Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Fee wars are heating up yet again in the exchange-traded fund space. Joining me to share some perspective on the latest news is Ben Johnson, he's director of global ETF research for Morningstar.
Ben, thank you so much for being here.
Ben Johnson: Thanks for having me Christine.
Benz: Ben, let's start with a topic that I think will be of high interest to our viewers: Vanguard announcing a range of fee cuts on 10 specific exchange-traded funds. Which funds are effected by this?
Johnson: Yeah, so it's fee war season in ETF land. The firm that arguably fired the first volley in the fee wars over 40 years ago now, Vanguard, as part of the normal course of business in filing annual prospectuses for their funds, let it be known that for 10 of their ETFs, they would be reducing the annual fee for these funds.
Now more notable still is that simultaneously they filed prospectuses for the Admiral share classes of those same funds. And for the first time ever, there's a difference between the two as it pertains to fees.
Benz: They had been in lock step before?
Johnson: They had always been lock step, and now for the first time, the ETF share class is actually priced below the Admiral share class of the mutual fund.
Benz: So one of the notable funds effected is the Vanguard Emerging Markets ETF. And in this case it's actually moving a hair cheaper than competing iShares product.
Johnson: Yeah, so the Vanguard Emerging Markets ETF, the ticker for which VWO, is now a shade cheaper than it's closest competitor I would argue, which is the iShares core emerging-markets, ETF, the ticker for which is IEMG.
Benz: So when investors are taking a step back and looking at whether they should go to an all Vanguard ETF portfolio or maybe look at some competitor portfolios, competitor ETFs, what's your take on that question? How do the Vanguard ETFs stack up relative to the competitive universe?
Johnson: Generally speaking, Vanguard's ETFs and their index mutual funds have always been fee competitive, if not the low cost leaders for most exposure to most corners of the market. Over the course of the past decade, I would argue and the data would bare out that a lot of the rest of the world is caught up, be it Fidelity, be it Schwab, be it Black Rock iShares. The competition now for assets in broad based index linked products is as heated as it's every been. If you look at these 10 most recent fee cuts, in some cases, again, now they're edging out the competition and others. If they're not the low cost leader, they're certainly neck and neck with their competitors.
Benz: Another related piece of news relates to a firm called SoFi, which made news this week when it launched a slate of free exchange-traded funds. First question before we get into what SoFi is, were you expecting the free ETFs to come from SoFi or were you thinking that another perhaps more established provider would launch that free ETF lineup?
Johnson: Well if you look back to last year and the announcement from Fidelity that it was going to launch a series of zero fee index mutual funds, that kind of gave birth to a lot of speculation around when would this happen in ETF land? What would be the first zero fee ETF, who would launch it?
And initially the speculation centered around Schwab that year launched the ETF version of their Schwab 1000 index product, that that might be the first zero fee ETF. There's still a filing out there from JP Morgan for a market cap weighted U.S equity ETF. Many thought maybe JP Morgan would be the first to do it. I don't think anyone, myself included, expected that it would be SoFi which this week updated a filing that had been out there for a while to show that two of the four ETFs that its registered for will, at least initially, be offered with a 0% expense ratio. And I say at least initially because that zero fee is made effective by way of a fee waiver that may or may not expire at some point in the future.
Benz: So what is SoFi? What business is it in? And also, can you talk about the types of ETFs that it's coming to market with?
Johnson: SoFi is sort of a financial services technology mashup. One of these firms that's trying to bring to bear many of the same services as many names that we've come to know and trust and do business with. But do it in a way that sheds brick and mortar, sheds oak paneled rooms and quilted leather chairs. And strips out all of those sort of legacy costs from the business to be much more competitive in terms of the rates it offers on banking products, loan products. And increasingly expanding its products suite into investing by way of opening up a brokerage portal, it's sort of own home-spun robo advisor and as well now, being at the cusp of throwing its hat into the ETF ring.
Benz: So the lineup that it's coming to market with are the ETFS that it's launching with zero priced tags, temporarily at least. It's not a conventional plain-vanilla market-cap-weighted series of funds, right?
Johnson: No, it's not. And I think the firm is trying to align this product suite, which is very growth oriented. So the first two ETFs, these zero fee ETFs, will tilt toward stocks that have kind of more growth oriented characteristics, their growing their sales, their growing their earnings, in an attempt to sort of align with kind of the demographic of the it's current and perspective clientele. Which, when I heard that, struck me as somewhat funny because that was actually the thinking behind sort of the original growth index fund, the Vanguard growth fund which launched in 1992. And per Jack Bogle, was developed with a sort of similar objective in mind.
That said, what you have to understand is that these have no peers. So it's not as though they're bringing to markets a total stock market index ETF that, by virtue of being free, is three or four or five bps cheaper relative to competitors. It's a free growth ETF that doesn't have competition so I liken it to someone giving me a free pair of size 17 basketball shoes. I mean, thank you but frankly I don't know what I'm going to do with this.
Benz: Investors who are watching these fee wars, if they're ETF investors they might feel a little like they're watching a game of tennis where you wonder one day, "Should I be a Vanguard investor, should I invest in iShares or Fidelity?" What's your advice to investors whether in traditional index funds which have been caught up in some of these fee wars as well or ETFs? How should they deal with these fees going lower? It's good for them but should they be chasing around the cheapest products?
Johnson: I think there are three things that investors should be aware of in all of this to help kind of cut through the noise. First and foremost, be wary of the risk of being a penny wise and a pound foolish, of being in a situation where you decide you're going to switch wholesale from one fund to another or one platform to another. Especially if you're in a taxable setting ...
Benz: Tax cuts for sure.
Johnson: ... you're never going to bring those savings back if you're a tax-sensitive investor. Second, and somewhat related to this, is to be cognizant of what's going on more fundamentally at the level of portfolio construction. So saving a basis point or two in fees here and there is certainly wise to do if you're comparing substantially similar portfolios. But when you're talking about indexes that, at face value, would at least appear to be similar, but once you peek under the hood are fundamentally different, saving a basis point or two on fees is going to mean nothing when framed against what might be measured in a percentage point's worth of difference in terms of long-term performance.
So to go back to the example that we referenced earlier in the pair of emerging markets ETFs, Vanguard's and iShares, those are underpinned by indexes from two different fund families or two different index families that have different definitions as to whether or not, South Korea is an example, major global market, is an emerging one or a developed one. And those differences in portfolio construction and index construction, over a long period of time, are going to be far more important than a bps or two worth of fee savings.
The final thing I'll say is that is the explicit, very transparent fees that see and we pay for investment products go ever lower, either approach zero or hit zero, more and more sort of the cost of the being an investor is going into the dark and becoming less explicit and more implicit.
I think that the poster child for this would be, what are you earning on your cash account? Depending on the platform that you're at, you might be earning 0.01%, you might be earning 2.25%. There's a real opportunity cost there, and your opportunity cost is the means via which that platform, that organization that you're doing business with is subsidizing things that are nominally free.
Benz: Great points Ben. It's always great to your perspective. Thank you so much for being here.
Johnson: Thanks for having me Christine.
Benz: Thanks for watching. I'm Christine Benz for morningstar.com.