As ETFs Explode in Popularity, Industry Pioneer State Street Lags

Industries Reuters

The ETF boom may be leaving its architect behind.

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State Street Corp, the company behind the first and best-known U.S. exchange traded fund, reported a record $22.8 billion in estimated withdrawals in 2015, even as sales for the broader ETF industry were strong.

Moreover, its flagship fund - the SPDR S&P 500 ETF - did the worst, losing $39 billion to withdrawals while a competing Vanguard ETF took in $12 billion, according to Lipper. Since its founding in 1993, State Street's so-called "Spider" has been the largest ETF to package every stock in the S&P 500.

"They should have a much bigger market share than they do based on their heritage," said Todd Westby, an industry consultant and former industry executive.

State Street has not invested aggressively enough in developing new products or in marketing to new clients, Westby said.

The company says it is fighting back with more specialized ETFs and has made some key hires to bolster sales.

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"We continue to have a lot of faith and belief" in SPY, said David Mazza, head of research for SPDR ETFs. "Some of the newer products continue to resonate."

State Street spokeswoman Anne McNally said some outflows were driven by institutions moving to riskier investments to improve returns or generate cash as commodity prices fell.

Beyond SPY, State Street produced five of the 10 largest funds released in the last two years, Morningstar said. These tend to be more specialized and allow the company to charge more, making them more profitable.

The company also has poached senior executives from rivals, recently rehiring Bobby Brooks, who helped State Street launch its ETF sales unit before moving to Invesco PowerShares in 2006. There he helped PowerShares triple its assets to $98 billion before he left last year.

ESCAPING THE SPIDER WEB

SPY still has $168 billion in assets and is the most widely traded ETF.

But annual management fees of 0.09 percent of assets make it almost twice as expensive as the Vanguard 500 ETF and dent its popularity with long-term investors. Also, its antique legal structure as a unit investment trust, rather than an "open-end" fund like most ETFs, can be a hindrance.

That prohibits it from lending stocks to speculators for a fee as many rivals do. It also cannot reinvest the dividends paid on stocks. Instead it holds that cash and pays it out quarterly. The uninvested cash hurts performance in an up-market but helps when stocks fall.

"Beyond product innovation, in the last several years we have made significant investments in our ETF business that we expect to continue to pay off going forward," said McNally.

(Reporting by Trevor Hunnicutt; Editing by Dan Burns and Steve Orlofsky)