The Price War in ETFs: Are We Reaching the Bottom?

The battle for dominance between the world’s two largest exchange-traded funds (ETFs) has reached a turning point. On February 18th, Vanguard’s VOO—an ETF tracking the S&P 500—became the world’s largest, briefly surpassing SPY, a competing S&P 500 ETF managed by State Street Global Advisors. Just days later, SPY reclaimed the title. Both funds now command more than $620 billion in assets, underscoring their immense popularity.

For retail investors, ETFs and the index-tracking investments they enable are among the greatest financial innovations of modern times. First introduced in the 1990s, ETFs have allowed investors to bypass expensive fund managers, offering highly liquid, low-fee investment vehicles that have collectively saved investors trillions of dollars. SPY, America’s first ETF, charges an annual fee of just 0.09% of assets, while VOO, launched in 2010, undercuts its rival with an even lower fee of 0.03%.

While the giants of the ETF world continue driving costs down, a different trend is emerging among newer funds—one that raises concerns. According to data from Morningstar, the fee advantage of new ETFs over traditional mutual funds has shrunk significantly, from a 0.7 percentage point gap in 2014 to just 0.2 percentage points today. Even more troubling, fees on recently launched ETFs are rising rather than falling, reversing a decades-long trend. Most funds introduced in recent years charge fees of 0.5% or more.

Is the Low-Fee Era Coming to an End?

Not necessarily. The trajectory of ETF fees will largely depend on investor preferences. If investors continue prioritizing broad market exposure and cost efficiency—the hallmarks of the ETF revolution—fees can still decline. The largest ETFs have accumulated extraordinary levels of assets: the top 15 equity-focused ETFs hold $3.9 trillion, more than the next 100 combined, which in turn surpass the next 1,000 combined. This scale advantage significantly reduces costs, as larger funds can spread fixed expenses—such as trading, management, and regulatory compliance—across a broader base. Citigroup estimates that half of all American ETFs lose money for their issuers because they lack the necessary scale to cover such costs.

However, the rise in ETF fees is not solely due to a lack of scale. Traditional ETFs typically track well-established indices like the S&P 500 or NASDAQ Composite. In contrast, many newer ETFs cater to niche markets or specialized strategies. Some focus on environmentally friendly industries, while others invest in stocks with specific financial traits, such as strong free cash flow. Many of these funds are actively managed, diverging from the passive indexing model that made ETFs so cost-effective. Others veer into the absurd—offering, for instance, three-times leveraged bets on a single stock like Nvidia. This added complexity comes at a price, both in terms of higher fees and greater investment risk.

The Pitfalls of Trend-Chasing ETFs

Many of these newer funds are best avoided, regardless of their fees. Some semi-transparent ETFs, which disclose holdings infrequently and charge premium fees, stretch the very definition of an ETF. Heavily leveraged and single-stock funds cater more to traders than long-term investors. Thematic ETFs—often built around fleeting market fads—rarely stand the test of time.

Yet, despite the rising popularity of higher-fee ETFs, the broader industry’s low-cost model remains intact. On February 1st, Vanguard, the undisputed leader in the low-fee movement, slashed expenses on 87 of its funds, bringing its average expense ratio down from 0.08% to 0.07%. With $10 trillion in assets under management—double its 2018 total—Vanguard continues to rely on simple, broadly diversified funds that require minimal management.

A Strange Symbiosis

Interestingly, the megafunds and their pricier, more speculative counterparts coexist in a way that benefits investors. By allocating the bulk of their portfolios to ultra-low-cost ETFs, investors can significantly lower their overall expense ratio. This cost savings then allows them to take calculated risks on higher-fee, specialized funds if they so choose. In other words, the cheaper the largest ETFs become, the more leeway investors have to experiment with smaller, more adventurous bets.

Thus, if average ETF fees begin to plateau, it won’t signify that the industry has hit its cost-cutting limit. Rather, it will reflect the fact that more investors are seeking out niche opportunities beyond traditional indexing. Regardless, ETFs are poised to generate trillions more in savings for retail investors in the coming years. And if investors lean more toward low-cost, diversified funds rather than speculative alternatives, those savings will be even greater.