State Street Challenges BlackRock With Low-Cost Equity ETFs

In a move that is clearly aimed at reversing its dwindling fortunes in the booming exchange-traded fund (ETF) market, State Street (NYSE:STT) announced the launch of a new low-cost equity ETF linked to the Russell 2000 Index – the SPDR Russell 2000 ETF – on July 8. ^[1] The asset management giant’s intention to feed off the popularity of the iShares Russell 2000 ETF provided by market leader BlackRock (NYSE:BLK) becomes evident at once from the fact that State Street launched the new ETF with an expense ratio of 12 basis points (0.12%) – well below the 28 basis points charged by BlackRock’s equivalent iShares offering. ^[2] The iShares Russell 2000 ranks fifth in the list of most-traded ETFs in the world.

State Street also seeks to make three of its existing equity ETFs more appealing to investors by switching them from Dow Jones indexes to Russell indexes and slashing the expense ratio for each of them to 10 basis points. These price cuts make the three ETFs cheaper than equivalent iShares offered by BlackRock.

The focus on low costs by State Street in these four equity ETFs, marks a more aggressive approach by the second-largest ETF provider towards grabbing a bigger share of the market – especially since it has had its problems in growing its ETF asset base at the same rate as the industry over recent months (see State Street Struggles To Make The Most Of The ETF Growth Story).

See our full analysis for State Street | BlackRock

A glance at the chart shows that despite its commanding presence in the global ETF industry, State Street draws a very small amount of its organizational value from the business – about 6% to be precise – with its custody banking services being responsible for most of the bank’s value. But State Street cannot afford to overlook ETFs as it is an important revenue driver in the current low interest rate environment, which is squeezing the profitability of State Street’s core custody business. Moreso because the ETF industry is witnessing a boom which the bank cannot afford to lose out on.

However, things haven’t worked out well for State Street over the recent months as it saw a net outflow of assets from its ETFs over the first half of the year, in stark contrast to competitors BlackRock and Vanguard who reported handsome inflows. While the biggest factor behind this is the tumbling value of gold which hit State Street’s extremely popular gold ETF, one can see from a comparison of the growth in assets managed by the various ETFs offered by State Street (fixed-income, equity and alternative), with those by competitors that State Street’s ETFs haven’t quite hit the same tone with investors. To put things in perspective, BlackRock’s considerably larger iShares assets have grown by more than 20% between Q1 2012 and Q1 2013, compared to a growth of less than 15% for State Street over the same period. And Vanguard is steadily narrowing the gap with State Street in its race to grab the #2 position in the ETF market.

State Street’s decision to switch gears by competing on price is, hence, no surprise. By cutting down expense ratios by half, State Street has made these ETFs which track various Russell indexes several basis points cheaper than counterparts offered by competitors. This should increase the attractiveness of these ETFs and will likely result in better growth in the assets they manage over the coming months. There is of course an inherent trade-off, as the lower expense ratio would mean lower fee revenues from these ETFs.

Submit a Post at Trefis Powered by Data and Interactive Charts | Understand What Drives a Stock at Trefis

1. New ETF Benchmark Changes from SSgA Feed Investor Appetite for Increased Access to US Equity Market, State Street Press Releases, Jul 9 2013 [↩]
2. State Street ETFs undercut iShares and Vanguard, Pensions&Investments Online, Jul 10 2013 [↩]