STT State Street Corporation

By Asjylyn Loder 

For State Street Corp., the company that pioneered the $5 trillion exchange-traded fund industry, it's been a long way down.

Last week, the Boston firm reported that investors took out as much cash as they put into its $639 billion ETF business this spring. It was the worst showing among the three largest issuers and sent State Street's share of the U.S. ETF industry to an all-time low.

State Street launched the first ETF 25 years ago and dominated the market for a decade. Today, its slice of U.S. ETF assets is just 17.3% -- down from 49% 15 years ago. More worrying for its future, State Street captured just 5.9% of the $343 billion that poured into ETFs in the past year. By contrast, Vanguard Group and BlackRock Inc.'s iShares took in a combined 67%. Even Charles Schwab Corp., a relative newcomer with just 22 ETFs, had a fatter haul.

How State Street squandered its first-mover advantage for one of the most popular financial products ever created shows that being first can sometimes be as much of a hindrance as a head-start.

It's easy to point out State Street's missteps in hindsight, but no one knew then how big the ETF industry was going to be, said Jim Ross, chairman of State Street's global SPDR business. "If you go back 25 years, you can think of some things you might do differently," he said.

To be sure, State Street is still the third-largest ETF issuer, but it has been hamstrung by a product suite that's vulnerable to market whims. It has struggled to connect with mom-and-pop investors. Some of its most popular funds are burdened by decades-old agreements that make State Street's funds more expensive than the competition's, a disadvantage in an industry where the cheapest funds win the most assets.

State Street doesn't even own the brand name of its ETF franchise, and instead pays hefty fees to rent it from index provider S&P Global Inc.

Nowhere are State Street's problems more apparent than in its flagship fund. The SPDR S&P 500 ETF Trust, best known by its ticker SPY, has swelled into a $269 billion behemoth and is one of the most-traded securities on the planet. But it has seen $4.2 billion in investor withdrawals in the past year while nearly identical products from BlackRock and Vanguard -- which cost half as much -- gained a combined $26.3 billion.

Named after Standard & Poor's Depositary Receipts, shortened to SPDR (pronounced "spider"), SPY was the first to package every company in the S&P 500 index into a single share that, unlike a mutual fund, could be bought and sold on the stock exchange. The now-defunct American Stock Exchange celebrated SPY's January 1993 debut by hanging a 9-foot inflatable spider over the trading floor and giving out hundreds of plastic spider rings.

SPY was a far bigger hit than its inventors had predicted, and State Street followed with new ETFs pegged to other stock indexes, including the popular sector ETFs that invested in industries like energy and technology.

But there were early signs of trouble. The staid Boston institution has long treated its ETF business as an afterthought compared with its far larger businesses in trust banking and asset management for major institutional investors.

Earlier in July, State Street's share price plummeted after the firm announced it was buying a financial-data firm and canceling planned share buybacks. In the earnings call that followed, ETFs were barely mentioned.

"The ETFs were a small part of a big bank that didn't get this business, " said John Jacobs, a former Nasdaq executive who launched the popular Nasdaq 100 ETF in 1999. "They were really, really conflicted about how much to put into the business and how much to go after it."

When a quirky San Francisco offshoot of Barclays PLC rolled out dozens of new iShares ETFs in mid-2000, State Street was slow to perceive the threat. In the years that followed, the upstart hired a massive sales force, sponsored a Tour de France team (later dropped amid doping allegations) and backed a catamaran racing series that traveled the world, iShares emblazoned on the sails.

IShares unseated State Street as the world's largest ETF issuer in early 2004 and widened its lead in the years that followed. Vanguard, too, pushed into the market, and its low-cost funds quickly began gobbling up market share.

State Street was caught flat-footed. Its ETFs were sold under multiple brand names. The ideas for its biggest successes, notably SPY and the sector ETFs, had come from outside the firm. In fact, State Street nearly declined the World Gold Council's idea for a bullion-backed ETF. The fund, better known by its ticker GLD, is now one of State Street's most lucrative.

To amp up its brand recognition, State Street consolidated all of its ETFs under the SPDR name in 2007, but there was a downside: The SPDR trademark belongs to S&P. When it expanded its use of the name, State Street also extended until 2031 a contract under which S&P gets one-third of the fees paid by SPY's investors. S&P's cut alone -- $3 a year for every $10,000 invested -- is almost as much as the entire fee BlackRock and Vanguard charge for their comparable funds.

Between SPY and other fee-sharing arrangements, State Street paid almost $143 million to S&P last year, more than triple the licensing, data and other fees paid by Vanguard and almost double those of BlackRock, which bought iShares from Barclays in 2009.

Those legacy contracts make it difficult for State Street to match aggressive price cuts from BlackRock and Vanguard, especially after BlackRock launched an ultra-low-cost ETF lineup in 2012.

Compounding the problems, the fallout from the financial crisis left State Street financially hobbled. In 2011, activist investors urged the firm to sell off the investment-management division. Market share kept falling, along with morale in its ETF business.

The firm hired a consultant to figure out where it had gone wrong. Some of the client feedback was scathing. Customers called State Street "amateurish" and "plain vanilla" compared to the "rocket scientists" at the competition, according to a copy of the 2013 report reviewed by The Wall Street Journal.

Executives summoned dozens of managers to a two-day meeting at Babson College in October 2013, a few miles from its Boston headquarters. The message: State Street needed a comeback. But some of State Street's ETF veterans grumbled that the firm had paid consultants to repeat what they'd been telling their bosses for years.

Following the report, State Street recruited several new executives, among them iShares alum Rory Tobin, who is now head of the SPDR ETF business.

Shortly after he arrived, Vanguard overtook State Street as the second-largest ETF issuer, and State Street's market share continued to fall as investors flocked to the cheaper ETFs offered by BlackRock and Vanguard.

"When I started here in December 2014, I was struck by the way it was organized -- or maybe the degree to which it was not organized -- the way iShares was," Mr. Tobin said.

State Street has since restructured its fragmented ETF business, an ongoing process that included an overhaul of its sales force last year, Mr. Tobin said.

One of the biggest changes was State Street's introduction of its own low-cost lineup last October, a move that industry analysts viewed as long overdue. The funds have since attracted more than $16 billion in new investor cash. But just as it took years for State Street to squander its lead, it will also take years to regain its former dominance, if it can.

"It's step by step," Mr. Tobin said. "I'm not going to say there's a silver-bullet answer that gets us back up to significant market share."

Write to Asjylyn Loder at asjylyn.loder@wsj.com

(END) Dow Jones Newswires

July 27, 2018 05:44 ET (09:44 GMT)

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