Online Brokers Now Battling for Assets

Everyone knows investing in technology stocks is a risky business.

And investors are taking those risks to their online brokers. In good times, everyone wins. But last quarter, the more customers won with hot momentum stocks like Ventro (VNTR Quote) and Qualcomm (QCOM Quote), the more they traded and for many, the more they traded, the more they lost. The more they balanced their accounts with mutual funds and index products, however, the less they lost.

And that means that when it comes to customer assets, the more diversified players like Charles Schwab (SCH Quote) are faring better at keeping assets up than brokerages like E*Trade (EGRP Quote) and DLJdirect (DIR Quote). At issue is whether customers will get tired of trading in a protracted market decline, and if the transaction-oriented brokers can learn to live through boom and bust cycles.

Seeing how investors react to their first weak stock market can provide clues to how their tolerance might change going forward, says Rich Repetto, an analyst at Lehman Brothers. Lehman hasn't done underwriting for any of the firms mentioned.

On the surface, online brokerage total customer assets fell more slowly than the broader market, but that's largely because the rate of money flowing into the brokerages offset declines related to the market's fall.

For example, during the second calendar quarter, the decline in the stock market contributed to about a 12% fall in assets in customer accounts at E*Trade, according to a company spokesman, compared with an 8.5% drop in customer assets. DLJdirect, a unit of Donaldson Lufkin & Jenrette (DLJ Quote), meanwhile, estimates that asset decline at 13%-15%, while Charles Schwab data show that customer assets fell about 6% because of the market. Ameritrade (AMTD Quote) declined to comment.

Meanwhile, the Nasdaq Composite Index gave up 13%, the S&P 500 backed off about 3% and the Dow Jones Industrial Average edged down 4.3%. On the fund side, the Vanguard S&P 500 index fund fell 2.6% during the quarter and the giant T. Rowe Price Science & Technology fund gave up nearly 13% while, according to Lipper, the average technology fund lost 11.1%.

Comparing those numbers shows that online investors aren't immune to the market's downturn, Lehman's Repetto says. "This is probably the first real pain that investors have felt over the last eight quarters or so," he says. "I think they're resilient but I think this shows that if this was to happen over a sustained period of time, you would see investors start to refine their habits."

The differences between the E*Trade and Schwab declines aren't surprising if the clients of transaction-oriented firms such as E*Trade are more likely to trade hot high-technology issues, says Brad Barber, an associate professor of finance at the University of California at Davis and co-author of a study last year that showed active trading can hurt an investor's bottom line.

But if those assets were down more than the Nasdaq, Barber says, that could present a compelling argument that self-directed investing in individual tech stocks during a down market isn't as rewarding as investing in the broader index.

That, in turn, could mean that customers start mixing up their holdings more, turning more to mutual funds, fixed income, money market funds and other products. The online brokerages are already preparing for that. E*Trade, for instance, several months ago created the position of chief asset gathering officer to develop new investment products. Back in February, Schwab purchased New York-based US Trust, which has given it more diversified services, like estate planning and asset-management products.

But it's a tough road to diversification for these brokerages whose customers are still focused on trading. Even at DLJdirect, its ties to tony DLJ haven't translated into accounts with conservative holdings.

DLJdirect Chief Financial Officer Karen Vernamonti says that one of the reasons DLJdirect's customer accounts may have suffered more than those of Schwab is that their investors are largely holding the riskier stock portions of their portfolios in their DLJdirect accounts, and the mutual funds and fixed-income parts elsewhere.

"When you look at what our customers hold, it's a combination of Nasdaq and Internet index stocks," Vernamonti says. (The firm doesn't break out money flowing in and out of accounts and Vernamonti estimated the 13%-15% decline based on a sampling of large accounts.)

And for the most part, the holdings are stock. For instance, as of Aug. 2, 69% of DLJdirect's customer assets were in equities, 22% in cash, 7% in mutual funds and the rest in options, fixed income or other. (At the quarter end, customer assets were $27.5 billion.) Meanwhile, of Schwab's $931.2 billion in assets at the end of the quarter, about one-third, or $312 billion, was in mutual funds, $427 billion was in equities or other securities and $57 billion was in fixed income.

As August heats up, the question isn't just how sticky an online brokerage site is, but how sticky its assets are.