August 8, 2013

Schwab to Launch 6 Fundamental Index ETFs

CSIM will track the Russell Fundamental Index Series, based on methodology developed by Rob Arnott and Research Affiliates

Fundamentally weighted methodologies are often referred to as “smart beta” because securities are screened and weighted based on objective factors, says Tony Davidow of the Schwab Center for Financial Research. Fundamentally weighted methodologies are often referred to as “smart beta” because securities are screened and weighted based on objective factors, says Tony Davidow of the Schwab Center for Financial Research.

Charles Schwab Investment Management (CSIM) announced Thursday that it will begin trading six new Schwab Fundamental Index exchange-traded funds next week. The new funds will be available for purchase commission-free online in Schwab accounts beginning Aug. 15.

With the six new ETFs, CSIM will track the Russell Fundamental Index Series, which is based on a methodology developed by Rob Arnott and Research Affiliates. Arnott is chairman and CEO of the Newport Beach, Calif.-based Research Affiliates, an index fund pioneer that produces asset-allocation and other strategies used to manage approximately $110 billion in assets worldwide.

“It’s been more than a decade since we began discussing the fundamental index strategy at Research Affiliates,” Arnott said in a Schwab media call announcing the new ETFs on Thursday. “A number of observers were skeptical of the methodology’s outperformance before we had a track record, but now we have a track record.”

To be sure, Schwab has plenty of competition in the ETF space. For example, Fidelity Investments recently announced plans to launch 10 sector-specific ETFs that will be subadvised by BlackRock. Known more for its actively managed mutual funds, Fidelity seeks BlackRock’s expertise in passively managed products to bring its new ETFs to market more quickly than it might otherwise have been able to.

‘These ETFs Add a New Flavor to Our Pure Vanilla ETFs’

Since launching its first Fundamental Index mutual funds in 2007, Schwab has seen a steady increase in demand from advisors, particularly registered investment advisors (RIAs), according to CSIM President Marie Chandoha, who introduced the six new ETFs in a media call on Thursday. Schwab’s five mutual funds using this approach now have $4.5 billion in total assets under management as of June 30, she noted.

“We know RIAs have been waiting for these ETFs, and we’re excited to deliver them,” Chandoha said. “These ETFs add a new flavor to our pure-vanilla ETF market-cap lineup and demonstrate our commitment to offering core products that help investors build their portfolios and potentially achieve better outcomes.”

Tony Davidow, alternative beta and asset allocation strategist for the Schwab Center for Financial Research, explained during the media call that fundamentally weighted methodologies are often referred to as “smart beta” because securities are screened and weighted based on objective factors such as adjusted sales, cash flow and dividends or buybacks.

Davidow, Arnott Use Apple to Argue Their Fundamental Point

“We believe fundamental weighted index ETFs are a revolutionary step forward,” Davidow said. “We believe that fundamentally weighted strategies bridge the gap between active and indexed strategies.”

In comparison, Arnott pointed to the example of Apple stock’s overheated performance in many index funds, because traditional market-cap indexes weight securities based only on market capitalization, so the largest companies have the largest weight in the index. Traditional market-cap indexing overemphasizes popular stocks at the expense of undervalued securities, and thus exposes investors’ portfolios to market speculation and bubbles, Arnott said.

“But the fundamental index says, thank you very much for the lovely gain, now let me reweight Apple back to a smaller footprint in the index,’” Arnott said.

The new Schwab Fundamental Index ETFs, which join Schwab’s other 15 proprietary ETFs, reflect the investment services firm’s heightened commitment to ETFs, which began in earnest in February when Schwab introduced a commission-free ETF platform of 105 ETFs from six big ETF providers.  The six new ETFs will be added to Schwab ETF OneSource on the first day of trading.

The new ETFs are:

Schwab Fundamental U.S. Broad Market Index ETF (FNDB) – Seeks to track the Russell Fundamental U.S. Index; Operating expense ratio (OER) of 0.32%

Schwab Fundamental U.S. Large Company Index ETF (FNDX) – Seeks to track the Russell Fundamental U.S. Large Company Index; OER of 0.32%

Schwab Fundamental U.S. Small Company Index ETF (FNDA) – Seeks to track the Russell Fundamental U.S Small Company Index; OER of 0.32%

Schwab Fundamental International Large Company Index ETF (FNDF) – Seeks to track the Russell Fundamental Developed ex-U.S. Large Company Index; OER of 0.32%

Schwab Fundamental International Small Company Index ETF (FNDC) – Seeks to track the Russell Fundamental Developed ex-U.S. Small Company Index; OER of 0.46%

Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE) – Seeks to track the Russell Fundamental Emerging Markets Large Company Index; OER of 0.46%

(Read Tony Davidow, ‘Equal Weight Evangelist,’ Brings His Message to Schwab at ThinkAdvisor.)

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