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Schwab Ups the Ante on ETFs

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Schwab Investment Management Services announced November 2 that it is launching its own lineup of Schwab-branded ETFs that feature very low expense ratios and which will trade for free on the Schwab advisor platform. Charles Schwab Corp. CEO Walt Bettinger said the move was similar to the launch 20 years ago of Schwab’s OneSource mutual fund platform. “When we looked at how ETFs are distributed,” said Bettinger, “we saw some limitations” that the commission-free trading could help solve, “making dollar-cost averaging possible in ETFs.” Bettinger noted that “15% to 20% of retail ETF trading goes through Schwab already,” and that the November 2 announcement was only “a first step” in the ETF arena.

This first step might well be a wise one, says Tom Lydon, president of Global Trends Investments, and editor and proprietor of “From a strategy standpoint,” says Lydon, “Schwab’s timing is great,” since the move indicates that the firm is saying, “We’ve been looking at ETFs for a while now, we’re going to make a commitment to ETFs, it’s right for individual investors, it’s right for advisors. The first rollout will be broad-based ETFs, with very low expense ratios, and to top it off we’re not going to charge a commission, we’re going to subsidize that internally.”

Moreover, Lydon suggests that since most advisors do not believe we are in a recovery, and that the market’s performance since March is merely a “bear market rally,” any moving of clients’ money away from cash and fixed income into the equities market would likely be into a “more defensive posture,” and that the Schwab ETFs would be considered by most advisors to be low-cost, conservative core holdings.

The four ETFs available at launch in November were the:

o Schwab U.S. Broad Market ETF (SCHB), with an expense ratio of 0.08%

o Schwab U.S. Large-Cap ETF (SCHX), a blend fund, with an expense ratio of 0.08%

o Schwab U.S. Small Cap ETF (SCHA), with an expense ratio of 0.15%; and

o Schwab International Equity ETF (SCHF), also with expenses of 0.15.

In December, Schwab said it will roll out large-cap growth, large-cap value, small-cap international equity, and emerging markets ETFs.

Peter Crawford, Schwab Investment Management Services Senior VP, said the no-commissions scheme applies to trades made by advisor clients on and its trading platforms. There is no limit on the number of trades, said Crawford, and the more than 800 non-Schwab ETFs will retain their standard commissions.

In a separate interview, Crawford said that “unlike some of our competitors,” Schwab itself will not be making any money from lending securities in the ETFs, “all those revenues will go back to shareholders alone,” he pledged. When asked if Schwab expects other ETF makers to follow its lead and perhaps form a no-transaction-fee platform for ETFs similar to OneSource, Crawford only says that “we’ve had general conversations” with other ETF makers.

Lydon said the move struck him as “pure Schwab,” and that Charles Schwab himself “loves ETFs and owns them.” While Crawford wouldn’t say that the no-trading idea was Chuck’s, he did say Mr. Schwab saw the move as a great opportunity, an “example of something he gets incredibly passionate about,” as he did with the OneSource platform.

Bernie Clark, head of national sales and relationship management for Schwab Advisor Services, Schwab’s RIA custodial arm, said the move was “a natural” for Schwab, pointed out the growing appeal of ETFs for advisors, particularly their liquidity, transparency, and performance, and said advisors had told Schwab “how important this is to them.”

Vaughan Scully, senior financial writer at S&P, says he doesn’t see the Schwab move as “being a “game changer” initially, suggesting it would be most appealing for “highly active traders who pay a lot of trading commissions.” However, Scully says that those “serious traders will want to see the trading volumes and the bid/ask spread for those ETFs before diving in.”

Scully, who regularly contributes in print and on the Web for Investment Advisor and, says that “for the rest of us, these are plain vanilla ETFs looking to compete with a large number of other, more unique products. Sure it’s great to get a ‘deal’ by not paying the $10 to $20 per trade commission, but it’s asking a lot for someone to move their account to Schwab simply to save the trading commission and 0.01% in annual expenses.”

However, Scully admits that “success breeds imitation,” so if Schwab’s ETFs attract plenty of assets, he expects “someone would offer a similar alternative, but I’d guess that most of the large ETF issuers–Barclays, State Street–will wait to see how popular this gets before deciding on whether to respond.”