Today’s grossly overcrowded exchange-traded fund marketplace has made “new” awfully difficult. Providers are scraping the barrel, getting into things like emerging African equities and managed future strategies, just to differentiate themselves — not good considering thin profit margins pack on the pressure to release viable products.
This is why several fund sponsors have launched “me-too” products covering indices and sectors already covered by other fund managers.
Enter State Street (STT), the second-largest ETF issuer, and its latest fund.
State Street Global Advisors has just released its own ETF covering the Russell 2000 — the most popular small-cap index out there and the benchmark for several successful funds. The question begged by you and I: Does it actually bring anything worthwhile to the table?
Another Russell ETF?
State Street basically created the ETF back in 1993 when it launched the popular SPDR S&P 500 ETF (SPY), and it was the first to offer a physically backed gold ETF — SPDR Gold Shares (GLD). Hit products like these have helped the investment manager rake in over $328 billion in ETF assets, so it’s not like SSgA is an industry lightweight.
But that’s why it’s puzzling to see State Street launch a copycat fund.
The new SPDR Russell 2000 ETF (TWOK) will track (through representative sampling) the small-cap Russell 2000. The index is considered the benchmark for attaining small-cap exposure, and both fund managers Vanguard and BlackRock (BLK) already cover the index via ETFs — the Russell 2000 Index ETF (VTWO) and iShares Russell 2000 ETF (IWM), respectively.
The iShares Russell fund is one of the largest ETFs period, with $23 billion in assets, and is the fifth-most-traded ETF in the world. According to Morningstar, IWM has an average daily trading volume of about 39 million shares per day. That dominant position as America’s favorite small-cap fund has come from a 13-year operating history and heavy institutional ownership. The Vanguard fund is no slouch, either, with nearly $500 million in AUM under its wing.
So State Street would have to offer something pretty compelling to unseat these two entrenched competitors … right?
Where It Gets Interesting
Given that State Street’s new Russell fund is tracking the same index as two already established funds, the only way to differentiate itself from the other products (other than its clever ticker) is on cost.
The fund will have lowest expense ratio of the three ETFs tracking the index, at just 0.12%, or $12 for every $10,000 invested. IWM currently charges 0.28%, while VTWO costs 0.21%, so that’s certainly a significant difference.
Lower expense ratios allow investors to keep more of their gains/earnings and track indices more closely. Over the longer haul, smaller fees can add up to serious returns for investors — and more importantly to State Street, potentially more assets under management for fund issuers.
For the most part, State Street is losing the cost battle among the three big ETF sponsors. According to data from ETFdb.com, the firm’s average expense ratio is 0.36% — more than double Vanguard’s. As you might expect, State Street’s market share had declined to 22.3% of overall ETF assets at the end of last month, down from 30% at the beginning of 2009. Meanwhile, Vanguard’s market share has grown to 19.3% — up from just 8.5% in 2009.
While State Street isn’t going away anytime soon, it could be attempting to regain some of its lost mojo by replicating Vanguard’s success in the small-cap ETF space with its own ultra-cheap Russell fund. The launch also could coincide with State Street’s ambitions to get its ETFs into more 401k plans and 529 college savings accounts. By offering the benchmark index in the small-cap space, the firm could better appeal to plan administrators.
But Should You Switch?
I highly doubt that hedge funds, pension plans and other institutional investors are going to give up on iShares’ Russell fund anytime soon. Its first-mover advantage has allowed it to be the preferred choice for larger investors wanting quick small-cap exposure. And 39 million shares a day gives you plenty of room to buy/sell large blocks of shares easily; even the Vanguard Russell option can’t do that.
Still, the retail set could warm up to TWOK over time thanks to its lower expense ratio … even if State Street’s motives are more self-involved than altruistic. But that’s assuming trading volume for the fund picks up. Costs related to wild bid/ask spreads and trading costs can easily outweigh lower operating expenses.
However, there are plenty of cheaper ways to gain access to U.S. small-caps — such as the Vanguard Small-Cap ETF (VB) or Schwab U.S. Small Cap ETF (SCHA) — if you’re willing to track another index besides the Russell 2000. Plus, it’s a good bet that Vanguard has plans to lower its Russell ETF’s expenses as assets grow. It always does.
All in all, the new SPDR Russell 2000 ETF doesn’t really bring anything new to the table aside from being the cheapest way (so far) to get exposure to the leading small-cap index.
I say skip it for now until assets and trading volume pick up.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.