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

Few would dispute that point.

If the last decade was marked by the dominance of iShares, the next is shaping up as a battle royal among the industry's biggest players for a piece of a market that is fast nearing $1-trillion - more than 10 per cent of the total long-term mutual fund market and growing.


That exchange-traded funds have become one of the fastest growing and competitive segments of the investing world in less than 10 years must come as a shock to all but the most rabid true believers.

The first ETF was dreamed up in the late 1980s by Nathan Most, a former coconut oil futures trader spending the twilight of his career helping the American Stock Exchange think up new products.

It took six years to get Mr. Most's idea approved by regulators, but the S&P 500 Depository Receipts, dubbed "Spiders" based on the initials SPDR, quickly caught on. To this day, the original Spiders remain the largest single ETF whether measured by total assets or daily trading volume.

Not much happened right away. But since the first batch of iShares funds debuted in May, 2000, the industry has grown almost 20 times in size - and this has happened during the so-called lost decade, when the stock market made virtually no gains at all.

This year, ETFs are dominating sales of many of the top fund categories. Vanguard's emerging market ETF has pulled in almost $19-billion through the end of October, more than any other fund in its sector and the second most of any kind of fund after Bill Gross's Total Return Fund, according to Lipper data. State Street's SPDR Gold Fund captured $7-billion, the most of any commodity fund and sixth best overall.

In a sign of the growing preference for passive over active management, investors have been adding to equity ETFs this year while pulling money from their mutual fund counterparts. Stock ETFs gained $54-billion in net new money through the end of October, compared with net outflows of $30-billion year-to-date for stock mutual funds, according to data from the Investment Company Institute.

Through ETFs, even individual investors are accessing an array of markets that were previously out of reach or too expensive, including emerging market bonds, non-U.S. dividend stocks or precious metals like platinum and palladium .

Financial advisers appreciate the ability to craft investment plans with targeted holdings in various ETFs, which lately have ranged into niches like companies mining rare earth minerals.

The industry has encountered a few growing pains of late. More ETF prices were hit during the May 6 "flash crash" than those of ordinary stocks, prompting new SEC trading rules. Regulators also had to crack down on marketing of some leveraged ETFs last year. And some commodity-oriented funds have not performed as expected.

None of which has slowed the popularity of ETFs much. Investors poured $85-billion into ETFs through the end of October.


Against that backdrop, the Vanguard-iShares battle has taken centre stage. The two are index fund pioneers. Jack Bogle created Vanguard in 1975 to bring index funds to the masses. iShares grew out of Wells Fargo's former investment arm that opened the first index fund for institutional investors in 1973.

But the conflict was a long time coming. After competing weakly for years, Vanguard only made ETFs a top priority as Mr. McNabb took over as CEO in 2008. Total staff dedicated to ETFs has hit 300 from about 50 five years ago, Mr. McNabb said. And after some lean years for new funds, Vanguard has introduced 17 so far this year.

As for iShares, one of its largest and most popular funds, the $47-billion MSCI Emerging Markets index Fund , lagged its benchmark by almost seven percentage points in 2009. Vanguard had no such tracking error issue with its now $41-billion emerging market ETF, which used to be half the size of the iShares fund and also happens to charge a 63 per cent lower management fee.

With investors pouring into all manner of emerging market funds, the iShares ETF has garnered only a net $4.4-billion through the end of October, compared with the Vanguard fund's net inflow of $18.7-billion, according to data from Lipper.

After years of largely ignoring Vanguard offerings, top financial advisers and brokers now applaud the enhanced service and expansion of Vanguard's line-up. Over the summer, the firm outpolled iShares for the first time in an annual survey of ETF customer loyalty among financial advisers conducted by Cogent Research.

"In many cases, we've found they offer the most efficient way to get the exposures we're looking for," said Jeff Layman, chief investment officer at BKD Wealth Advisors in Springfield, Missouri.

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