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Pricing Wars Weigh on Broker ETFs

ETFs with exposure to online brokerage firms have been hurt by price-cutting in that industry.
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) -- ETF Investors interested in online brokerages have two ways of gaining exposure to the industry, with

iShares Dow Jones U.S. Broker Dealers Index Fund

(IAI) - Get iShares U.S. Broker-Dealers & Securities Exchanges ETF Report

the slightly better choice over

SPDR KBW Capital Markets

(KCE) - Get SPDR S&P Capital Markets ETF Report

right now.

IAI has a greater allocation than KCE to Internet broker companies, with 20.6% of the holdings of IAI falling into this category and 16.8% of KCE's. Although investors should note that these fund are hardly pure plays on Internet brokers, their allocation to the sub-sector is strong enough to influence the funds.

A big reason for the difference in online brokerage exposure between the funds is that KCE has no allocation to

E*Trade Financial

(ETFC) - Get E*TRADE Financial Corporation Report

, while the company accounts for 3.6% of IAI.

Although small, the allocation to E*Trade contributed to IAI's recent underperformance of KCE. Year to date, ETFC declined by 15.3% and helped IAI fall by 9.5%, in comparison to KCE's decrease of only 8.5%.

The latest developments in the industry have been price cutting. E*Trade recently lowered its highest trading fees from $12.99 to $9.99 in the latest installment of an online brokerage price competition, a response to Fidelity's recent drop in its per-trade commission from $19.99 to $7.95. Although ETFC went up on the news of its own fee reduction, price wars are rarely constructive for the parties involved.

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Customers may enjoy trading more freely with lower fees, but it could hurt the bottom line of online brokers and another round in this price war would not reflect well on these ETFs.


(AMTD) - Get TD Ameritrade Holding Corporation Report

, which accounts for a small part of both IAI and KCE, set the trading price level that other companies, including


(SCHW) - Get Charles Schwab Corporation Report

, are competing to reach.

Shares of the TDAmeritrade may face downward pressure as they lose market share to competitors that are now offering prices closer to their level. AMTD was recently downgraded from 'buy' to 'hold' by Ratings, due in part to a low growth score.


's entrance into the pricing fray should not be discounted either. Even though it is not in either IAI or KCE, the company may take away customers from ETFC, SCHW, or AMTD with its new reduced trading fees and the 25 ETFs that they now allow customers to trade for free.

On top of the pricing upheaval in the industry, the performance for the online brokerage companies in IAI and KCE has been dismal, as has the performance of the funds. Unpredictable financial regulation from Washington cast a shadow on the traditional banks and brokerages that are prominent in these funds, such as

Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. Report


Morgan Stanley

(MS) - Get Morgan Stanley Report

, and the outlook from here looks tepid at best.

While the two funds are similar enough that performance should be similar, investors that have confidence in the industry should choose IAI on the chance that E*Trade, which has been the target of takeover speculation for several months now, may find a buyer.

Both ETFs trade with sufficient liquidity, although IAI's average for the trailing three months is about four times greater at 404,000 shares in comparison to 98,000 shares for KCE. In terms of fees, IAI has a higher expense ratio of 0.48% compared to 0.36% for KCE, but I think its performance potential will help it overcome this fee difference.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion has no positions in the equities mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.