By Matthew Hougan
When will Barclays do the right thing for investors and bring down the price of EEM?
All this talk about a possible new Vanguard MSCI Total Market ETF, and how that would pressure Barclays Global Investors [BGI] to lower expenses on its MSCI-based ETFs, got me thinking again about the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM).
It's stuck in my craw for a long time that BGI continues to charge 0.74% in expenses for EEM. As of August 8, that fund had $21.5 billion in assets under management—a huge amount, making it the third-largest ETF in the world. With a 0.74% expense ratio, BGI is earning $151 million per year in revenues from EEM alone. I don't begrudge them profits, but $151 million from a single fund seems indulgent.
BGI has rules in place for many of its ETFs that require it to systematically lower the expense ratio as assets under management grow; that's why you see single-country ETFs from BGI cutting their expense ratios year after year.
But for whatever reason, EEM is exempt for those rules, and the management team in San Francisco keeps the expense ratio stuck at 0.74%.
The fact that the Vanguard Emerging Markets ETF (AMEX: VWO) tracks the same index and charges just 0.30% per year makes the EEM expense ratio seem especially high.
It is starting to hurt EEM's inflows a little. From December 29, 2006, through August 8, 2008, investors poured approximately $4.4 billion in new money into EEM, compared to $5.7 billion into VWO.
Still, EEM's assets under management grew more on a net basis, as a rising market inflated the value of its larger assets base. Over that same time period, EEM's assets rose from $15.6 billion to $21.5 billion, an increase of $5.9 billion; by contrast, VWO's assets rose from $2.0 billion to $6.9 billion, an increase of $4.8 billion (after you adjust for rounding errors).
There are some possible explanations why investors aren't up in arms about EEM's high fees.
A lot of the money invested in funds like EEM is being used for trading purposes, where EEM's huge liquidity trumps any expense ratio savings. If you're only holding the fund for a few months, buying the most liquid ETF is a no-brainer.
It's also possible that investors are comparing the performance of EEM and VWO over the past year, and seeing that EEM has beaten both its competitor and its benchmark. In fact, EEM has delivered a 0.98% return over the past year, while the index is down 2.07%. While that sounds good, it actually makes me nervous: EEM is a heavily optimized fund, holding just 338 of the 800+ stocks in the underlying index. That optimization process means that EEM will sometimes beat its index; of course, at other times, it will lose. As I wrote in ETFR in September 2007, for the year ending July 31, 2007, EEM lagged its benchmark by 7%. Tracking error can and does go both ways.
In the end, it comes down to a simple observation: The expense ratio is too high. $151 million in revenues per year? Investors may not care enough to pressure BGI on this, but they should.