The Evil ETF Cartel?

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 |  Includes: BLK, STT
by: Roger Nusbaum

Tom Lydon sat for what turned out to be a poorly conducted interview with Mark Haines and Simon Hobbs about whether iShares, SPDR and Vanguard represent an ETF cartel with their combined 83% market share. I'm not sure if Haines really does not understand the product or just acts like he doesn't understand the product, as he often asks something like, 'with over 1100 ETFs which ones can I make money with now?'

The cartel argument was quickly quashed by Tom for the price undercutting that exists. To this I would add that there is also overlap with only slight differentiation in many market segments and it seems like there will be more in the way of me-too funds across the entire industry.

In talking about brokerages offering free ETF trades, Mark asked what is in it for them, and Tom took "them" to mean investors but I think Mark meant the brokerages. The answer here is an asset grab to hopefully (from the perspective of the brokerage) charge fees for other things and possibly also to build an asset base to lend shares out to make revenue that way. The share lending would potentially apply to anyone with their own ETFs, not Fidelity or TD Ameritrade (NASDAQ:AMTD) who are offering other companies' funds.

Simon asked a question about whether fees might go up at some point should the largest providers' market share grow. While nothing can be ruled out, seemingly every fee that existed prior to ten years ago has gone down -- $19.95 used to be a very cheap commission and now it is not even remotely competitive -- but there are now fees for services where there used to be no fee, like for transferring accounts, and there are many others, but investing expenses and trading expenses seem like they've been a one-way trade for years, maybe even decades.

Tom got jumped on for saying early on 'no cartel' but then saying that companies work together to be "protective of the industry." From where I sit it seems to me that the firms participating in the industry realize they have a gold mine and are very motivated to not foul it up. I would be shocked if there was actual collusion, and I think the points about fees and products go a long way toward undercutting the cartel argument, but no one should lose sight of the dynamics here. These are financial companies with financial products. Some element of buyer beware must exist, even if just for common sense reasons.

As someone whose livelihood includes the use of ETFs, I have to believe the providers are trying to make a profit, which creates some level of adversarial relationship. This is not a reason to avoid the product in my opinion as the funds help our clients, but in the entire relationship between the provider and the end user, both parties are not on the same side of the table for each individual issue. The same is also true with providers of traditional mutual funds or anyone executing an individual stock trade for you. Anyone not aware of this does not understand the body of water they swim in, which is a far bigger problem than the threats that exist within the ETF industry.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.