BlackRock revenue takes hit in ETF fee wars

BlackRock Inc. is losing its tight grip on the $927 billion U.S. ETF market — potentially costing the company hundreds of millions of dollars in revenue — and the competition is just starting to heat up. A major competitor, The Vanguard Group Inc., has been gaining market share at BlackRock's expense, undercutting the latter's iShares products on fees and rolling out new exchange-traded funds that go head-to-head with the market titan. BlackRock, which has $494 billion in global ETF assets, holds 46% of the worldwide ETF market, according to a report by The Goldman Sachs Group Inc. Its nearest competitor, State Street Global Advisors, with $140 billion in global ETF assets, accounts for 13%, and Vanguard, with $113 billion in assets worldwide, accounts for 11%. But BlackRock's dominance is under threat, at least in the United States, its primary market. BlackRock's U.S. market share was 46.9% as of Aug. 31, according to Goldman, down from 59.3% four years earlier. By contrast, Vanguard's U.S. market share was 14.9%, up from just 5.3% in 2006. U.S. ETF revenue for this year is estimated to be $1.35 billion for BlackRock, $336 million for SSgA and $177 million for Vanguard, according to an analysis by sister publication Pensions & Investments. U.S. ETFs contribute an estimated 18% to BlackRock's money management revenue and 30% to SSgA's, according to the P&I analysis. P&I wasn't able to determine how much ETFs contribute to Vanguard's revenue. According to P&I's analysis, a potential fee war could cost BlackRock about $400 million in lost revenue annually. The challenge that BlackRock faces is exemplified by the small net inflows to its $48 billion iShares MSCI Emerging Markets ETF compared with a similar Vanguard fund. The emerging-markets ETF — BlackRock's biggest revenue-producing ETF — garnered $4.3 billion in net inflows this year through October. But Vanguard's MSCI Emerging Markets fund had $16 billion in net inflows during the same period, reaching $40.5 billion in assets. The BlackRock ETF is priced at 72 basis points; Vanguard's at 22 basis points. The Vanguard emerging-markets fund is on track to topple BlackRock's within a matter of months, said Paul Justice, Morningstar Inc.'s chief ETF strategist. The reasons, he said, are lower costs and an increase in liquidity as Vanguard's ETF gets closer in size to BlackRock's. That change would be no small matter for BlackRock's iShares unit, which would lose an estimated $115 million in revenue if it reduced its fees on its emerging-markets fund by 25 basis points to stay competitive, according to P&I's analysis. The change would mean more than a 1.5% hit to BlackRock's total revenue, according to P&I estimates.

CUTTING FEES

Analysts said that BlackRock might have to cut its fees on a number of its most popular and profitable ETFs to keep pace. “We see this dynamic pressuring management fees for iShares in order to maintain its current market share,” according to the Oct. 5 research report from Goldman. Goldman noted that increased competition among ETFs is occurring as the industry matures and inflows decline. Goldman estimates total 2010 net inflows of $91 billion, compared with $116 billion last year and $177 billion in 2008. Vanguard introduced 17 funds last month alone, all of them using Standard & Poor's or Russell Investments indexes and competing directly with BlackRock. The Vanguard funds cost 22% less than Blackrock's. SSgA filed in October with the Securities and Exchange Commission to shift seven of its passive equity funds to the more popular S&P indexes from the Dow Jones & Co. Inc. indexes. The change also will allow SSgA to compete directly with some of BlackRock's products. Both SSgA and Vanguard were able to take advantage of the end of an exclusive 10-year index licensing agreement between BlackRock and S&P. “Our clients gave us feedback that they liked the S&P indexes better,” said Gary MacDonald, managing director and global head of ETF marketing at SSgA. “It was a better-known brand.” SSgA's ETF fees generally are between BlackRock's and Vanguard's. Vanguard officials said that they plan to continue to expand in the ETF market. “We are committed to this marketplace as a strategic imperative,” said Joel Dickinson, a senior ETF strategist at Vanguard. Vanguard didn't cut its expense fees with BlackRock in mind, he said. The company annually reviews its fees to offer the best prices, Mr. Dickinson said. He attributed Vanguard's increase in ETF market share to a growing awareness of its products. “Financial advisers and investors are giving our ETFs greater scrutiny, and they are realizing they are a better product,” Mr. Dickinson said.

BEST PRODUCTS

BlackRock officials said that they have the best products and a good pricing schedule that doesn't need to be revised. “We believe iShares ETFs are fairly priced and deliver value, high quality and reliability to investors,” said Kevin Feldman, BlackRock's managing director and head of U.S. marketing for iShares. “We have the longest, most successful track record in the industry, and our products have been time-tested through various market cycles.” But BlackRock probably can't win a price war against Vanguard on its emerging-markets ETF, said Ed McRedmond, senior vice president of institutional and portfolio strategies at Invesco PowerShares Capital Management LLC. PowerShares has almost $52 billion in assets and about 5.6% of the ETF market, according to the National Stock Exchange. “For [BlackRock], it's a tough decision. Do they cut the expense ratio and take a big, immediate hit or do they maintain their fees and potentially lose assets over time?” Mr. McRedmond asked. BlackRock also faces increased competition from smaller players. A recent Morningstar analysis noted, for instance, that money manager Van Eck Global's ETF business increased by $10 billion to $17 billion in the past year. Van Eck's newer products, including its Junior Gold Miners Fund and its Brazilian Small-Cap ETF, have been a resounding success with investors, according to the report. BlackRock executives have chosen to make one price cut, however, taking direct aim at SSgA. Seeing an increased demand for gold, Mr. Feldman said that executives decided after a strategic review this year to cut prices on its gold ETF, iShares Gold Trust, to 25 basis points, from 40, effective July 1. That gave BlackRock a 15-point advantage over SSgA's offering, SPDR Gold Shares, the second-largest ETF in the world, which has stuck to its 40-basis-point fee. SSgA is the marketer of the ETF, which is sponsored by the World Gold Council. The largest ETF is State Street's SPDR S&P 500, which has more than $80 billion in assets. BlackRock's gold ETF has about a 7% market share in the United States; market share gains could create pricing pressure for SSgA. With $55.9 billion in assets, SPDR Gold contributes an estimated $69 million, or 20%, of SSgA's ETF revenue and 6.2% of the firm's asset management revenue, the analysis shows. Before the price cut, BlackRock's gold ETF would have brought in about $19 million annually. At the new price, it is expected to bring in about $12 million annually. Between July 1 and Oct. 31, the iShares gold fund had $685 million in net inflows and the SSgA gold fund had $961 million in outflows, according to data from EPFR Global, an industry data provider.

ALL THINGS EQUAL

The SPDR gold fund is a far superior product to its competitor, said Tom Anderson, global head of ETF strategy and research for SSgA. Without mentioning BlackRock by name, he said that SSgA's fund had much greater liquidity, trading 44 times as many shares on a daily basis as the next-biggest competitor at the end of October. Investors will flock to the lowest-priced ETF if all factors are equal, creating more competition in the future on some select products, Mr. Anderson said. But he said that SSgA executives think that the firm is well-positioned. Andy O'Rourke, chief marketing officer for Direxion Funds, a small ETF company, said that while the biggest players have been counting on their brand names to drive sales, it might not matter much. “Those big players, they're fighting for market share,” he said. “They're looking to establish a brand in a market space where brand doesn't matter.” Randy Diamond is a reporter, and Aaron Cunningham is the data editor, at sister publication Pensions & Investments.