BlackRock’s ETF unit iShares is by far the largest ETF provider in the world but rivals are chipping away at the leader’s market share by competing on cost, according to a report.

“They are in the middle of a price war whether they admit it or not,” said David Nadig, director of research at IndexUniverse, in a Reuters article this week.

Specifically, ETF competitor Vanguard is enjoying strong inflows to its low-fee funds. Vanguard ETFs often undercut iShares funds on expense ratios.

The head-to-head matchup between Vanguard MSCI Emerging Markets (NYSEArca: VWO) and iShares MSCI Emerging Markets (NYSEArca: EEM) is a striking example.

The two ETFs track the same emerging market index, but VWO has an expense ratio of 0.2% while EEM charges 0.67%.

Investors have pumped $7.4 billion into VWO this year as of June 30, according to data from the ETF Industry Association. Year to date, EEM has gathered net inflows of $693 million, according to the ETF Industry Association. In 2011, investors pulled $8.5 billion from EEM, while VWO recorded net inflows of $5.3 billion last year. [Vanguard, Bond Funds Dominating ETF Flows]

Investors and advisors clearly prefer the lower-cost Vanguard ETF for emerging markets. [Bargain Hunters Flock to Vanguard Emerging Market ETF]

Vanguard ETFs are structured as separate share classes of the firm’s existing index funds. [Vanguard Indexing Guru Gus Sauter on ETFs]

“If Vanguard has the same ETFs that are identical in makeup to iShares and two-third of the cost, it is my fiduciary responsibility to my clients to switch,” a financial advisor told Reuters.

“Many people underestimated the long-term value of the brand and the experience of Vanguard,” added Lee Kranefuss, industry consultant and former iShares chairman, in the story.

Vanguard is the third-largest ETF provider by assets but is gaining on rivals iShares and State Street Global Advisors.

At the end of June, assets in U.S.-listed iShares ETFs totaled $482.3 billion, according to ETF Industry Association data. State Street controlled $290.7 billion and Vanguard held $208.3 billion.

Together, the so-called ETF Big Three control a market share of 83.4%, according to Morningstar. [Energy, REITs Lead Inflows to Sector ETFs]

“ETFs are not commodities,” a BlackRock spokesman told Reuters. “Buyers care a lot about liquidity, brand, product quality and accuracy of exposure.”

So far in 2012 through the end of June, Vanguard ETFs have attracted net cash inflows of $29.6 billion, according to the ETF Industry Association, while iShares has gathered $16.2 billion and State Street has collected $10.3 billion.