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.

Major competitor The Vanguard Group Inc. has been gaining market share at BlackRock's expense, undercutting BlackRock's iShares products on fees, and rolling out new ETFs that go head-to-head with the market titan.

BlackRock, with $494 billion in global ETF assets, held 46% of the worldwide exchange-traded fund market, according to a report by Goldman Sachs Group Inc. Its nearest competitor, State Street Global Advisors, with $140 billion in global ETF assets, accounted for 13%, and Vanguard, with $113 billion worldwide, accounted for 11%.

But BlackRock's dominance is under threat, at least in the United States, its primary market.

Its U.S. market share was 46.9% as of Aug. 31, according to Goldman, that was down from 59.3% four years ago. By contrast, Vanguard's U.S. market share as of Aug. 31 was 14.9%, up from just 5.3% in 2006.

U.S. ETF revenue for 2010 is estimated to be $1.35 billion for BlackRock, $336 million for SSgA and $177 million for Vanguard, according to an analysis by 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 was not able to determine how much ETFs contribute to Vanguard's revenue.

According to P&I's analysis, a potential fee war could cost BlackRock around $400 million in lost revenue annually.

The challenge BlackRock faces is exemplified by the small net inflows to its $48 billion iShares MSCI Emerging Markets 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, 22 basis points.

Paul Justice, Chicago-based Morningstar Inc.'s chief ETF strategist, said the Vanguard emerging markets fund is on track to topple BlackRock's within a matter of months. 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 25 basis points on its emerging markets fund to narrow the fee difference 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.

Analysts say BlackRock might have to cut its fees on its emerging market fund and other of its most popular and profitable ETFs to stay competitive.

“We see this dynamic pressuring management fees for iShares in order to maintain its current market share,” the Oct. 5 research report from Goldman Sachs said.

Goldman noted that increased ETF competition is occurring as the industry matures and inflows decline. Goldman estimates total 2010 net inflows of $91 billion, compared with $116 billion in 2009 and $177 billion in 2008.

Vanguard introduced 17 funds last month alone, all of them competing directly with BlackRock using the Standard & Poor's or Russell indexes, and with an average of 22% lower fees.

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 indexes. The change will also allow SSgA to directly compete 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 say 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 in Valley Forge, Pa.

Mr. Dickinson said Vanguard was not cutting its expense fees with BlackRock in mind. He said the company annually reviews its fees to offer the best prices.

Mr. Dickinson attributes Vanguard's increase in ETF market share to growing awareness of its products. “Financial advisers and investors are giving our ETFs greater scrutiny, and they are realizing they are a better product,” he said.

BlackRock officials say 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 managing director and head of U.S. marketing for iShares in San Francisco. “We have the longest, most successful track record in the industry, and our products have been time-tested through various market cycles.”

Even if BlackRock were to maintain its pricing, it likely would lose revenue to Vanguard on its emerging markets ETF, said Ed McRedmond, senior vice president of institutional and portfolio strategies at Invesco PowerShares, Wheaton, Ill. PowerShares has almost $52 billion in assets and about 5.6% of the ETF market, according to the National Stock Exchange.

“For them (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 is facing increased competition from smaller players. A Morningstar analysis last month noted that money manager Van Eck's ETF business increased by $10 billion to $17 billion in the last year.

The report said the firm's newer products have been a resounding success with investors, including its Junior Gold Miners fund and its Brazilian small-Cap ETF.

BlackRock executives have chosen to make one price cut, however, taking direct aim at SSgA.

Seeing an increased demand for gold, BlackRock's Mr. Feldman said executives decided after a strategic review earlier 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, with more than $80 billion in assets.)

BlackRock's gold ETF has around a 7% market share in the U.S.; 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. After the price cut, it will bring in around $12 million annually.

Between July 1 and Oct. 31, the iShares gold fund has had $685 million in net inflows and the SSgA gold fund, $961 million in outflows, according to data from EPFR Global, an industry data provider.

Tom Anderson, global head of ETF strategy and research for SSgA in Boston, said the SPDR gold fund is a far superior product to its competitor. Without mentioning BlackRock by name, he said 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.

Mr. Anderson said investors will flock to the lowest-priced ETF if all factors are equal, creating more competition in the future on some select products. But he said SSgA executives believe the firm is well positioned.

Andy O'Rourke, chief marketing officer for Direxion Funds, a small ETF company based in Milwaukee, said 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."