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Did Vanguard hand BlackRock a 'monster' gift?

Did Vanguard hand BlackRock a 'monster' gift?

BlackRock recorded a ‘monster’ quarter for exchange traded fund (ETF) flows at the end of last year, leading analysts to question whether Vanguard is taking its foot off the pedal.

In its latest earnings results, BlackRock reported net new business returned to pre-crisis levels, with more than $85 billion in new assets generated in 2012 in its iShares ETF business.

However, analysts at Bernstein Research suggest that perhaps what is less well known is iShares has seen a ‘reversal of fortunes’ in its emerging market ETF product – EEM – which has been losing substantial share to Vanguard’s emerging market product (VWO) over the last few years.

In Q4, iShares’ emerging market product took in $8.9 billion, while Vanguard’s fund, in contrast, had $800 million of outflows.

The shift in flows into emerging markets ETFs, which now leans in favour of iShares, has led the analysts at Bernstein Research to ask if Vanguard has handed BlackRock ‘a gift.’

‘On one hand, the outsized level of flows into EEM might simply suggest increased engagement of institutional investors with the emerging market category - EEM caters more to institutional investors; VWO to retail investors,’ the analysts said.

‘However, EEM's strong December and Q4 flows and VWO's weak flows may also affirm conjecture that some institutional investors might abandon Vanguard's product after it dumped the MSCI indices in October.’

Vanguard said its replacement of MSCI with FTSE benchmarks was partly due to the new index excluding South Korea, which is arguably a developed nation.

‘Yet, as we've noted, the risk/return experience of these two indices has been nearly identical over the last seven years,’ the analysts said. ‘In our view, this affirms that the Vanguard decision was driven almost completely by cost considerations.’

Nonetheless, the move by Vanguard may have been a strategic error. ‘We think many institutional investors continue to view MSCI as the gold standard for international indexing,’ said the analysts.

‘Vanguard arguably expressed a willingness to risk loss of institutional market share to BlackRock with this move. This would seem consistent with Vanguard's focus on being the low-cost provider in the retail market, as well as its capacity as a mutually-owned firm to make decisions more agnostic to bottom line profits,’ they said.

Whether these cost savings are worth the risk of losing accumulation of scale, which also benefits retail ETF investors, is up for debate.

The analysts added: ‘We continue to be concerned that BlackRock will encounter challenges in capturing the faster-growing US retail (buy-and-hold) ETF market segment.’

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