Inside Schwab’s ETF Price Cuts
September 27, 2012
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Charles Schwab’s dramatic gesture in September to cut the prices on all 15 of its ETFs looks to be more the stuff of catchy headlines and sexy marketing rather than a real enticement that will drive investors to quickly switch to Schwab, an informal IndexUniverse survey of financial advisors found.
As is often the case with any subject matter, the more deeply one delves into the price cuts, the less clear things seem to become. Yes, the price cuts made the Schwab ETFs the cheapest in their respective classes, and yes, Schwab clients can trade those ETFs for free which, given the need to rebalance, is a great deal. You can’t blame Schwab for trumpeting the move with big ads in The Wall Street Journal.
But are the funds really cheaper when taking into consideration sometimes-overlooked variables such as bid/ask spreads? And how important is the fact that commissions Schwab does charge on, say, nonproprietary ETFs, are more expensive than what its arch rival Vanguard charges? And perhaps most relevant, are Schwab’s ETFs as good as the competition’s from a portfolio management point of view?
At the very least, it's clear that Schwab’s moves are the latest reflection of a deepening trend of downward pressure on prices across the financial services industry. But it’s also pretty clear that Schwab aims to attract investors and advisors to its platform and then charge them for products and services that will contribute to the San Francisco-based company’s bottom line.
“Schwab and others are not charities,” said Tyler Mordy, a financial advisor at Toronto-based Hahn Investment Stewards.
“But the flip side is that there’s a continuing pressure on fees,” Mordy added, stressing that the ETF looms largely in the dropping-cost scenario because asset allocation has never been so inexpensive and potentially thorough, given the growing number of available ETFs.
So, when Schwab Chief Executive Officer Walt Bettinger told journalists last week that the bold price cuts were motivated by what’s good for investors, it seems advisors do take Bettinger seriously, but only up to a point.
After all, Schwab's 15 ETFs don’t yet canvass nearly all the pockets of financial markets, meaning commissions are almost inevitable, and advisors seem to understand this pretty clearly.
And, as far as that goes, commissions at Schwab are about $9 a trade, compared with $7 at Vanguard for buying and selling securities that aren’t part of each company’s free ETF trading programs. That, too, adds up.
A Loss Leader
Moreover, it’s hard to get away from the conclusion that, after the price cuts, Schwab is losing money on its ETFs, according to Rick Ferri, head of Michigan-based registered investment advisor Portfolio Solutions and a well-known figure in the world of index investing.
That’s because we know that Vanguard—a mutual fund company that’s owned by its fund holders—runs its funds at cost as a matter of course. Vanguard’s funds are considerably bigger than Schwab’s, meaning it has better economies of scale than Schwab. So, if Schwab’s smaller funds are cheaper, it’s pretty obvious Schwab is losing money on them, Ferri said.
Ferri stressed that Schwab will try to use the cheap and commission-free ETFs as loss leaders.
“What they’re trying to do is get people to come to their platform,” said Ferri. “Get them into the store, then they’ll spend money there,” he added, noting Schwab is said to make good money on products such as its money market funds. Its Options Express unit is also said to be very profitable.
A Vanguard official made clear that Vanguard will never use a loss-leader approach to selling its funds, again, because it’s owned by fund holders, and such a policy would violate its at-cost pricing policy.
“If it is a loss leader for them, we just wouldn’t be pulled into that,” Vanguard spokesman Dave Hoffman said in a telephone interview. “We would also ask, how long can a company play that game?,” Hoffman added.
“We don’t view reducing our prices as being competitive. We reduce our costs because it’s a function of our structure. We pass on savings with increased assets.”
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