CHICAGO – As alternative products grow to record levels, analysts expect continue downward pressure on fees.

Now with a combined $707 billion in assets across 1,320 total products, the global strategic-beta exchange-traded product market has swelled 28.4% in the last year since June 2016, Morningstar reported at its eighth annual ETF Conference. In the U.S., 650 total products now account for $620 billion in combined assets, or 88% of the cumulative strategic-beta market.

“In the first eight months of the year, what we’ve seen is just mind-boggling, record-breaking growth in just ETFs at large within the U.S. marketplace,” said Ben Johnson, Morningstar’s director of global ETF and passive strategies research.

“In the years to come, an increasingly crossed and competitive landscape will put pressure on fees,” said Ben Johnson, Morningstar’s director of global ETF and passive strategies research.
"An increasingly crossed and competitive landscape will put pressure on fees,” said Morningstar's Ben Johnson. Wyckoff-Tweedie Photography

When analyzing the growth, analysts say fees for strategic-beta ETPs will trend lower with time. Of the 419 strategic-beta ETPs that existed in the U.S. in June 2016, 25% reported average fee reductions of 0.01%. Just 27 of the funds reported a median increase of 0.01% and 287 saw their expenses unchanged.

Johnson says asset managers now have more responsibility than ever to scrutinize whether the funds are suitable for their clients or platform given their complexity.

‘PRESSURE ON FEES’
“In the years to come, an increasingly crossed and competitive landscape will put pressure on fees,” Johnson said. “It remains to be seen whether incumbents’ fees will face pressure from competitors.”

Goldman Sachs’ asset management unit has cut fees to its Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC), a multifactor fund launched in September 2015, to just nine basis points for a portfolio of exposure to a basket of large-cap stocks. That is cheaper than any comparable equal-weighted fund, including State Street’s S&P 500 ETF Trust (SPY), set at 10 basis points, according to Bloomberg.

To put it into perspective, a similar $13.5 billion ETF run by Guggenheim Partners has made cuts to 20 basis points, down from 40 basis points in June.

“It’s becoming questionable whether or not the fees that many of these funds charge are justifiable,” Johnson said. “In many cases, what you see is the fees these funds charge are a fraction of those charged by their median active peer, but they can be many multiples those charged by something that’s much more mundane broad-based total market exposure.”

Morningstar analysts noted that while merits of these funds are often “exaggerated,” a large minority of the funds outperformed their replicating portfolios.

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Funds best positioned for volatility
These funds have the smallest beta scores, either positive or negative, indicating the least variability from market returns.

“Strategic-beta funds aren’t as distinctive as they may first appear,” said Alex Bryan, Morningstar’s director of passive strategies research, North America. “Investors shouldn’t pay significantly higher fees for these strategies than market-cap-weighted alternatives, which capture the same performance drivers and can replicate most of their returns.”

Andrew Shilling

Andrew Shilling

Andrew Shilling is an associate editor for Financial Planning, Bank Investment Consultant, On Wall Street and Money Management Executive. Follow him on Twitter at @AndrewWShilling.