Schwab plunge into ETFs may open floodgates

Move is seen likely to entice Fidelity and other mutual fund leaders

Feb 22, 2009 @ 12:01 am

By David Hoffman

Big-name mutual fund companies leery of jumping into exchange traded funds have finally received the signal that they need to make a major push into that arena.

On Jan. 30, the investment management arm of The Charles Schwab Corp. filed with the Securities and Exchange Commission for exemptive relief to create its first ETF.

"I think this is going to force ... a lot of the big mutual fund firms to move forward," said James Pacetti, president of ETF International Associates Inc., an industry consulting firm in New York.

San Francisco-based Schwab has deep relationships with financial advisers, who look to the company for solutions, he said.

For the most part, big-name fund companies with actively managed products have held off getting directly involved in the creation of ETFs, which are a low-margin business compared to funds.

But Schwab Investment Management Inc.'s sudden interest in ETFs makes sense.

Thanks to the turbulent market, investors yanked $181 billion more out of mutual funds in 2008 than they put in, according to Strategic Insight Mutual Fund Research and Consulting LLC of New York.

ETFs, however, saw $176 billion inflows for the year.

There are a number of reasons for that.

ETFs are generally cheaper than mutual funds, transparent and can be traded intraday — qualities that make them more attractive to investors in volatile markets.

Such characteristics are expected to help propel U.S. ETFs, which had $536 billion in assets at yearend, to the $1 trillion mark in just a few years, according to Strategic Insight. Worldwide, the company expects ETF assets, which stood at $725 billion at yearend, to eclipse the $1 trillion mark within two years.

Given such numbers, it is likely Schwab's competitors will counter with their own ETFs.

Rumors are already swirling that Fidelity Investments of Boston is getting ready to renew its long-stalled efforts to create ETFs.

It launched the Fidelity Nasdaq Composite Index Tracking Fund (ONEQ) in 2003, but hasn't followed up with any further introductions.

That may change, however, now that an alumnus of State Street Global Advisors of Boston — the firm responsible for bringing the first ETF to market in 1993, and the second-largest ETF provider by assets — is in charge of product development at Fidelity.

Fidelity announced Feb. 13 that Anthony W. Ryan would start today as the firm's new head of asset management strategy and product development.

A principal at SSgA from 1994 to 2000, he has served in high-profile roles within the Department of the Treasury since 2006. "Right now we can't speak to any initiatives that may or may not happen under Tony's leadership," said Stephen Austin, a spokesman for Fidelity.

But industry watchers said Fidelity would be foolish not to jump into ETFs.

"There are too many reasons not to [wait]," said Loren Fox, a senior vice president with Strategic Insight.

In addition to Schwab, a small number of other mutual fund companies have already thrown their hats into the ETF arena.

Pacific Investment Management Co. LLC of Newport Beach, Calif., filed for exemptive relief with the SEC July 29 to offer passively managed, index-based bond ETFs. It followed up that filing with one on Sept. 3, asking to be granted approval to offer active strategies.

The Dreyfus Corp., a subsidiary of The Bank of New York Mellon Corp.'s BNY Mellon Asset Management unit, began an effort last year to co-brand and help market a line of ETFs in the international-cash and fixed-income areas with WisdomTree Investments Inc. of New York.

And in 2006, Amvescap PLC of London, now Invesco Ltd. of Atlanta, bought ETF provider PowerShares Capital Management LLC of Wheaton, Ill.

Schwab's entrance into the ETF game, however, has the potential to be the most meaningful.

"Schwab's deep pockets could launch a thousand ships if it wanted," said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor, a monthly newsletter.

Not everyone, however, is impressed.

Schwab may have deep pockets, but it and any other newcomers will face a challenge in developing new products based on indexes that haven't already been snapped up, said Martha Papariello, a principal with The Vanguard Group Inc. of Malvern, Pa., one of the first major mutual fund companies to launch ETFs in 2001.

It's a problem Schwab is likely to face right off the bat.

Its proposed ETF would track the Dow Jones U.S. Total Stock Market Index, a benchmark index that measures the total return of the entire U.S. stock market.

That's a very similar description to that of the Dow Jones Wilshire 5000 Index, which SSgA already uses as the benchmark for the SPDR Dow Jones Wilshire 5000 ETF (TMW).

E-mail David Hoffman at


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