By Erika Fry, reporter
FORTUNE -- Vanguard rose to the pinnacle of the mutual fund world with a simple but potent formula: an emphasis on low fees and index funds. These days Vanguard is applying that same philosophy to a fast-growing sector of the investing universe already built around low-cost indexing: exchange-traded funds. The company is making dramatic inroads.
In just four years Vanguard has doubled its share of the ETF market to 18.2%. Much of that gain has come at the expense of leader iShares, which was bought by BlackRock in 2009. iShares now holds 41.2% of the market, seven percentage points lower than three years ago, according to Morningstar. SPDR, owned by State Street Global Advisors, retains 24.4% of the market.
It's a clash of the trillionaires as Vanguard (which manages $2.2 trillion) squares off against BlackRock (which oversees $3.7 trillion), while State Street ($2.1 trillion), for now, hangs back and observes.
Vanguard isn't just the cheapest of the three. Its fees -- 0.15% of assets for stock ETFs -- are about a quarter of the average 0.56% for equity ETFs, according to data through September provided by Lipper. (The equivalent figure for mutual funds is 1.29%.)
Vanguard's approach has spurred a series of price cuts. In April, Vanguard reduced its fees. In September, ETF newbie Charles Schwab (SCHW) outdid that with offerings as low as 0.04%. In October, BlackRock slashed its prices and introduced a new line of low-cost ETFs. In November, Invesco, the No. 4 player, announced a reduction. And in December, Vanguard cut fees again, only months after announcing it will change indexes for some ETFs in 2013, a move also intended to bring down costs.
The flurry of discounting is the latest phase of a battle that has been playing out for several years, says Matt Hougan, president of ETF analytics at IndexUniverse. It started when investors took notice of Vanguard's Emerging Markets ETF (VWO). Priced at less than half the comparable iShares offering (EEM) (0.35% vs. 0.75%), Vanguard's fund was also performing better. That fund's success then helped draw investors to Vanguard's other low-cost ETFs.
Despite the repeated cuts, the competitors absolutely, positively deny that they're waging a fee war. BlackRock CEO Larry Fink scoffed at the notion on a recent analyst call. Adds Patrick Dunne, head of global markets and investments for iShares: "This is about investors, not competitors."
Vanguard echoes that sentiment. "We're not engaging in a fee war," says Martha King, managing director of Vanguard's financial adviser services. "We're running this company the way we have for decades." Still, King allows that change is afoot, and that what has been dubbed the "Vanguard effect" has a lot to do with it: "We've been able to bring lower and lower cost investments to our clients over the decades. Our competitors are taking notice and responding by trying to price their products in a competitive manner."
State Street has not reduced fees. Kevin Quigg, global head of ETF strategy and consulting there, argues that SPDR funds remain good values. Their large size, he says, makes them more liquid and better able to buy the component securities in the ETFs at attractive prices.
The ETF titans are battling for pieces of a rapidly expanding pool. ETF assets have increased 12-fold during the past decade and stood at $1.3 trillion at the end of November, according to the Investment Company Institute. (That means that even as it lost market share last year, BlackRock enjoyed record ETF inflows.)
It's little surprise ETFs are thriving. The days when investors assumed they'd get double-digit returns by picking stocks -- and didn't give a hoot about fees -- are a distant memory. Fewer and fewer are willing to pay a premium for an active fund manager who in most cases isn't beating the index. Adding to the allure of ETFs: They're easier to trade than mutual funds and are typically more tax-efficient. The impression that ETFs are on the rise was further cemented last year when mutual fund giant Pimco launched an ETF version (BOND) of its massive Total Return Fund (PTTRX).
When it comes to stocks, ETFs have been dominating of late. The mutual fund industry has seen steady outflows from equity funds in the past few years -- $122 billion in the first 11 months of 2012, according to ICI. During the same period, $100.6 billion moved into equity ETFs.
It's a different story when it comes to bonds. Even as cash was fleeing equity mutual funds through November, some $400 billion of it was gushing into bond mutual funds. Only $52 billion went into bond ETFs. And the mutual fund industry, with $12.9 trillion under management, continues to dwarf ETFs.
Still, the falling cost of investing in ETFs is reshaping the financial landscape. "It's absolutely phenomenal for the average investor," says Hougan.
