Exchange Traded Fund (ETF) Trading Strategies

Monday, June 14, 2010

Schwab Declares Price War With ETF Fee Cuts


Charles Schwab, the discount broker that began rolling out its own exchange-traded funds in November, has cut expense ratios on six of its eight ETFs, including its emerging markets offering, raising the stakes in its competition with other fund purveyors, particularly Vanguard.

In its press release announcing the price cuts, Schwab went out of its way to show how its new costs measure up against the top three U.S. ETF firms, iShares, State Street Global Advisors and Vanguard, respectively. It said in the release that its fees are now lower than those on any competing funds.

The comparison to Vanguard is particularly apt because all six of Schwab’s price cuts make its ETFs cheaper than similar funds from Vanguard, a firm long associated with affordable prices. Moreover, Schwab and Vanguard have each offered their clients free trading on their respective ETFs, lending Schwab’s price cuts an aspect of a brewing price war between it and Vanguard.

“To have the lowest price, we have to be lower than Vanguard,” Peter Crawford, a Schwab executive in charge of investment management services, said in a telephone interview. "With ETFs it’s about getting to scale," Crawford added in response to a question about whether such low prices might not be in Schwab’s interest.

While acknowledging that Schwab’s move was akin to “paying it forward,” Crawford declined to estimate a level of assets when its ETFs would no longer have the appearance of being little more than loss leaders. Whatever challenges Schwab faces, there's a lot for investors to like in all this, as Matt Hougan said in his blog.

“We feel very confident given the first six or seven months of our launch that we’ve achieved some level of scale, and we feel confident we’ll get to the next level of scale,” he added.

Schwab’s entrance into the world of proprietary ETFs has so far been successful. The San Francisco-based company’s ETFs have gathered more than $1 billion since it rolled out its first funds in November. Also, the company said in April that its ETF-based advisory program it launched this year had collected more than $500 million in assets.

The Price Cuts

The most conspicuous price cut is on the Schwab Emerging Markets Equity ETF (NYSEArca:SCHE - News). Schwab sliced the expense ratio on SCHE to 0.25 percent a year from 0.35 percent previously, 2 basis points lower than the 0.27 percent fee Vanguard charges on its MSCI Emerging Markets ETF (NYSEArca:VWO - News).

VWO had ongoing success attracting assets, in part because of its relatively low cost. The Vanguard fund, now the fifth-largest U.S. ETF, is steadily catching up to iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM - News). EEM is the biggest U.S. emerging markets fund and was the third-biggest of all U.S. funds at the end of May, according to data compiled by IndexUniverse.com.

Expense ratios on all of Schwab’s funds were already lower than costs of competing funds from iShares and SSgA, the company said.

The new prices on the funds are as follows:

The Schwab U.S. Broad Market ETF (NYSEArca: SCHB) will now cost investors 0.06 percent, compared with 0.08 percent before and 0.07 percent for Vanguard’s “VTI;”

The Schwab U.S. Large-Cap Growth ETF (NYSEArca: SCHG) now costs 0.13 percent compared with 0.15 cent previously and 0.14 percent for Vanguard’s “VUG;”

The Schwab U.S. Large-Cap Value ETF (NYSEArca: SCHV) now costs 0.13 percent compared with 0.15 percent previously and 0.14 percent for Vanguard’s “VTV;”

The Schwab U.S. Small-Cap (NYSEArca: SCHA) now costs 0.13 percent compared with 0.15 percent previously and 0.14 percent for Vanguard’s “VB;”

The Schwab International Equity ETF (NYSEArca: SCHF) now costs 0.13 percent compared with 0.15 cent previously and 0.15 percent for Vanguard’s “SCHF.”

Context Is Critical
Schwab left unchanged the price of its U.S. Large Cap Fund at 0.08 percent, which was already undercutting its competition, notably the SPDRs S&P 500 ETF (NYSEArca: SPY), the world’s biggest exchange-traded fund. SPY, which costs 0.09 percent, had about $70 billion in assets at the end of May, according to the IndexUniverse.com data on May ETF flows.

The company also left alone the price of its International Small-Cap Equity ETF (NYSEArca: SCHC) at 0.35 percent.

All the prices are definitive, and would require shareholder approval to be undone, Crawford said. That’s different than, for example, a recent price on an emerging market fund by Old Mutual, a South Africa-based money management firm. The company recently cut the fee on its GlobalShares FTSE Emerging Markets Fund (NYSEArca: GSR) to 0.25 percent, from 0.39 percent, saying the teaser rate was good for a year, and could be extended if assets start flowing in.

Crawford said it’s important to understand Schwab’s price-cutting plan move in the context of the company’s broader place in the money management industry. It’s long been a champion of delivering relatively inexpensive services, and it can afford to do so, in part because it’s been successful attracting assets.

It now houses about $1.4 trillion in assets, $200 billion of which is in its own mutual funds. That means its ETFs, which again have attracted just over $1 billion since the rollout began in November, are a relatively small piece of its overall business.

“At Schwab, our approach is about the totality of our relationship with our clients. If we provide them with an exceptional value across the board in all these different products, they’ll bring us more of their business and they’ll tell their friends.

“That’s a strategy that helped us bring in $85 billion last year in net new assets last year, and it continues with strong growth this year. So we do expect these [ETF] products to be profitable and not a loss leader. At the same time, at Schwab, it’s always been about more than product profitability.”

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