A new game changer in the ETF business

Having studied the growth and development of the Australian exchange traded fund (ETF) industry for the past 10 years, I have come to the conclusion that there are very few events that are real game changers.

What we have seen from ETF providers in the past is pretty much what we expect from them in the future.

But there is one ETF provider that has broken with its past patterns and the result is, in my view, a game changer.

Wise decisions

Let me explain.

On a recent weekend, I was driving around the streets of Melbourne delivering kids to parties and sports, and trying to get home before the summer heat peaked for the day.

It was then I heard someone say something profound on Radio National.

National security expert Professor Zachary Shore (don't worry, I'd never heard of him either) was speaking on ABC Radio's Big Ideas program (also available as a podcast). Shore has spent his life studying and writing about how governments and other institutions make wise decisions.

One such decision was the Marshall Plan. Most people with any familiarity with the Marshall Plan agree that it was one of the most important and beneficial foreign aid programs of the 20th century, simultaneously bringing Europe out of deep poverty after World War II and acting as a bulwark against Russian aggression during the Cold War.

What is less known is that it replaced another program, the Morgenthau Plan. This was a proposal to weaken Germany after the war by destroying its industrial base and preventing it from re-arming.

Although the Morgenthau Plan still had vociferous advocates, it was recognised it would lead to mass starvation and more conflict within Europe. In other words, the Marshall Plan was the complete opposite of the Morgenthau Plan in deed and intent.

But the Marshall Plan would not have been possible without the Morgenthau Plan and the reaction against the suffering it would cause.

The ETF industry

Now, readers might be wondering what this has to do with the Australian ETF industry.

My latest ETF research article is an analysis of the growth rates of the major players - Vanguard, BlackRock, Betashares, Van Eck, Global X and State Street - for the 12 months to September 2024.

I nearly left State Street out of the analysis.

Besides being the 'original gangsta' of Australian ETFs - the first ETFs to list were the SPDR S&P/ASX 50 Fund (ASX: SFY) and SPDR S&P/ASX 200 Fund (STW) back in 2001 - it had been losing market share consistently over the years due to higher costs (similar products were falling rapidly in price) and probably lack of innovation.

To me, it was a classic example of rent-seeking behaviour.

Having built what was a large asset base, State Street was more concerned with maintaining its revenue stream for as long as possible, even as it declined in absolute terms, rather than competing for new dollars on issues that mattered to new investors: generic products based on market capitalisation indexes and innovation for smart products at the right price.

One thing that kept existing investors as clients was the rise in the Australian sharemarket. This was a disincentive for investors to sell because of potential capital gains tax liabilities.

But I decided to have a look at State Street anyway. After all, it was still the fifth largest ETF provider in the country.

Measures of growth

One of the measures I used as a proxy for growth was estimated revenue. While all the other managers had positive revenue growth ranging from 15% for BlackRock to 37% for Van Eck, State Street's revenue had fallen by 33% despite a 20% increase in assets under management.

Another measure I used was asset growth from net flows. In the case of State Street, the growth from net flows accounted for about 1% of asset growth, compared with 19% growth from financial market gains.

How did that happen?

This sent me back to look at the management fees of their products in the past 12 months. I was amazed to see that 12 out of 17 products had fee reductions in the past 12 months, ranging from 30% to 62%.

If these fee reductions had occurred at the beginning of the year instead of at various times through the year, the reduction in revenue would have been much greater than the 33% I calculated.

One of the things Shore said in his interview was that the people who were best at reading the intentions of others did so not just by scrutinising past behaviour but by scrutinising behaviour at pattern break points.

In other words, missing out on the natural growth from the Australian ETF market was causing more pain than the benefits of pursuing rent-seeking behaviour.

Break in behaviour

The fee reductions were a significant break in their behaviour (despite periodic but modest fee reductions in the past).

For investors looking for a market that has both size and competition, this is good news. It means that State Street is back in the business of providing ETFs to Australian investors.

I have only once said that something was a game changer in relationship to the Australian ETF market, and that was the launch of the Betashares Australia 200 ETF with a management fee of 0.04%pa. It is now a $6 billion-plus product.

My hope is that these fee reductions on State Street products are another game changer. State Street is the third largest ETF provider in the US.

It can't afford to let the Australian market be its one failure point.

My prediction is that it is about to launch a bunch of new products that draw on both its huge intellectual capital and the success of its products in the US market. The beneficiaries will be the investors of Australia.

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