With ETFs, commission-free doesn't mean cost-free

Dec 16, 2012 @ 12:01 am

The Charles Schwab Corp. made a big splash three years ago when it offered the first exchange-traded funds to trade commission-free.

Now the company may be on the verge of one-upping itself.

Schwab is in the process of creating a commission-free-ETF supermarket that will include products from a variety of providers, according to Reuters. Only Schwab's proprietary ETFs are available commission-free to its brokerage customers.

The hitch? None of the three biggest providers — BlackRock Inc.'s iShares, The Vanguard Group Inc. and State Street Global Advisors — has signed on yet, according to the Reuters report.

Those three held 83.5% of the $1.3 trillion in ETF assets as of the end of last month, according to Morningstar Inc.

The sticking point reportedly is a 5- to 10-basis-point distribution and marketing fee which Schwab has proposed that the ETF providers pay to be on the platform. It would be similar to the 12(b)-1 fees that some mutual funds charge.

The fee may seem small, especially compared with the 25 basis points mutual funds routinely charge in 12(b)-1 fees. But for the lowest-cost ETFs, the levy could almost double or triple expenses.

The $23 billion Vanguard Total Stock Market ETF (VTI) charges 6 basis points. The $33 billion iShares S&P 500 ETF (IVV) charges 7. Further complicating matters is Schwab's commission of just $8.95 per trade. For some accounts, costs actually could go up, thanks to the free program.

In smaller accounts, such as a $100,000 portfolio, the fees don't make as much of a difference. Assuming a 5-basis-point fee, six trades (or a typical re-balance) would cover the costs of distribution and marketing.

Larger accounts could be adversely affected, however.


“It's the most expensive commission-free program an investor will ever see,” said Rick Ferri, founder of Portfolio Solutions LLC.

A spokeswoman for Schwab declined to comment.

Although the new fees could cause a headache for bigger advisers, the program could be a pretty good deal for Schwab.

The fees would give the brokerage firm a steadier stream of income than commissions, given trading volumes are at multiyear lows, as Reuters noted.

The proposed platform also suggests that Schwab has its eyes on grabbing a big piece of the ETF boom's coattails, said Ben Johnson, director of ETF research at Morningstar.

“It seems, from their perspective, in line with a strategy to become a one-stop shop for ETF investors,” he said.

Schwab this month also launched an educational ETF website that brings together research from such ETF providers as Guggenheim Investments, SSgA and Vanguard. That, Mr. Johnson said, is one more example of Schwab's reaching out to the ETF investor community, not just pushing its own products.

It isn't surprising that Schwab wants to expand its ETF pitch to advisers beyond its own products. Even though the brokerage firm offers the lowest-priced ETFs in the 15 categories in which it competes, its ETFs have failed to capture new deposits on the same scale as those from iShares and Vanguard.

Schwab ETFs had $2.5 billion in inflows year-to-date through last month, while iShares and Vanguard each had more than $45 billion, according to Morningstar.

ETFs are on pace for their biggest year ever, Morningstar said.


The passively managed low-cost vehicles had $154 billion in inflows this year through last month, which puts them on pace to top 2008's $168.3 billion in inflows, the research firm reported last Monday.

The new platform would make Schwab the first brokerage firm to offer advisers commission-free trading on an unlimited number of ETFs from multiple providers.

TD Ameritrade Holding Corp. offers commission-free trading on 101 ETFs, but the list is missing notable funds such as the $74 billion SPDR Gold Shares ETF (GLD), the $42 billion iShares MSCI Emerging Markets ETF (EEM) and the $30 billion PowerShares QQQ ETF (QQQ).

E*Trade Financial Corp. offers commission-free trades of ETFs from niche providers Deutsche Bank AG, Global X Funds and WisdomTree Investments Inc.

The question remains whether the new platform will attract new advisers or if the other platforms simply will copy it.

Mr. Johnson doesn't see it as a game changer. “I don't think it's something that would necessarily drive massive amounts of assets on other platforms to Schwab,” he said.

jkephart@investmentnews.com Twitter: @jasonkephart


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 30


Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video


State Street's Brie Williams: How financial advisers can protect clients with cognitive decline

Advisers need to take note of changes in their clients’ behaviors as they age, and help protect them from unnecessary financial fraud or loss, according to Brie Williams, head of practice management at State Street Global Advisors.

Latest news & opinion

House panel passes bill to replace DOL fiduciary rule with one requiring disclosure of conflicts

Measure likely to continue in partisan advance in House, but could stall in Senate.

Morgan Stanley says recruiting and attrition have slowed down

If wirehouses can successfully reduce their reliance on signing bonuses to recruit brokers, they could increase profits.

Managed accounts look attractive to 401(k) advisers, but how do you measure performance?

The customization that makes them a good investment option presents a benchmarking challenge.

National Holdings' acquisition of broker-dealer WFG Investments and its 200 advisers called off

Under an alternative plan, WFG's advisers will be relocated to three broker-dealers, including one owned by National Holdings.

House committees ready two assaults on DOL fiduciary rule this week

One is a vote on a bill to kill Labor's rule and replace it with a disclosure-based best-interest standard, while the second is legislation to prevent funding for enforcement of the regulation.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print