Ron Rowland, editor of Invest with an Edge, is very excited. He’s just discovered that Charles Schwab is upping the ante on the exchange-traded fund industry by launching commission free ETFs.
In fact, four such funds were launched on Wednesday: The Schwab US Broad Market ETF, The Schwab US Large Cap ETF, The Schwab Small-Cap ETF and The Schwab International Equity ETF.
Rowland calls it nothing less than a ‘watershed’ moment, gushing:
This is historic. Just as no-load no-transaction fee mutual funds changed the mutual fund landscape, commission-free ETFs will forever alter the way that ETFs are perceived. With this one change, nearly every argument in favor of mutual funds instead of ETFs goes away.
Of course, as Felix Salmon at Reuters rightly picks up - when something sounds too good to be true it usually is. As Salmon reminds there are usually two main costs involved when you buy or sell equities: the commission and the bid-offer spread. And as he notes:
…if the new Schwab funds remain relatively small and illiquid, it’s still going to be a bad idea to buy them, just as it’s a bad idea to buy any ETF with less than a billion dollars or so in assets.
Meanwhile, Charles Schwab aren’t being as innovative as they might think. The FT reported on Monday that in a different model Deutsche Bank’s db x-trackers in Europe has been in on the no-management fee game since July (our emphasis):
In a world where investors are too often fleeced by exorbitant fees, investors in db x-trackers’ DJ Euro Stoxx50 exchange traded fund received a pleasant surprise in July. The company, a division of Deutsche Bank, decided to scrap the 0.15 per cent annual management fee on the fund, designed to track the performance of Europe’s heavyweight blue-chip stocks. From that point on the fund’s total expense ratio was reduced to zero.
If, by the way, you were wondering how an ETF issuer like db x-trackers can afford to waive management fees for everyone — not just commission fees to customers of its brokerage firm –it’s pretty much down to auxiliary activities like stock lending and index arbitrage in some cases.
Which perhaps gives us a clue as to what’s really the profitable side of the ETF business — and why waiving fees for the sake of popularity and asset growth makes sense for ETF issuers all round. Although, as the FT notes, this doesn’t come without its risks for ETF investors in the dbx product:
Securities lending also entails a degree of counterparty risk; if those to whom you have lent go under, will the collateral you are holding protect you against financial loss?
Not that it has put off customers in db X-trackers’ case. Dbx told the FT it’s been rewarded for its apparent generosity by seeing assets in its EuroStoxx product rise by 35 per cent to €2.4bn since it scrapped fees just about three months ago. As for how much of those auxiliary proceeds might end up with the investor, the FT notes:
Db x-trackers favours the alternative approach; indirect, or synthetic, replication. Here the exposure to the underlying index is gained via a swap contract, so there are no underlying securities to lend. However the swap counterpart, in this case Deutsche Bank, does hold the underlying securities, which can thus be lent out. Again the proceeds are split with the ETF, but the exact nature of the split is not publicly available. Mr Mistry says “a large part” is passed to the fund.
So, the sum is not at all defined. Not that that should worry investors seeking a cheap index-tracking product, just those seeking a transparent index tracking product.
To surmise, commission-free and management-fee free ETFs may very well lower fees for the industry as a whole, and that is a good thing, but there’s no real benefit to investors unless the business they attract tightens bid-ask spreads too.
Related links:
Synthetic ETF attack - FT Alphaville
