Schwab Creates Watershed Event with Commission-Free ETFs

Yesterday, November 3, 2009, marked a watershed event for the ETF landscape.  It’s the day that Schwab, absent from the ETF industry for past 16 years, upped the ante for any company thinking about getting into the business.  Charles Schwab Investment Management, Inc. launched its first four ETFs.

At first glance, the new Schwab ETFs are nothing special – just four broad based core holdings, just like dozens already available from other fund companies.  But look closer, and you will see they are also the lowest fee funds within each of their respective asset classes.

Look yet again, and see that these ETFs are also commission-free for Schwab brokerage customers.  This is historic.  Just as no-load no-transaction fee mutual funds changed the mutual fund landscape, commission-free ETFs will forever alter the way that ETFs are perceived.  With this one change, nearly every argument in favor of mutual funds instead of ETFs goes away.  Dollar cost averaging?  No longer costly with commission-free ETFs.  Small account size?  Not a problem anymore. 

Schwab has arrived, and they didn’t do it quietly.  Now all eyes will turn to the competition to see how they react.  Will other brokerage firms roll out their own ETF brands?  Will iShares and SPDRs get into the discount brokerage business?  “Strategic alliances” will be discussed, but in all likelihood are not feasible since there are not enough fees to share.  Schwab has erected a significant barrier to entry and is now well positioned to go after the lucrative 401k market.

The four new ETFs launched by Schwab:

• Schwab U.S. Broad Market ETF (SCHB) (SCHB overview) will track the Dow Jones U.S. Broad Stock Market Index with a 0.08% expense ratio. The underlying index represents the largest 2,500 U.S. equities and is float-adjusted market cap weighted.
• Schwab U.S. Large-Cap ETF (SCHX) (SCHX overview) will track the Dow Jones U.S. Large-Cap Total Stock Market Index with a 0.08% expense ratio. The underlying index represents the largest 750 U.S. equities and is float-adjusted market cap weighted.
• Schwab U.S. Small-Cap ETF (SCHA) (SCHA overview) will track the Dow Jones U.S. Small-Cap Total Stock Market Index with a 0.15% expense ratio. The underlying index represents the stocks ranked 751–2,500 of the largest 2,500 U.S. equities and is float-adjusted market cap weighted.
• Schwab International Equity ETF (SCHF) (SCHF overview) will track the FTSE Developed ex-US Index with a 0.15% expense ratio. The underlying index covers1,400 large cap and mid cap stocks from more than 20 developed international markets.

Online trades of Schwab ETFs are commission-free at Schwab, while trades of third-party ETFs are still subject to commissions.

Unfortunately, the first day of trading had some glitches.  SCHA traded at the wrong price for the about the first ten minutes with those who bought early receiving about a 10% discount from NAV, unless those trades get busted.  SCHX appeared to have a similar problem but fewer shares were involved.  Market makers had trouble maintaining the appropriate depth on SCHB, and it appears some larger orders created price spikes.  SCHF had the most orderly first day of the bunch.

Schwab expects to offer four additional ETFs in December: Schwab U.S. Large-Cap Growth ETF (SCHG), Schwab U.S. Large-Cap Value ETF (SCHV), Schwab International Small-Cap Equity ETF (SCHC), and Schwab Emerging Markets Equity ETF (SCHE).

Additional Information: press release, Schwab ETF website, prospectus download page

Disclosure compliant with FTC 16 CFR Part 255 covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.