SSgA Moves to Defend Sector SPDRs' Turf

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 |  Includes: VAW, VCR, VDC, VDE, VGT, VHT, VIS, VOX, VPU, XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY
by: IndexUniverse

By Murray Coleman

As stock markets took a beating in 2008, so did assets in most niche-focused sector exchange-traded funds.

And the hits were taken irrespective of sponsor. For example, look at the Consumer Discretionary category. Vanguard's entry (NYSEARCA:VCR) dropped from $133 million a year to $97 million by Dec. 31, 2008. Meanwhile, the SPDR tracking the same sector (NYSEARCA:XLY) dropped from $716 million to $667 million in the same time frame.

A review by IndexUniverse.com of data from key fund providers—as well as various sources such as the National Stock Exchange and Morningstar—found the same pattern holding up across the board.

For better or worse, sector ETFs, even when following different benchmarks and holding differing levels of concentration—basically followed the same downward trends last year in terms of assets.

As a result, it's interesting to note that the two leading low-cost players in that marketplace, Vanguard and SSgA, have recently adjusted their prices. (See charts below.)

Vanguard sector ETFs at the end of last year bumped their expense ratios up to 25 basis points each. And even more recently, SSgA has gone the other way, dropping their Select Sector SPDRs from 23 to 21 basis points apiece.

Battling To Be Low-Cost Leader

It's important to note that Vanguard says it runs ETFs and its mutual funds essentially at cost. Since it's set up as a shareholder-owned company, in most cases, that gives it an advantage as the industry's low-cost leader. But that isn't always the case. A few years ago, Fidelity Investments undercut Vanguard's index funds by selling several competing passively run funds at below cost.

At the time, Vanguard explained it wouldn't get involved in a price war and that it sold index funds at cost. A spokeswoman for the company reiterated that stance to IndexUniverse.com in a written response to questions regarding the fee increases for its sector ETFs.

Even though ETFs and mutual funds run by the company are priced at cost, administrative expenses and shareholder-related service operations are a function of asset growth, says Vanguard.

"As a fund's assets grow, funds realize economies of scale that help to reduce fund expense ratios. Correspondingly, as assets of a fund decline, expenses are spread across a smaller asset base, causing expense ratios to increase," said the Vanguard spokeswoman.

The fact that assets declined last year in not only Vanguard but also SSgA sector funds indicates that fee increases could be more a result of simple economics. As related by Vanguard, economies-of-scale can be used to a competitive advantage.

But when facing a bigger product lineup, such as the case seems to be with niche families such as the Select Sector SPDRs, those economies of scale can work against Vanguard. With highly specialized sector ETFs, a case certainly can be made that those types of investors are much different than Vanguard's usual ETF customer.

The result, says Lipper analyst Jeff Tjornehoj, is that SSgA has much greater resources from a purely asset-base level to compete against the much smaller Vanguard sector ETF family.

"State Street is vigorously defending its market share in sector ETFs. As much as Vanguard would like to offer the lowest-cost products everywhere it competes, this is a good example of how that's just not always going to be possible."

Competition

He added that Vanguard's main strength clearly remains with its more diversified family of ETFs. "But they remain highly competitive with State Street in sector ETFs," said Tjornehoj. "State Street and Vanguard both stand out as low-cost leaders in that part of the marketplace."

Entering 2009, Vanguard had assets of nearly $2.9 billion in nine sector ETFs. By contrast, corresponding sector SPDRs had slightly more than $23 billion in assets at the end of last year, according to NSX estimates.

"The expense ratios for our sector ETFs remain among the lowest-cost in the industry, and we have a history of lowering expense ratios over time as our funds grow in size," said the Vanguard spokeswoman. "In fact, the sector ETFs remain significantly lower-cost than at the time of their introduction in 2004, when their ERs were 0.28%."

And to be fair, the Vanguard sector ETFs have during good times dropped as low as 0.20% as markets soared and assets swelled.

But as markets continue to experience rough waters in 2009, investors more narrowly focused will no doubt be trying to gain as much advantage anywhere they can find it. Perhaps the most direct route is through reducing fund expenses.

Again, however, different sector funds track different benchmarks. That can cause two ETFs providing exposure to a seemingly narrow sliver of the market to display somewhat different characteristics. So while comparing expense ratios can be useful, remember that the differences in costs between the two families battling to be viewed as low-cost leaders in sector ETFs still are quite competitive.

Change is taking place however. We'll continue to monitor the situation and let you know how fluctuations in assets are being handled by different fund complexes and what sort of economies of scale they've got to work with at any given time.

The New Cost Leaders In Sector ETFs ...

Name

Ticker

Exp. Ratio (%)

1-YR Returns (%)

'08 Assets
($ mil)

Financials SPDR

XLF

0.21

-68.16

7,792*

Con. Disc. SPDR

XLY

0.21

-40.92

667

Con. Staples SPDR

XLP

0.21

-18.05

2,233*

Energy SPDR

XLE

0.21

-34.40

4,453

Health Care SPDR

XLV

0.21

-20.48

2,060

Industrials SPDR

XLI

0.21

-45.47

1,125

Technology SPDR

XLK

0.21

-36.19

1,837

Materials SPDR

XLB

0.21

-47.88

947

Utilities SPDR

XLU

0.21

-24.96

1,959

Click to enlarge

And The Old Cost Leaders ...

Name

Ticker

Exp. Ratio %

12-Mo Rets (%)

'08 Assets
($ mils)

Consumer Discret

VCR

0.25

-43.92

97

Consumer Staples

VDC

0.25

-20.06

571*

Energy

VDE

0.25

-35.03

549

Health Care

VHT

0.25

-20.71

529*

Industrials

VIS

0.25

-46.40

201

Technology

VGT

0.25

- 36.91

304

Materials

VAW

0.25

- 49.88

160

Telecom Services

VOX

0.25

- 34.52

148

Utilities

VPU

0.25

- 24.10

289

Click to enlarge

Source: Companies, NSX, Morningstar *=gain from 2007