Analysis: U.S. ETF duopoly meets increased competition

CHICAGO (Reuters) - Exchange-traded funds have seen exponential growth over the past decade, but just two firms -- State Street Corp STT.N and BlackRock's BLK.N iShares unit -- were the main beneficiaries.

Now that may be changing.

Mutual fund giant Vanguard Group, which had been a minor ETF sponsor, has moved aggressively to introduce new products with even lower fees than some of the category leaders.

As a result, Vanguard, best known for its low cost index mutual funds, has collected almost half of the new money from ETF investors this year, $22.6 billion through the end of August, according to Strategic Insight, a market research firm in New York.

New entrants including fixed-income titan PIMCO and discount broker Charles Schwab SCHW.N have garnered a growing share of the new inflows. PIMCO's bond-oriented ETFs picked up almost $1 billion in the first eight months of the year. And Schwab's broader line-up, helped by its offer to let customers trade its ETFs for free, has brought in $1.2 billion.

“The ETF space is just growing more and more relevant for investors every day,” Morningstar analyst Paul Justice said. The main attractions of ETFs are “the focus on keeping costs low and transparency,” he added.

The Chicago research firm -- traditionally focused on mutual funds -- is holding its first conference devoted solely to ETFs this week.


After years of fund introductions focused on smaller and smaller niches, this year’s ETF market is also seeing more focus on new funds that essentially duplicate the very largest and most popular existing funds.

Just this month, for example, Vanguard decided to take on the largest ETF of all, State Street's $80 billion SPDR S&P 500 fund SPY.P.

The SPDR fund, known by its ticker symbol “SPY,” averages over 200 million shares traded a day and is used by everyone from “buy and hold” retail investors to the fastest of the computer driven high-frequency trading firms.

Vanguard's fund will charge investors a 6 basis point annual fee, below the 9 basis point fee charged on the SPY and iShare's S&P 500 ETF IVV.P.

State Street and BlackRock are shrugging off the increased competition, saying there is room enough in what is now an $800 billion market for plenty of rivals.

“Competition is always going to be there and, frankly, if you don’t have competition you don’t have a good marketplace,” said Jim Ross, senior managing director for ETFs at State Street.

London-based ETF Securities has drawn attention for its new line of precious metal funds, including products investing in gold, platinum and palladium, and collected $1.2 billion from U.S. investors this year.

Still, State Street's gold ETF, the $53 billion SPDR Gold Shares fund GLD.P, dominates that sector.


One question hovering over the ETF market remains the performance of many funds during the May 6th “flash crash” when stock prices plummeted and recovered in a 20-minute span.

Even though most stocks dropped 10 percent or less in price on May 6, many ETFs that track indexes of those stocks briefly lost more than 60 percent of their value, with a few trading as low as a penny. More than two-thirds of the trades canceled from the market maelstrom involved ETFs.

Though no one has definitively explained the flash crash or why ETFs were disproportionately affected, the Securities and Exchange Commission has extended its new individual security trading halts, or circuit breakers, to many ETFs.

Morningstar analyst Justice said the crash exposed “a growing pain” in the ETF market that he expected market makers and regulators would address. “The industry still has some work to do,” he said.


ETF sponsors are still scrambling to fill a few empty niches. On Tuesday, State Street introduced the SPDR S&P Global Natural Resources ETF GNR.P. Existing natural resource funds, like the iShares S&P North American Natural Resources Sector Index Fund IGE.P, generally have a narrower focus that the State Street fund which will hold 90 stocks from 25 countries.

Some money managers had expected that last year’s regulatory approval of actively-managed ETFs would help ignite further growth. But so far there are few signs of that, according to Strategic Insight’s data. Actively managed funds totaled just $2 billion at the end of August.

“This could be another area of innovation, but it is too soon to tell,” analyst Loren Fox at Strategic Insight said.

Reporting by Aaron Pressman. Editing by Robert MacMillan