The low fee entry strategy and first mover advantage in the ETF market


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Academic literature struggles to explain investors’ attitude towards fees and expenses charged by mutual funds. In general, investors have been found to exhibit a puzzling lack of interest in this non-trivial component of their total return, raising questions of rationality of real-world investor behavior. An emergence of exchange-traded funds (ETFs), their rapid proliferation in the past decades and distinct features, such as more simple expense structure, present a valuable opportunity to contribute to the debate surrounding the pricing of funds. To better understand the expense policy/fund flows dynamics, the authors first test a conjecture that later entrants in the ETF markets face a disadvantage in competition for fund flows. Then, they test whether competitive pressure can be successfully overcome by lowering expenses charged to ETF investors. The results suggest that, though it is not necessary to be a first entrant in a fund category to enjoy competitive advantage, an earlier market entry is beneficial for attracting fund flows. It is also found that later entrants’ to the ETF market successfully use the strategy of reducing their expense ratios. Firms with lower net expense ratios obtain greater investment, as evidenced by greater capitalization and market share, supporting our intuition that investors may acknowledge the merits of low-cost ETFs.

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    • Table 1. Number of US exchange-traded funds by year
    • Table 2. Statistics of ETF providers by net asset value and the number of ETFs as of August 6, 2012
    • Table 3. Comparison of Vanguard ETFs with first movers
    • Table 4. Regression of net asset value (NAV) on FirstEntry, net expense ratio, age of fund, total NAV of fund family*
    • Table 5. Percentage of change in adjusted market capitalization* one and two years after the entrance of low fee ETFs
    • Table 6. Percentage of change in market share one and two years after the entrance of low fee ETFs