184-Investment Turf Wars

Over the last year, U.S. investors have pulled over $20 billion out of domestic stock funds and replaced these investments, in large part, with bond funds. Not every type of stock fund suffered, however. The February 2010 data illustrate this. Domestic stock funds, during that month, suffered $3.7 billion in withdrawals. On the other hand, international stock funds gained $4.6 billion. But the big winners were domestic Exchange Traded Equity Funds. They gained $4.8 billion. These ETFs are attracting investors with their very low costs in management fees and superior tax efficiency over the average mutual fund. Their growth is also an indication that investors have become more price-sensitive than they have been in the past. (See the Symptom & Implication, “Customers are more price sensitive” on StrategyStreet.com.)

There is another interesting example of this emerging price-sensitivity in the potential for something of a price war among similar ETFs. In particular, there are two ETFs which seem to be squaring off against one another. One fund, iShare’s MSCI Emerging Markets Index Fund (EEM) is the dominant leader among ETFs that track emerging markets. A growing follower is Vanguard’s Emerging Markets ETF (VWO).

The approach and results from both funds are similar. Each fund tracks the same index, the MSCI Emerging Markets Index, though they follow somewhat different approaches in tracking that index. Over the last five years, both funds have had similar returns on investment after consideration of price appreciation and dividends.

Despite their similarities, the two funds today show radically different appeals to investors. Over the last three months, EEM has experienced $4.4 billion in net outflows. In contrast, VWO has had $8 billion in net inflows over the same period of time. This $12 billion difference flies in the face of the fact that EEM today has over $39 billion under management, while VWO has $21 billion.

The apparent explanation? Pricing. The prices of these two similar ETFs are different. EEM charges 72 basis points (a basis point is 1% of 1%, so 50 basis points is equivalent to half a percent, or .50%). VWO, on the other hand, charges only 27 basis points.

The competitive landscape may be changing for these two very large ETFs. For most of the last five years, they did not bump into one another with great frequency. EEM concentrated on the institutional market, while VWO sought the hearts of retail investors. That may be changing. As markets grow fast, sooner or later companies in similar niches begin running into one another. (See the Symptom & Implication, “Competitors in formerly underdeveloped markets have begun meeting one another” on StrategyStreet.com.) Witness Lowes and Home Depot, Staples and Office Max and Office Depot. When that happens, pricing begins to play a more important role in the battle equation between the two competitors.

Over the last few years, investors have developed a clear preference for inexpensive ETF funds rather than actively managed mutual funds. Now that low-price preference also seems to be showing up in competition among ETFs. Investors will surely be the winners here.

Posted 5/3/10

Without question, the market has made a clear statement on the relative value of VWO compared to EEM. The ETF VWO, managed by Vanguard, has an expense ratio of eight basis points and assets under management of $96 billion. VWO has become both much larger and notably less expensive over the last 12 years. On the other hand, EEM, managed by BlackRock, is shrinking even though its expense ratio is somewhat lower than it was 12 years ago. EEM’s expense ratio is 68 basis points; it oversees $26 billion in assets.  The ETF VWO is a Transformer Next Leader product, which has both function and price advantages over EEM. The gap in size between the two funds can only grow larger. See HERE and HERE and HERE for more perspective.



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