BASIS INSTINCT — THE SEQUEL: SCHWAB TAKES STAB AT ANOTHER FEE HIKE FOR SMALLEST FUNDS

One year after Charles Schwab & Co. first required small mutual funds to pay set-up and maintenance fees to be listed on its powerful fund supermarket, the discount broker is jacking up those charges.

That’s a rude surprise to some small funds, who say they are rethinking whether joining the dominant OneSource sales network is still worth it.

Schwab has raised the initial fee for new funds by 50% to $18,000 for a fund family’s first offering on the network and $6,000 for each additional fund. Before mid-July, when the fee changes became effective, the charges were $12,000 and $3,500, respectively.

In addition, Schwab has hiked the fees paid by funds with minimal assets on its OneSource network, which allows investors to buy and sell mutual funds at no charge. Now, funds with less than $6.8 million in OneSource will pay $2,000 a month to Schwab, regardless of the asset totals.

Schwab chose the $6.8 million cutoff as its break-even point, based on the 35 basis points each fund pays annually on its assets in OneSource, spokesman Greg Gable says. For asset totals exceeding $6.8 million, funds simply pay the 35 basis points. (Some fund firms that got into OneSource early pay just 25 basis points, but Schwab has been working in recent months to boost their fees, too.)

The upshot: A fund joining OneSource today that garnered less than $1 million in its first year on Schwab would be charged $24,000 — effectively, a charge of 240 basis points or more.

Under the previous policy, that fund would have paid $4,500, the flat annual charge Schwab levied on funds with less than $1 million in OneSource. (That amount would decrease on a sliding scale to zero once the fund hit $5 million.)

The new policies don’t affect funds already on the network, but they do apply to existing fund groups that want to list new funds.

“The current fee structure wasn’t paying for the capacity needed to maintain the funds,” Mr. Gable says. “We’re just trying to get this so the fee structure matches the costs associated with (OneSource).”

Schwab’s charges now are far steeper than those of its chief supermarket rivals: Boston-based Fidelity Investments, San Diego-based Jack White & Co. and Denver-based Datalynx Inc.

No. 2 supermarketer Fidelity, for instance, levies a one-time $10,000 fee for new families on its system, but doesn’t charge that for each fund. Fidelity also charges a flat $3,000 to $4,500 annually for funds with less than $5 million in its network, but averages the assets across the entire family so that funds with few assets avoid the fees if the same family has a top performer or two with a lot of assets. A spokesman says the company has no plans to change those fees.

Jack White and Datalynx currently have no such fees, although Datalynx plans to start charging something later this year.

Support for Schwab’s move is coming from an unlikely quarter — Chicago-based fund tracker Morningstar Inc., which has been a consistent campaigner against excessive mutual-fund fees.

“I actually think the charges are appropriate,” says Don Phillips, Morningstar’s president. “The costs of serving smaller accounts can be quite prohibitive. Schwab is just reflecting the reality of that situation.”

But Schwab’s changes are causing some small fund groups that have been waiting to be listed on OneSource — in some cases for months — to consider whether they can afford it.

Representatives of two firms, both of whom spoke on condition of anonymity, say they are reassessing and might either reduce the number of funds they’re listing on OneSource or bow out altogether.

pay or pray

That’s a tough choice, because Schwab controls about 80% of supermarket distribution and is most used by the independent financial planners many of these small funds are targeting. Indeed, many planners who use Schwab exclusively won’t consider buying a fund not on Schwab’s network.

“To me, it’s a no-brainer — you pay that cost,” Mr. Phillips says.

In some cases, the steeper fees are forcing fund firms to try harder to round up investment commitments ahead of time from advisers because Schwab continues to waive the fees for funds that can demonstrate strong adviser demand.

“Schwab’s in the driver’s seat,” says Robert Bacarella, chairman of Wheaton, Ill.-based Monetta Financial Services Inc., which manages $220 million in its seven mutual funds. “If you want to go through their distribution channels, you have to pay the price.”

Mr. Bacarella adds: “I can’t afford it. My expense ratio would skyrocket or it would eat into my management fees. But we as little funds have to deal with it. I have to create my own demand. Schwab doesn’t create the demand.”

fees are here to stay

Monetta has applied to be listed on OneSource, but Mr. Bacarella says he’ll make a decision about whether — and how — to go ahead when Schwab asks him.

One potential fallback is to get listed on the less popular transaction-fee side of Schwab’s system, which requires investors to pay when they buy or sell funds and doesn’t extract the 35 basis points from the funds themselves.

The initial set-up fees still apply there, but maintenance charges are a flat $1,000 a month for funds with less than $5 million. Not exactly a bargain, considering that new funds on the transaction-fee network previously were spared maintenance fees altogether.

While the charges clearly will cause problems for new fund families, some advisers have argued that slowing the creation of new funds isn’t bad, given the 11,000 or so available today.

But Schwab insists its intention isn’t to weed out any funds.

“On a case-by-case basis, (funds) are going to have to make that decision,” Mr. Gable says. “At the same time, we have to make our fees really reflect the cost of doing that business. We want to open the door widely, but do that without too much risk to our own business.”