S&P Launches Attack on Vipers                                Page 2

SSgA has borne the brunt of being an ETF trailblazer. Entering the field before expense ratios and licensing fees imploded to tiny quark-sized figures, State Street pays 0.04% of SPY's assets annually to S&P. It also pays S&P 0.03% of assets (or $450,000, whichever is larger) on its select sector Spiders, of which there are nine. Bullard projects that based on the miniscule 0.0945% expense ratio that BGI charges on its iShares S&P 500 fund, Kranefuss and Company were able to negotiate a better deal. He guesses that they're paying only 0.01% for the license. This, of course, assumes that Barclays is not trotting out the fund as a loss-leader flagship of the iShares funds.

It seems likely that BGI may in fact be paying an expense ratio that is higher than 1 basis point for its iShares 500, and that this is at the heart of the lawsuit. While Bullard hints at the fact that Vanguard's entrance into the field may be all about renegotiating fees down to less profitable levels for S&P, he also guesses that Barclays is paying a low single basis point on its iShares 500. It may in fact be more likely that BGI is also paying more like 2 or even 3 basis points to license the S&P 500 index.

It appears in any case that SSgA is stuck paying 4 basis points on its S&P 500 ETF. Because iShares had a clearer idea of the playing field when it negotiated, however, it seems quite likely the BGI representatives negotiated some sort of conditional exclusivity deal with S&P whereby the iShares expense ratios would be lowered to the level of any new ETF entrant. Therein lies the rub. It seems unlikely that S&P would take on its best client to scrape out a basis point or two on a fund that will have a tiny amount of assets compared to the flagship Vanguard 500 for some time to come. However, with the possibility of the Vipers forcing renegotiation of terms with iShares 500 (which currently has over $600,000,000 in assets), and even State Street's SPY (with over $20 billion in assets) the stakes of this battle become clearer.

Vanguard pays something less than 0.01% to S&P off the top of its Vanguard 500 fund, the world's largest mutual fund, with assets of over $104 billion, more than twice the total net assets of all 93 ETFs currently in existence. With that kind of money, the Vanguard folks feel that it's definitely a case of the old feeding-hand being bitten. Clearly, Vanguard played a significant role in bringing the S&P 500 the kind of unrivaled benchmark status that it now enjoys.

And with the group of very savvy (and very loyal) long-term investors, it is not out of the range of possibilities that Vanguard could dump S&P altogether and restructure its S&P fund into a very similar (and no-cost) beast - say, the Sauter 503 or Bogle's Basket. This would relieve S&P of approximately $10,000,000 per annum. All this aside, clearly Standard and Poor's was caught off-guard by the Vipers launch. And there are who would question the notion of an exchange-traded fund being just another chip off the old open-ended block. The implications of the suit are significant. We'll be watching closely.

11/03/2000