Schwab’s no-commission ETFs may spark a price war

Last week’s decision by The Charles Schwab Corp. to offer its own ETFs commission-free could result in less product education for financial advisers and investors, say rival ETF providers.

Eliminating commissions potentially puts the industry on a “slippery slope,” where ETF providers find themselves competing to the bottom with regard to fees, said Christian Magoon, president and senior managing director of Claymore Securities Inc. and Claymore Advisors LLC.

Although of obvious benefit to investors in the short run, the problem with such a race over the long run is that education and investor support likely would be sacrificed, said Mr. Magoon, who participated in an InvestmentNews round table on exchange-traded funds last week (see story on Page 12; an edited transcript of the round table will appear in the Nov. 30 issue).

“We know there is no free lunch,” said round-table participant Noel Archard, head of iShares U.S. product research and development at Barclays Global Investors, referring to the fact that neither Schwab nor other ETF providers can slash fees and commissions to the bone and continue to provide a high level of service.

Even though Schwab is only making its own ETFs available commission-free, the move has some attraction for advisers; aside from having to be a Schwab client, it appears to come with no strings attached. Still, few think that it is Schwab’s intention to become a major ETF provider. Instead, they see the commission-free move as a gambit to give advisers another reason to move assets into custody with Schwab.

“It’s not an extraordinary profit center for Schwab, but it does indeed provide them an attractive quiver,” said Harold Evensky, president of Evensky & Katz Wealth Management, which has $500 million in assets under advisement.

Schwab wants to use ETFs’ growing popularity among advisers to its advantage, said Richard Repetto, principal at Sandler O’Neill & Partners LP of New York.

“I think they are just trying to make sure they are covering themselves on all bases,” he said.

It is a smart move, said Richard Romey, president and founder of ETF Portfolio Solutions Inc., which manages $52 million.

“If all of a sudden the Schwab ETFs get traction, and I have a client that comes to me and is using two or three Schwab ETFs, I may be apt to use Schwab as a custodian,” he said.

Advisers, however, are unlikely to dump their ETFs in favor of Schwab’s just because they are commission-free, Mr. Romey said.

“I don’t know if I’m going to choose an ETF based on whether I have to pay a $9 commission,” he said. “The question the client will ask is: “Are you buying the best thing for me or just trying to save $9?’”

Schwab’s ETFs will have to prove — by closely tracking their index and keeping spreads tight — that they are either equivalent to, or better than, similar ETFs from other competitors, said Mark Balasa, a financial adviser and co-president of Balasa Dinverno & Foltz LLC, which manages $1.5 billion in assets.

“If they maintain this and keep it permanent, it’s one of the most shareholder-friendly moves that a fund company has done in a long time,” said Scott Burns, director of ETF analysis at Morningstar Inc., who added that the move likely will force ETF providers as well as custodian/discounters such as Fidelity Investments and TD Ameritrade Holding Inc. to cut fees and commissions.

Commission compression among brokerage platforms has been going on for some time.

Wells Fargo Investments LLC, a subsidiary of Wells Fargo & Co., has offered 100 commission-free ETF trades per year — with strings — through its WellsTrade online brokerage since February 2007. The trades are available only to Wells Fargo checking account customers who maintain balances of $25,000 or more in a combination of bank products.

Bank of America Corp. has offered a similar commission-free deal with similar strings attached since October 2006.

Launched last week, the Schwab U.S. Broad Markets ETF (SCHB) and Schwab U.S. Large-Cap ETF (SCHX) each have an expense ratio of 0.08%. The Schwab International Equity ETF (SCHF) has an expense ratio of 0.35%, while the Schwab U.S. Small-Cap ETF (SCHA) has an expense ratio of 0.15%.

Next month, Schwab plans to introduce four ETFs: the Schwab U.S. Large-Cap Growth ETF (SCHG) and the Schwab U.S. Large-Cap Value ETF (SCHV), which will each have an expense ratio of 0.15%, and the Schwab International Small-Cap Equity ETF (SCHC) and the Schwab Emerging Markets Equity ETF (SCHEX), which carry an expense ratio of 0.35%.

All Schwab ETFs are expected to be as cheap as or cheaper than comparable funds, with the exception of its emerging-markets ETF, which is more expensive than its counterparts from The Vanguard Group Inc. (0.27%) but less expensive than the offerings from iShares (0.72%) or State Street Global Advisors (0.59%).

Schwab’s domestic-equity ETFs will follow Dow Jones stock in-dexes, while its international-equity ETFs will follow FTSE stock in-dexes. All will be advised by Charles Schwab Investment Management Inc.

Schwab is able to market such low-cost ETFs without commissions because its $1.3 trillion of client assets provide the scale to offer the products without sacrificing investor support, Peter Crawford, a senior vice president in Schwab’s investment management services organization, said during a kickoff event last week.

“We think this is a game changer,” Walter W. Bettinger II, president and chief executive of Schwab, said via a satellite link to the event in New York.

Without commissions, ETFs that use dollar cost averaging finally will become feasible for small investors, he said.

E-mail David Hoffman at [email protected].

Related Topics: Charles Schwab & Co.