The price wars in ETFs are raging on. Last month, online lending platform SoFi launched the first no-fee ETF in a disruptive move to the industry. It was bound to happen, since Fidelity got into the no-fee index fund business last year.
The price pressure has gone so far that some are referring to ETFs as loss leaders. Eric Balchunas, an ETF analyst at Bloomberg Intelligence, describes fee cuts in ETFs as “the mother of all trends,” with a “near-perfect record of working.” On the same day that SoFi announced its no-fee ETF, Vanguard announced another round of fee cuts to 10 major ETFs.
So, we can all agree that ETFs are a full-blown commodity market. Most ETF providers are addressing the seismic wave of price pressure by taking the marketing approach that is traditional to commodity suppliers: differentiate to serve a targeted segment. If it’s been a while since you considered the basics of commodity-marketing strategy, here’s a tidy overview that considers the segment-differentiate-bundle-brand process (with the delightful title “How to Brand Sand”).
What that looks like in ETF world is: ESG offerings, factor/smart beta offerings, and even actively managed ETFs. Reports suggest that these were the hot topics at the February conference Inside ETFs. But there may not be that much unmet demand for these innovations among advisors. A recent report from Cerulli Associates found that only 17% of financial advisors see unmet demand for ESG products, for instance. That approach may not get investment firms as far as they hope, in terms of ETF profitability.
An alternate approach: segment by risk
It might be time to consider other approaches. Back in 2002, an article in Harvard Business Review took a fresh look at commodity marketing strategies – and the core ideas could be just as applicable to the ETF market, 17 years later. In A Smarter Way to Sell Commodities, marketing strategy thinkers Ajay Kohli and Robert S. Lurie make the case that not enough commodity suppliers consider how to differentiate their products on the basis of risk – product risks and client risks.
Among ETFs, the product risks aren’t synonymous with investment risks. This idea isn’t about downside capture and annualized volatility. Instead, think of it as the risks specific to ETF vehicles and markets; this CFA article lays them out nicely.
- Liquidity: There’s reason to believe that ETFs “overpromote” the liquidity of their underlying holdings. How can that be quantified, communicated and differentiated simply?
- Poor tracking: Tracking error could be higher than investors expect, a burn factor when it makes for underperformance.
- Leverage: There can be notable differences in leverage between ETF peers, and that may go unnoticed to the average advisor or investor.
I would add to that list some metric reflecting the “quant-quake” scenario – those persistent fears that ETFs will implode because they hold the same exact securities, exposing them to liquidation events that trigger stop-loss limits that trigger more liquidation, an event that is thought to have happened in August 2007 and is still talked about today.
At the bottom, only one way to go
As in the case of no-fee index funds, there could be some comfort in knowing where and when the bottom arrives – it’s here. Marketing teams are clearly hard at work looking for ways to provide more value to ETF investors. They’d be smart to explore every option.
Carolyn has been a freelance financial writer since 2015. She has an industry background, previously working as a risk analyst at a large brokerage and as an investment strategist at an asset management firm. She holds an MBA with a specialization in analytic finance from the University of Chicago Booth School of Business, and is a CFA charterholder. As a freelancer, she writes for asset managers, consulting firms and the occasional university publication. Carolyn is based in Washington D.C.