, SSGA’s DWX has lost assets and market share. By June 2022, its AUM stood at $561 million, an 11% market share. VYMI, in contrast, ended June 2022 with $3.95 billion AUM, a 79% market share. Eight percent of the remaining market share is now with the Schwab International Dividend Equity ETF (SCHY-US), which launched last April. SCHY’s expense ratio is a skinny 0.14%.
First Trust and DWS never gained traction, nor did new entrant Virtus. First Trust’s 2018 expense ratio cut, from 0.78% to 0.60%, left it in the same position—the most expensive in the segment. DWS cut HDAW-US’s fee in 2018 down to just 0.20%, and dropped the currency hedge. A fee of 0.20% should have been attractive to new buyers, but the strategy switch may have made investors nervous. Virtus WMC International Dividend ETF, launched in 2017, has been priced unattractively at 0.49%.
The chart below, which combines FactSet’s historical expense ratio data with AUM and fund classifications data, depicts how fee compression has reshaped this ETF segment. The minor competitors have been excluded, for readability’s sake.
Today, Vanguard and Schwab are the only real competitors in the international high dividend yield segment. Low-cost leader Schwab has taken over the task of consuming SSGA’s market share, while Vanguard holds steady. Will Vanguard announce a competitive fee cut for VYMI this year?
These examples of fee compression at work in the U.S. total market and the international high dividend yield segments are not anomalies. They are the headline story. Many asset management firms have leaned hard on rising markets to offset organic shrinkage, while preserving profit margins.
The combination of a bear market and fee compression leaves nowhere to hide. Firms like Vanguard, Charles Schwab, and Dimensional ETFs have figured out how to compete in a low-fee environment and have been reshaping the competitive landscape on their terms. It’s no mean feat to garner inflows 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 a starting 28.8% U.S. ETF market share. Schwab drew 6.9% of flows on a 3.8% base. Dimensional ETFs began 2022 with just 1.3% of overall ETF assets and went on to capture 4.8% of ETF flows (again, excluding conversions, even its 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, bringing in 23.5% and 0.3% of YTD flows against starting market shares of 34.2% and 14.5%. Blackrock’s asset-weighted average expense ratio in June was 0.18%; SSGA’s was 0.13%. The math is relentless.
For investors, saving on fees helps tremendously in a harsh market environment. For asset managers, bear market fee compression may prove a severe test. The low-fee, high flows quadrant can be an attractive environment for those who can adapt. Good luck out there.
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