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(Bloomberg) — Wall Street’s $7 trillion exchange-traded fund is causing headaches for issuers big and small: as many as 50% of their investment products are running at a loss.
Roughly one-third to half of the more than 3,300 US-listed ETFs are likely unable to cover their annual operating costs, according to a Citigroup Inc. analysis. That figure assumes that funds have between $200,000 to $350,000 in fixed costs, with up to 7.5 basis points in variable costs.
It’s a painful byproduct of the industry’s seemingly never-ending fee war. ETF expense ratios have dropped across asset classes as issuers compete for turf in an increasingly saturated market, with the likes of BlackRock Inc., Vanguard Group Inc. and State Street Global Advisors leading the charge. While beneficial for investors buying into the products, that race-to-the-bottom threatens to squeeze the asset managers helming the funds.
“In a maturing industry, there are still profits to be had, but success is not necessarily widespread,” analysts including Scott Chronert wrote. “Typically, strategies with higher associated fees tend to have greater percentages of covering their operating costs or earning more significant fees for their issuer.”
While higher fees mean higher profits, issuers are willing to sacrifice margin in order to attract inflows. For example, when State Street halved the fee on its $2 billion SPDR Portfolio High Yield Bond ETF (SPHY) to five basis points in August, more than $600 million worth followed — the fund’s biggest monthly haul on record.
That preference has lead to a wave of fee cuts from some of the largest asset managers over the past few years. Last month, Schwab Asset Management lowered the expense ratios on all of its fixed-income ETFs to just three basis points. In August, State Street dropped the cost on the $19 billion SPDR Portfolio S&P 500 ETF (ticker SPLG) to two basis points, undercutting BlackRock and Vanguard.
Even with billions of dollars under management, it’s difficult to make money off just a couple of basis points. Bloomberg Intelligence research shows that ETFs priced at 10 basis points or lower make up 60% of industry assets, but just 19% of estimated revenue. By comparison, ETFs with expense ratios of 50 basis points or more generate 30% of the industry’s revenue despite accounting for 8% of assets.
For most issuers, that means that launching a “hot sauce” product — such as thematic funds or actively managed ETFs, which tend to carry higher fees — is needed to offset potential losses from other parts of the lineup, according to Bloomberg Intelligence’s Athanasios Psarofagis.
“You need the crazy products to pay the bills,” said ETF analyst Psarofagis. “The lights have to stay on.”
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