A Panoply of Free ETFs: Implications for the Industry, Discount Brokers and Investors

by: Sam Subramanian
Competition in the online trading space is intensifying. As reported in Discount Online Stock Trading: Charles Schwab Calls the Shots, Charles Schwab (NYSE:SCHW) recently launched eight in-house exchange-traded funds offering commission free trading on these products to its customers. The Schwab ETF lineup includes U.S. Broad Market (NYSEARCA:SCHB), U.S. Large Cap (NYSEARCA:SCHX), and International Equity (NYSEARCA:SCHF) ETFs.
Reacting to Schwab’s move, Fidelity has announced that its customers can trade 25 ETFs commission free. Fidelity and BlackRock (NYSE:BLK) have tied up to offer commission free trading on 25 iShares ETFs. Fidelity will receive a fixed amount from BlackRock to cover certain expenses.
Fidelity’s commission free ETFs includes several popular domestic equity, international equity, and income ETFs and expands the range of indexed products available to Fidelity customers. The list includes S&P 500 Index Fund (NYSEARCA:IVV), Russell 1000 Growth Index Fund (NYSEARCA:IWF), Russell 1000 Value Index Fund (NYSEARCA:IWD), Russell 2000 Index Fund (NYSEARCA:IWM), Barclays Aggregate Bond Fund (NYSEARCA:AGG), Barclays TIP Bond Fund (NYSEARCA:TIP), MSCI EAFE Index Fund (NYSEARCA:EFA), and MSCI Emerging Markets Index Fund (NYSEARCA:EEM).
What does this mean for the ETF industry?
Mutual fund supermarkets that offer commission-free trading of no-load mutual funds have been around for a few decades now. Schwab’s initiative and Fidelity’s response mark the advent of no-transaction-fee ETFs into the market place.
BlackRock’s tie-up with Fidelity can set the trend with other ETF sponsors like State Street (NYSE:STT) forging alliances with brokers and make the sponsor’s ETFs available to the brokers’ customers commission free. Following Schwab’s lead, brokers with in-house ETFs like the Vanguard Group can also waive commission on their in-house products for their clients.
These developments can lead to the formation of large ETF market places akin to mutual fund supermarkets.
What it means for brokers?
The competition among online stockbrokers is escalating at a time when industry’s fundamentals are challenging. The number of revenue generating trades is down from the highs seen in 2008. Also, the low interest rate milieu is forcing brokerage firms to waive fees on money market funds. These conditions may well catalyze consolidation in the online trading space.
Given the firm’s weak finances, speculation on E*Trade Financial (NASDAQ:ETFC) being acquired has surfaced often. This marriage may be solemnized with either TD Ameritrade (NASDAQ:AMTD) or Schwab likely being the suitor.
Opportunities for Investors
As noted in Best ETFs to Build Your ETF Portfolio, investors tend to view commission-free ETFs as asset allocation products suitable for building core portfolios. Investors may now look for the prospect of more commission free ETFs with low expense ratios become available and widening their choices.
By eliminating commissions, hitherto a major disadvantage of ETFs compared to mutual funds, ETFs are now amenable to dollar-cost averaging. ETFs are becoming an appealing option for young investors looking to build wealth from a small asset base.
Disclosure: I own IWM and EEM shares. I do not have long or short positions in any of the other securities discussed.