Schwab Jumps Into ETF Race

Charles Schwab has set his sights on the ETF industry in an effort to stay on the cutting edge in a rapidly changing investment environment.

Passive proprietary models from firms like Charles Schwab ( SCHW) will soon go toe to toe with firms like iShares in the fight for rapidly increasing share volume.

ETFs are becoming part of the larger strategy at firms such as Vanguard, Fidelity and Pimco, and the future of the ETF industry will be with large companies like Schwab, looking to diversify their investment offerings.

Schwab is in a good position to stake out the new ETF territory. While other money managers felt the pullback caused by economic distress, Schwab brought in $113 billion though brokerage services and funds.

Charles Schwab

According to Barron's Leslie P. Norton, this figure is larger than what Citigroup ( C), Morgan Stanley ( MS), Merrill Lynch, E Trade ( ETFC) and TD Ameritrade ( AMTD) brought in combined. Schwab currently has $1.1 trillion across all of its businesses. Norton also notes that it is the country's 13 largest fund complex, with $242 billion in assets.

As new firms enter the ETF fray, the race is on to offer the cheapest versions of popular funds. Many Vanguard ETFs, and early Pimco ETFs, are directly taking aim at pricier iShares funds. This is a process that Schwab will most likely meet head on.

In May, Schwab cut the expense ratio of its Schwab S&P 500 Index ( SWPIX) to 0.09%, a fee which is less than the Vanguard 500 Index ( FVINX) fund. As investors start to look for one-stop shopping of mutual funds, ETFs, and fixed-income products, the manager with the lowest fees and largest assets will be the most competitive.

Schwab's model focuses on independent financial advisors, which make up approximately 40% of their business. These advisors have been lured in largely by Schwab's low-cost proprietary mutual funds.

Peter Bourbeau, a portfolio manager at ClearBridge Advisors, a unit of Legg Mason, noted that "there's roughly a $2 trillion opportunity in the advisor channel, and they have 25% of the market--double the nearest competitor." As clients clamor for ETFs, Schwab should be able to parlay this interest into new funds.

The success of ETF products depends largely on the volume that they are able to drive. Higher volume results in more liquid funds, and customers look to buy ETFs at or near net asset value. Schwab's corner on the independent advisor market could spell huge success for its ETFs. When it comes to new ETF funds, Schwab will certainly have a captive audience.

Don Dion is the 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.

Dion is also 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.

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