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.
There are many steps to managing your money wisely. A good way to start: a visit with the father of indexing, Vanguard's Jack Bogle.
By Andy Serwer, managing editor
FORTUNE -- What if your life's work could be measured by one simple number, and what if that number was 2.2 trillion? As in dollars. I walked into an upscale Midtown Manhattan restaurant looking for such a man. He was easy to MOREDec 6, 2012 5:00 AM ET
Retirement plan providers have been overcharging investors for decades - creating a huge drag on returns. But new rules on fee disclosure should help drive down costs.
FORTUNE – If you're a typical 401(k) investor, perhaps you check your account now and then to see how your investments are doing. Or maybe you just let them ride. One thing is almost certain: You don't know how much you're paying in management MOREScott Cendrowski, writer - Jun 25, 2012 5:00 AM ET
Legg Mason's superstar is closing out a legendary career. Too bad his investors can't afford to call it quits.
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Adviser Investments, the independent advisory founded by noted Vanguard analyst Dan Wiener, is about to get a lot larger.
Fortune has learned that the firm -- whose principals also include Fidelity analyst Jim Lowell -- this morning acquired Kobren Insight Management from E*Trade Financial (ETFC). The deal will increase AI's assets under management from around $1.3 billion to over $2 billion, plus add fixed income capabilities.
"We're a big believer in buying MOREDan Primack - Mar 18, 2011 9:48 AM ET
So much for this being a stockpicker's market.
Vanguard, the leading purveyor of mutual funds that track market indexes, has passed Fidelity Investments as the largest U.S. mutual fund company by assets -- dethroning Boston-based Fidelity after two decades as the top fund manager.
Vanguard had $1.31 trillion in assets at July 31, Bloomberg reports, compared with $1.24 trillion at Fidelity.
The shift comes at a time when investors are shunning the actively MOREColin Barr - Sep 30, 2010 10:08 AM ET
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