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In great ETF war, Vanguard topples iShares Add to ...

BKD recently switched clients from a large iShares world equity fund to a competing product from Vanguard that offered broader market coverage and lower fees. "We're pretty interested in keeping costs low," Mr. Layman said.

Adviser Milo Benningfield in San Francisco said he has been steadily phasing out iShares funds as Vanguard has broadened its line-up. "When Vanguard offered only a handful of ETFs, I was happy to hold iShares products longer-term," Mr. Benningfield said. "But then they had some tracking error and were less tax efficient than I'd hoped."

Like much of the firm's success over the years, Vanguard's ascent in ETFs has been slow and steady, but it has been helped by stumbles at iShares. Since the BlackRock deal was announced last June, iShares has suffered from an exodus of talent, some inconsistent fund performances and generally higher fees than competing products.

At the same time, critical exclusive licensing deals with investment index providers like McGraw Hill's Standard & Poor's and Russell Investments expired, opening the door to more copycat funds with lower fees.

Vanguard rolled out nine ETFs tracking bread-and-butter S&P indexes like the S&P 500, Mid-cap 400 and Small-Cap 600 in September, for example. Seven Russell-based Vanguard ETFs arrived a few weeks later.

The copycats are intended for the giant brokerage and wealth management firms that issue research recommendations around one or another particular set of indexes. "We were hearing it from the front lines at Merrill Lynch and other big broker/dealers," said Rick Genoni, who heads Vanguard's ETF product management group. "If all their asset allocation models are based on S&P indexes, they aren't going to use ETFs that track MSCI."

SHARE AND SHARE ALIKE

No one expects iShares to fade away. The firm has tripled its new fund launches this year and slashed its fee to 25 basis points from 40 on its gold fund, a red hot category for investors worried about the Fed's controversial stimulus plans or further potential global debt calamities.

State Street's much larger gold ETF, which charges 40 basis points, still leads in inflows for the year but at least one major investor seems to have noticed the fee cut. George Soros's Soros Fund Management sold about 550,000 shares of State Street's gold fund in the third quarter and bought 5 million shares of iShares' fund, which trades at 1/10 the price of its competitor. Mr. Soros's firm declined to comment.

"By no means should you be putting a nail in the Blackrock iShares coffin," said financial adviser Gary Gordon, president of Pacific Park Financial in Orange County, California. "It'd be like counting out Coca-Cola because Pepsico is claiming market share."

For its part, BlackRock says it is ready for the competition, which ultimately could benefit the entire ETF market. "Sure, we want to beat the heck out of our competitors," said Noel Archard, who oversees product strategy, research and development for iShares. "On the other hand, the more people doing it right, the better it is overall."

There will continue to be plenty of business for iShares, he added. "How many SUVs are there?" asked Mr. Archard. "It's about brand affinity. Ultimately, the market will decide."

And he disputes that investors are shifting allegiance just because of expense ratio differences. "Vanguard, Schwab, they say look at the low expense ratio," Mr. Archard, who worked on Vanguard's ETF effort until 2006, said. "What about spreads, commissions, trading support? What is the total cost of ownership?"

In many cases, iShares funds have more trading volume per day and trade at tighter bid/ask spreads than competitors, Mr. Archard said.

The talent drain is nothing new for iShares either, executives at the firm noted. In 2006 alone, State Street recruited Anthony Rochte from iShares to head its ETF sales and Bruce Lavine left to help found an independent ETF shop called WisdomTree that now oversees about $9-billion.

FATHERLESS

Another challenge for iShares is the departure of the firm's father figure, chairman Lee Kranefuss. After the BlackRock acquisition, he retired in April.

"He is a sharp, sharp dude," Morningstar's Mr. Burns said. "For any company to lose somebody that's clearly that intelligent and had that much invested in the success of the product has got to be difficult."

A former business consultant with an entrepreneurial bent, Mr. Kranefuss joined Barclays Global Investors in 1997 to develop a strategy aimed at retail investors. Acquiring a mutual fund firm seemed too expensive at the time and Mr. Kranefuss eventually hit upon a tiny line of international ETFs which Barclays ran in conjunction with Morgan Stanley.

Sensing the potential to upend the fund business with a lower cost alternative, Mr. Kranefuss turned to Nathan Most, who developed the very first ETF in 1993, as a consultant and gave him an office at iShares.

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