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

DEC 16, 2012
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.

GOOD DEAL FOR SCHWAB

“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.

TOPPING 2008 INFLOWS

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. [email protected] Twitter: @jasonkephart

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