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Breaking Down Schwab's New ETF Offerings

Scott Burns

Scott Burns: Breaking down Schwab's new ETF offering. Hi there, I'm Scott Burns, director of ETF analysis with Morningstar. I'm joined today by Peter Crawford, senior vice-president of investment management solutions with Charles Schwab. Peter, thanks for joining me.

Peter Crawford: Thanks for having me.

Burns: So, you've recently launched four new funds and you've got four more on the way. Let's start off by talking about the four funds that came out...

Crawford: Yesterday.

Burns: Yesterday.

Crawford: So they started trading yesterday. The four funds that started trading yesterday are the US Broad Market, US Large Cap, the US Small Cap, and our International Equity ETF.

Burns: OK. So then I start to a very basic core portfolio for asset allocators.

Crawford: Absolutely. And then we will have another four in December which will be our Large Cap Value, Large Cap Growth, our International Small Cap, and Emerging Markets ETFs.

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Burns: Got you. So a little bit of style and then a little more diversification for those who are looking for a little more advanced. One of the things about these funds is that the fees have been incredibly competitive when we look at the landscape. Can you talk about what the fees are and how they match up to the industry?

Crawford: Sure. So the US Large Cap and the US Broad Market are priced at eight basis points expense ratio. Our International Small Cap and Emerging Markets will be at 35 basis points. And the others, the other four, will be at 15 basis points.

In nearly every category, that price point is the lowest price in the category. In some cases it may be tied with somebody else, but it is the lowest--you cannot get a lower-priced ETF in nearly every single one of those categories.

Burns: Right. Now, a lot of hoopla, and I think rightfully so, has been made about your decision to go commission-free trading on the Schwab platform for Schwab ETFs. But you can buy and sell these ETFs on any platform or any brokerage, any exchange.

Crawford: That is correct. So yeah, our ETFs will trade on NYSE. And any client of any brokerage firm can buy them and take advantage of these great expense ratios and the quality index construction. We are working with Dow Jones and FTSE as the index providers.

Certainly to take advantage of the commission-free trading you have to be a Schwab client or become a Schwab client, but anybody can buy these ETFs anywhere.

Burns: So when we look at what is next on the lineup and your overall kind of product-rollout game plan here, what kind of broad strokes can you sketch for our viewers out there?

Crawford: I think what we will really be focusing on is trying to find categories, looking at the categories that account for the bulk of our clients' assets, those major, major categories, like what we've been doing here. And there are potentially some other ones.

But I don't see us launching a Brazil Small Cap mining ETF, for example, going after those real niches. If a client wants that, that is fine. We have over 850 ETFs that you can buy through Schwab. You'll pay a commission on those, but what we're really focusing on for our manufacturing, for our ETFs, are those major, major core categories.

Burns: Would you say you're really targeting more investors, traders, more advisors, or individuals? What is really kind of your target market here?

Crawford: Well that is, I think, what's neat about this offering, is it really targets everyone. For the active investors, the active traders, the zero commission is certainly a very compelling offer, something that I think many of them have been looking for for years.

For the more buy-and-hold investors, the very low expense ratios are great. And for the advisors, the combination of all of the above is something that we think they'll find very, very compelling. And of course for the smaller investors, now eliminating that commission makes an ETF a viable product, where it might not have been previously relative to a mutual fund.

And so we think for all those segments of clients that these ETFs will have appeal.

Burns: Right. Now, when we get new offerings, and especially when we get new entrants in the ETF market, it's different than the open-end market. And we talked a little bit about that on the side here.

But what are some of the steps Schwab has made to embrace that, to deal with that? You know, the concern that investors are going to have about the liquidity, and the tracking, and the creation, and all that kind of stuff?

Crawford: That's a good question. So first of all, Schwab has been managing index funds for 20 years and we have almost $20 billion in index funds. So it's something we're familiar with, managing for tracking error, managing for tax efficiency, thinking about sampling and replication of an index, and so forth.

But also we recognize certainly with an ETF, there's the whole Street side of it, the whole trading, and the liquidity, and the market makers.

So we've hired a team of folks who have been working in this industry for years, people from the NYSE, from BGI, and from other places. We're able to combine their expertise with our index fund expertise and our history doing that to create what we think is a world class team.

Burns: So along with this learning curve about how you actually construct the portfolios and all that, I'm sure you have also now become kind of aware of the learning curve that your clients, whether they are advisors or individuals, the different mind-set they need when they are going to employ these ETFs, especially when it comes to investing versus open-end funds.

Crawford: Well, I think that's exactly right, and that's part of what Schwab is good at, is helping to educate our clients, helping to educate independent advisors.

We see, as you mentioned, ETFs are a relatively new product, a relatively new vehicle. And there are still people who think of them like mutual funds. They think that when they place that trade they're going to get executed at the NAV automatically.

And there's certainly some education we need to do about what that means, and how you have to think about liquidity, and spreads, and so forth. Certainly, among the individual investors, a lot of them don't even know what an ETF is. They may not even know what it stands for.

Burns: I get that a lot.


Crawford: EFT or something like that. So we see an opportunity to provide education there, as well, and make sure everyone understands how ETFs should be used, what the benefits of them are, what the issues with them are, what to be mindful of when you are placing trades, and so forth, and making sure that everybody really understands what this new product is.

Burns: Right. And that's a huge part of our goal here, too, at Morningstar. So we are definitely with you on that. So great job on the products. I think the very low costs, the no commission is a very nice twist. We like to say here at Morningstar, "When fund companies compete, the investor wins." So welcome to the ETF world, Peter, and good luck to you and your Schwab team.

Crawford: All right. Thanks very much, Scott.

Burns: Thanks. I'm Scott Burns, director of ETF analysis with Morningstar. For this and other ETF commentary, please check out the Morningstar ETF Center on and the Morningstar ETFInvestor newsletter.