And not just for ETF investors, says Morningstar analyst Ben Johnson. He says the fee war -- or whatever term you use to describe the series of price cuts -- is starting to put pressure on costs for mutual funds.
This story is from the February 4, 2013 issue of Fortune.
Bond fund chief says if Washington doesn't do something, our kids will be worse off.
FORTUNE -- PIMCO, the huge asset manager, has mapped out a contingency plan for what to do with its clients money should the U.S. go over the so-called Fiscal Cliff.
Speaking at FORTUNE's Most Powerful Women Summit on Wednesday, PIMCO's CEO Mohamed El-Erian said the U.S. economy will certainly collapse into a recession if Congress does nothing MOREStephen Gandel, senior editor - Oct 3, 2012 6:32 PM ET
His strategies are used to manage $100 billion - and he's seeing hopeful signs in emerging markets.
FORTUNE – Rob Arnott is one of the few major investors who buys and sells almost any asset anywhere in the world. Not only does he manage Pimco's $27 billion All Asset Fund (PASAX), but as chairman of Research Affiliates he has also devised strategies used to manage $100 billion. Arnott is the father MOREShawn Tully, senior editor-at-large - Jun 4, 2012 5:00 AM ET
Bond king Bill Gross says it's time to get your portfolio ready for a long-period of lower market returns.
FORTUNE -- Apparently, Bill Gross picks movies as well as investments.
Bond investor Gross, who runs the world's largest mutual fund Pimco Total Return (PTTRX), is known for his quirky letters to investors. In the past he has dispensed love advice (specifically for Europe) and written about why he hates automatic flush toilets. MOREStephen Gandel, senior editor - Mar 28, 2012 5:00 AM ET
Pimco is launching an ETF to track the biggest mutual fund, its Total Return Fund. Will this portend the end for mutual funds? We looked into the future to find out, and this 2022 story tells it all.
By Joshua Morgan Brown, contributor
March 1, 2022
FORTUNE -- Ten years ago, in March of 2012, the world's largest mutual fund cloned itself as an ETF. It occasioned a small amount of business media MOREJan 24, 2012 11:13 AM ET
The guys at Pimco are letting their imaginations run a little wild.
First Bill Gross called for a bond market turkey shoot and bet against U.S. government bonds just before they staged a big rally. Now one of his functionaries, portfolio manager Scott Mather, is warning about "financial repression."
That sounds vaguely Freudian, though it actually refers to the process of holding down interest rates to help pay down ridiculous government debt loads. MOREColin Barr - Jun 20, 2011 4:28 PM ET
A little Treasury rally doesn't faze the loquacious bond bear Bill Gross.
Gross, the manager of the world's biggest bond fund, increased his bet against U.S. government debt last month while adding to his record cash position – even as bond prices rallied.
Gross' Pimco Total Return fund held 43 cents of cash for every dollar it had in assets, according to data from the end of April (see chart, right). That's MOREColin Barr - May 10, 2011 10:31 AM ET
The coming bond market bloodbath won't necessarily look all that bloody.
So says the shy and reclusive Bill Gross, who is out Tuesday with his latest monthly investment outlook. Gross, who runs the world's biggest bond fund at Pimco, has been screaming for months that the sky is falling in the government bond market, thanks to an untenable U.S. fiscal position and all the problems that come with it.
But in the MOREColin Barr - May 3, 2011 1:32 PM ET
Buyout firms looking to cash in on their brand equity have either gone public or sold shares to a sovereign wealth fund. Now, there's an alternative.
PIMCO boss Mohamed El-Erian last week confirmed reports that firm employees were buying and selling equity via SecondMarket, the private online marketplace for alternative assets. Now it seems that PIMCO is just the tip of a much larger iceberg.
Jeremy Smith, chief strategy officer for SecondMarket, tells MOREDan Primack - Apr 4, 2011 12:34 PM ET
PIMCO boss Mohamed El-Erian was in Times Square this morning, for a wide-ranging interview with Reuters editor-at-large Christa Friedland. Lots of talk about Japan, Greek tragedies and the like.
Outside reporters were allowed in the door, but Reuters HQ is a couple hundred miles south of my current location. Too bad, because I wanted to ask El-Erian about a New York Observer report that PIMCO equity had begun quietly trading on SecondMarket, MOREDan Primack - Mar 31, 2011 11:12 AM ET
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