That sound you just heard was the latest shot fired in Canada’s ETF price war. iShares has just slashed the management fees on several popular equity and bond ETFs—and just like that the country’s oldest ETF provider has become the cheapest in many categories.
BlackRock has rebranded nine ETFs as the iShares Core Series, “a suite of funds covering key asset classes.” A balanced portfolio of these ETFs now has a weighted management fee of just 0.12% or so, less than half the former cost. (As a rule of thumb, expect the full MERs to be 8% to 10% higher due to taxes.) Here’s what a traditional Couch Potato portfolio might look like when assembled from the Core Series ETFs:
|ETF name||Allocation||Old fee||New fee|
|iShares S&P/TSX Capped Composite (XIC)||20%||0.25%||0.05%|
|iShares S&P 500 (XUS)||20%||0.14%||0.10%|
|iShares MSCI EAFE IMI (XEF)||15%||0.30%||0.20%|
|iShares MSCI Emerging Markets IMI (XEC)||5%||0.35%||0.25%|
|iShares High Quality Canadian Bond (CAB)||40%||0.30%||0.12%|
The cost of competition
BlackRock launched a family of Core iShares ETFs in the US back in October 2012. They identified 10 broadly diversified ETFs (as opposed to the dozens of narrowly focused products in their lineup), gave them new names to stress their role as the building blocks of a long-term portfolio, and lowered their costs. At the time a prominent observer noted that iShares had to make a move because it had been “a bit out of the game.” They were losing assets to Vanguard, Schwab and other providers who were undercutting them on fees.
You could say the same thing about BlackRock’s Canadian ETF lineup, which was in danger of becoming obsolete. iShares used to have the market all to itself, and at the end of February they still held about two-thirds of all ETF assets in Canada, but its competitors have been steadily eroding that market share. According to the Canadian ETF Association, Vanguard boosted its assets under management by $310 million in the first two months of this year, while BMO added $215 million. BlackRock, meanwhile, saw net outflows of $512 million, at least partly because the relatively high management fees on some of its older ETFs were increasingly hard to justify.
With the creation of the Core Series, however, iShares is now the the cost leader in several major asset classes:
- Canadian equities: XIC is now one of the cheapest ETFs in the country, with an annual cost of one shiny nickel per $100 invested. The BMO S&P/TSX Capped Composite (ZCN), which tracks the same index, carries a fee of 0.15%, while the similar Vanguard FTSE Canada All Cap (VCN) comes in at 0.12%.
- US equities: XUS now has a lower fee than the virtually identical BMO S&P 500 (ZSP) and Vanguard S&P 500 (VFV), both of which charge 0.15%. BlackRock also lowered the fee to 0.10% on XSP, the hedged version of its S&P 500 ETF.
- International equities: The total-market ETFs covering developed and emerging markets (XEF and XEC) now have lower fees than the Vanguard FTSE Developed ex North America (VDU) and the Vanguard FTSE Emerging Markets (VEE), which track similar indexes. BMO’s offerings in international equities are even less competitive on fees, though the recently launched BMO MSCI EAFE Index ETF (ZEA) does have a more tax-friendly structure.
- Bonds: The iShares High Quality Canadian Bond (CAB) is now the cheapest broad-based bond ETF, sharply undercutting the BMO Aggregate Bond (ZAG) and the Vanguard Canadian Aggregate Bond (VAB), which carry management fees of 0.20%.
A few question marks
The choice of CAB as a Core product is surprising: one might have expected the Core bond ETF to be the iShares DEX Universe Bond (XBB) instead. The granddaddy of fixed-income ETFs has an MER of 0.33%—much higher than its competitors—and is a prime candidate for a fee reduction.
In an interview, Mary Anne Wiley, Head of iShares Canada at BlackRock, explained the choice: “We’re building this for the future, but we’re mindful of who is there today, and what they’re looking for. That fund [XBB] is $1.5 billion, and a lot of investors are there for different reasons. Some are buy-and-hold, but others are using it to position their bond portfolio in a way that is more short-term in nature. Institutions are using that fund, and they’re valuing a couple of different things” other than low MER, such as liquidity and trading volume.
There’s nothing wrong with using CAB as a core bond holding so long as investors understand it. Until recently it was one of iShares “Advantaged” ETFs, which used a complicated structure to recharacterize interest income in a tax-friendly way. When the federal government cracked down on these structures, CAB became a traditional bond fund with 60% government and 40% corporate bonds, all investment-grade. By contrast, ZAG holds about 30% corporates, and while VAB holds just 20%, so the iShares fund has a higher coupon and slightly lower duration, but also a bit more risk.
There are a few oddball choices in the Core lineup: the iShares S&P/TSX Equity Income (XEI) holds 75 Canadian dividend stocks, which I would not even consider a discrete asset class. The iShares Canadian Short Term Corporate + Maple Bond (XSH) is also too specialized to qualify as a core fixed income holding. (A maple bond is issued in Canadian dollars by a foreign corporation.) Rounding out the Core list is the iShares DEX Long-Term Bond (XLB), which is likely to have more appeal for institutional investors. Wiley suggests these three Core fixed income ETFs can be combined to achieve whatever duration investors want in their portfolio.
Itching to switch
Whenever there’s a new product launch or a fee reduction like this, I get a wave of emails from investors who are itching to sell their current holdings to embrace the new ETFs. (Then they ask if I plan to change the recommendations in my model portfolios.) I remind them to keep cost reductions in perspective: low MERs are wonderful, but small differences are often trivial, especially when weighed against transaction costs.
Say you have a $20,000 holding in the Vanguard FTSE Canada All Cap (VCN) and you want to switch to XIC to save 0.07% in management fees. That works out to an annual savings of just $14. If you make two trades at $10 apiece and lose another $10 or $12 on the bid-ask spreads it would take more than two years to break even. If you’re investing in a taxable account and sitting on a capital gain, switching makes even less sense.
It will be interesting to see how Vanguard and BMO respond to this move. But even if the ETF providers call a truce in the price war it’s fair to say Canadian investors are finally getting access to enjoy the pricing that our neighbours in US have enjoyed for many years.