The Dual Impact of Fee Compression on ETF Managers: Blessing and Curse Unveiled

The Dual Impact of Fee Compression on ETF Managers: Blessing and Curse Unveiled

4 Min.

When it comes to choosing where to invest in the ETF market, investors often consider the expense ratio as one of the most important factors. This market has experienced tremendous growth in recent years, and competition has become increasingly intense. To remain competitive in this growing field of rivals, ETF providers must maintain their expense ratios at an extremely low level. In this article, we will take a look at the three largest ETF providers: Vanguard, Blackrock, and Schwab.


In the last decade, a trio of U.S. exchange-traded fund (ETF) issuers, namely BlackRock, Inc. (BLK), Vanguard, and The Charles Schwab Corporation (SCHW), has garnered the majority of net U.S. ETF inflows. These key players, while vying for market share, have engaged in a fee competition. The aggregate asset-weighted average ETF expense ratios, spanning all ETFs, dwindled to a mere 0.45% in 2019 from 0.87% two decades prior. This marks a fee compression of almost fifty percent, translating to an annual average reduction of 2.5%. In the subsequent discussion, we'll delve into the dual impacts of this fee compression on the broader ETF landscape.

Analyzing Expense Ratio Dynamics Among Leading U.S. ETF Issuers

Examining the top three U.S. ETF issuers reveals considerable variation in expense ratios across their offerings. Vanguard, commanding approximately one-third of ETF assets, maintains an asset-weighted average expense ratio of 0.09%. Despite starting the year with only 3% of total assets, Charles Schwab, attracting 13% of flows, now boasts an average fee of 0.09%.

While BlackRock/iShares recently experienced a market share decrease from 40% to one-third of new net ETF flows, the average expense ratio stands at 0.27%. This is influenced by the presence of more actively managed and leveraged ETFs in the iShares lineup.

Notably, the most significant declines in asset-weighted average fees occurred in passively managed index funds, driven by robust inflows. Overall, passively managed ETFs witnessed an 8% reduction in asset-weighted expense ratios from 2018. Among passive funds, municipal bond ETFs saw the most substantial decline, with asset-weighted average fees plummeting by 27% to a new low of 0.17%. This decline was, in part, a result of fee reductions among some of the category's largest funds.

For instance, BlackRock's iShares National Muni Bond ETF (MUB) slashed its fee from 0.25% to 0.11%, more than halving its previous rate. Similarly, Vanguard Tax-Exempt Bond ETF (VTEB) reduced its fee from the already modest 0.08% to 0.06%.

Challenges Arising From Fee Compression in ETF Management

The relentless decline in expense ratios poses challenges for ETF managers across specific domains. Investors now anticipate virtually cost-free portfolio management, placing pressure on ETFs that once leveraged greater liquidity to maintain market share. The competition intensifies as investor funds predominantly flow towards ETFs perceived as offering optimal value, compelling all market participants to consider fee reductions and cost-cutting measures.

According to an report 2020, in the U.S. ETF landscape, products gaining market share in their segments typically exhibit asset-weighted expense ratios below 0.20%, while those losing market share tend to cost more than 0.25%. The report underscores that each basis point increase in the expense ratio elevates the risk of irrelevance or failure, especially in competitive sectors.

Consequently, certain previously popular ETFs can no longer rely on niche market positioning. The entry of more affordable competitors triggers a fee race to the bottom. A notable example is the SPDR S&P 500 ETF Trust (SPY), which witnessed a substantial asset decline of over $21 billion in the first half of the year, with a significant portion of assets shifting towards lower-cost S&P 500 ETF alternatives. The comparability of these competitors with the pioneering SPDR series, which initiated the ETF trend, remains uncertain.

Investor Advantages in the Era of Fee Compression

The advantages stemming from fee compression are notably advantageous for investors, presenting an unprecedented array of economical options for diversified portfolios featuring both passive and active strategies. The rapid growth of the industry is significantly attributed to the prevalence of low fees within the ETF space. In contrast to mutual funds and other actively managed products, ETFs collectively provide a more appealing fee structure.


A persistent trend in the ETF realm involves a continuous reduction in fees as providers vie for assets. While initially an attractive feature differentiating ETFs from other products, this competitive dynamic now poses challenges for fund managers. Investor demands for fee reductions persist, and the trajectory suggests that expense ratios may eventually reach zero or the minimum required to sustain operational functions.

Exchange-Traded Funds (ETFs)