Schwab’s Peter Crawford: ETF managers need a management fee

Last year, The Charles Schwab Corp. launched its first exchange-traded funds, offering them commission-free

Last year, The Charles Schwab Corp. launched its first exchange-traded funds, offering them commission-free.

The pricing salvo triggered a price war, and soon Fidelity Investments, The Vanguard Group Inc. and, most recently, TD Ameritrade Holding Corp. began offering ETFs with no commission.

In June, Schwab went further, reducing total operating expenses of six of its eight ETFs, challenging Vanguard on its low fees.

Some industry experts predict that it is only a matter of time before another firm undercuts Schwab.

The price of ETFs in the United States ultimately will be zero, predicts Scott Burns, an analyst at Morningstar Inc., who noted that some ETF offerings in Europe are free.

Peter Crawford, senior vice president of investment management services at Schwab, sat down with InvestmentNews at Schwab’s Impact conference in Boston last month to discuss his views on the price war and on the ETF industry in general.

Q. Do you agree with Mr. Burns that ETFs ultimately may cost nothing?
A. I’m skeptical of that. At the end of the day, ETF managers are going to need to get some kind of management fee. Most managers, including ourselves, don’t make any money from securities lending. That money goes into the fund. But I do think there will continue to be price compression. Our U.S. Broad Market ETF (SCHB) is at 0.06% and I think we may see more of that, although I haven’t heard anyone say, “Gosh, I wish you had one that was 0.05%.” The big benefit of ETFs is with the pricing coming down, they are one-tenth the price of actively managed funds. If they go down another basis point or two, I don’t think it’s going to make much of a difference.

Q. Some skeptics think ETF providers are cutting corners to push fees down and that it isn’t sustainable. Do you agree?
A. We think ours is sustainable. We look at this as part of the total offering for advisers — part of the entire relationship, they will tell their friends, they will tell their clients. This is not a short-term strategy for us.

Q. What gaps do you see in your ETF product line?
A. The biggest gap is in fixed income. We launched three fixed-income ETFs in July — a [Treasury inflation-protected security] ETF and two in Treasuries. We have certainly heard a lot of demand for additional fixed-income ETFs, as well as additional equity ETFs. We recently filed to launch a mid-cap ETF and a [real estate investment trust] ETF, and that came purely from adviser demand.

Q. What are you considering developing on the fixed-income side?
A. I am not sure, specifically, but we are looking more on the credit side, like an aggregate-bond product. Our focus to date has been on ETFs that cover the biggest asset classes. And when you look at that, a total-bond ETF is one strategy that we are looking at.

Q. TD Ameritrade recently came out with commission-free ETFs and is pitching the fact that unlike Schwab, it doesn’t offer its own ETFs and is offering zero commissions on all ETFs on its platform. What is your response?
A. For someone who trades actively, we would happily put our offer up against theirs. At TD Ameritrade, you can’t trade within 30 days or you pay a penalty. At Fidelity, you can’t margin them. At Vanguard, I think you get in trouble if you trade them often. If people want to trade ETFs throughout the day, they can do that. If they want to margin them, they can do that. For active investors, we have the only offering that’s out there today. For buy-and-hold investors, we have the best combination of low expense ratios and free commissions.

Q. At the Schwab Impact conference, Mellody Hobson, president of Ariel Investments LLC, spoke about how the industry must get investors to think beyond short-term performance. By offering ETFs, are you helping to contribute to this short-term psychology?
A. Just because you can trade an ETF throughout the day doesn’t mean you are going to. We have plenty of advisers using ETFs as buy-and-hold investments. ETFs are great vehicles for buy-and-hold because of the tax efficiency. If you are trading them throughout the day, the tax efficiency doesn’t matter. But if you are holding them for five to 10 years, you don’t have to worry about paying an annual capital gains tax.

E-mail Jessica Toonkel at [email protected].