ETF Price Wars? Schwab Slashes Expense Ratios

by on June 15, 2010 | ETFs Mentioned:

Charles Schwab may be a relative newcomer to the exchange-traded fund game, but the San Francisco-based firm has made quite a splash since wading into the ETF waters late last year. On Monday, Schwab shook up the industry again, announcing that it was reducing the expense ratios on six ETFs, or three quarters of its existing product line. Each of the ETFs impacted by the changes now features the lowest expense ratio in its ETFdb Category:

Ticker Expense Ratio ETFdb Category ETFdb Category Average
SCHB 0.06% All Cap Equities 0.34%
SCHG 0.13% Large Cap Growth 0.41%
SCHV 0.13% Large Cap Value 0.40%
SCHA 0.13% Small Cap Blend 0.44%
SCHF 0.13% Foreign Large Cap 0.49%
SCHE 0.25% Emerging Markets 0.68%

The two Schwab product maintaining their current expense ratios are the U.S. Large Cap ETF (SCHX, 0.08%) and the International Small Cap Equity ETF (SCHC, 0.35%).

Schwab’s reputation for low costs has helped the company to make up for lost time in the ETF space; total assets now exceed $1 billion, making Schwab one of the fastest-growing issuers over the last year. The recent adjustment to expense ratios won’t cost the firm much in the way of revenues–it shaves less than $50,000 from each run fund’s annual run rate–but gives the firm valuable bragging rights in an industry that has become increasingly cost competitive. Following the reductions, each ETF offered by Schwab is the lowest in its ETFdb Category. For now at least.

Price Wars

In recent years, the average expense ratio has inched higher; most new product launches have been increasingly granular products that require higher expense ratios to be economically viable. Emerging markets exposure, for example, costs more to provide than does exposure to large cap domestic equities.

But the last year has seen a number of events place downward pressure on ETF expense ratios as well:

  • November 2009: Schwab launches four equity ETFs, officially breaking into the ETF space. The new ETFs included the Schwab U.S. Broad Market ETF (SCHB); the 0.08% expense ratio charged by the fund replaced the Vanguard Total Stock Market ETF (VTI), iShares S&P 500 Index Fund (IVV), and S&P 500 SPDR (SPY) as the cheapest ETF on the market (the other three charged 0.09% at the time).
  • November 2009: Geary Advisors slashed the expense ratios on the Texas Large Companies ETF (TXF) and Oklahoma ETF (OOK) from 0.85% to 0.20%.
  • December 2009: Old Mutual introduced the GlobalShares FTSE Emerging Markets Index Fund (GSR) with an initial expense ratio of 0.0%, an ETF industry first. That rate, of course, was only available for a limited time, increasing to 0.35% at the end of the following month.
  • January 2010: Vanguard lowers the expense ratio on VTI to 0.07%, reclaiming the title of “cheapest ETF.”
  • May 2010: Old Mutual reduced the expense ratio on GSR to 0.25% from 0.35%, effective for at least 12 months.
  • June 2010: Van Eck reduces the expense caps on three international equity ETFs; cuts range from six basis points to 0.21%.

One of the few head-to-head matchups of ETFs linked to an identical benchmark has provided some interesting insights into importance of expenses in the mind of an ETF investor. The iShares MSCI Emerging Markets Index Fund (EEM) and Vanguard Emerging Markets ETF (VWO) both track the MSCI Emerging Markets Index, and both are among the five largest ETFs by total assets. But the expense ratios are very different; EEM charges 0.72% while VWO charges 0.27% (see EEM vs. VWO: Five Critical Differences). At the end of May, VWO had assets of almost $24 billion, an increase of about 180% over the previous year. EEM’s assets totaled $33.2 billion, but had grown only 8% over the previous year (the fund’s share price was up 12% over that period, implying net cash outflows).

Many have attributed VWO’s surge in popularity to a preference for lower expenses, and wondered if the consistent cash inflows signaled the beginning of a larger industry trend. However, it remains clear that expenses aren’t the only consideration; in the month since GSR cut its expense ratio to 0.25%, cash inflows have been slow to materialize.

The ramifications of Schwab’s latest move on the competitive landscape in the ETF industry are unclear. Full-blown price wars involving some of the major players is certainly a possibility. Stay tuned for more on this story–it will be interesting to see how the rest of the ETF industry reacts to Schwab’s discounting.

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Disclosure: Long IVV.