ETF datapoints of the day, market-share edition

By Felix Salmon
January 20, 2012

Conceptually, it makes sense that ETFs would be a winner-takes-all phenomenon. Expenses rise much more slowly than assets, which means that the bigger a fund gets, the cheaper it can be. And given that ETFs compete first and foremost on expense ratio, money is likely to pour into the cheapest-and-biggest funds, which allows them to get even cheaper. And so on.

So this chart, from Lipper, comes as little surprise.

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In many ETF categories, it turns out, one ETF has the lion’s share of the market — Vanguard in total stock market ETFs, Market Vectors in precious metals, iShares in TIPS and investment-grade bonds.

So one would expect that those big dominant funds would be significantly cheaper than their competition — that would explain their dominance. And, one would be right — if you just look at precious metals. But elsewhere, that’s not the case.

Among total stock market ETFs, the Vanguard VTI fund is extremely cheap, charging just 0.06%, but the Schwab US Broad Market ETF charges exactly the same, and has just 0.46% of the assets in the class.

The cheapest investment-grade bond ETF is the Vanguard Long-Term Corporate Bond ETF, with an expense ratio of 0.14% — but it has only 2.3% of the purple pie. The iShares is only 1bp more, but has 90% of the assets.

And when it comes to TIPS funds, all of the big ETFs — iShares, Pimco, and SPDR — charge the exact same 0.20%. But iShares gets nearly all the business.

Now we’re not talking, here, about the kind of small, illiquid ETFs which can easily underperform. All of these funds are big enough that, to a first approximation, they’re all as safe as each other.

But still, at the margin, a big ETF is always going to be safer than a smaller one. And I suspect that most of these funds have a first-mover advantage, and that their competitors might well be losing money in their attempt to stay competitive with the giants in the space.

Is there any reason, for an individual investor, to choose one of the smaller ETFs rather than the big ones here? I don’t think so. Big mutual funds can be lumbering and dangerous, but big ETFs just have that much more clout in things like the repo market. And all ETFs get front-run by algorithmic high-frequency traders in exactly the same way: I don’t think big ones suffer more on that front.

My feeling is that if you choose the big fund, the fees might come down as it gets bigger; if you choose something small like the Schwab broad market fund, by contrast, the fees might well go up if its managers give up trying to compete with Vanguard. So if you’re going to buy one of these ETFs, you might as well follow the crowd. This is one area where contrarian investing will likely get you nowhere.

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