The mutual fund business will never be the same

Posted: March 21, 2013 in Interesting Facts

08-46[1]The mutual fund business will never be the same
By Chuck Jaffe, MarketWatch

BOSTON (MarketWatch) — When the biggest names in financial services fight over how to promote the next big investment trend, the clear winner is the consumer.

That’s not usually how it works for investors, but this week’s announcement of a new working arrangement between mutual-fund giant Fidelity Investments and exchange-traded fund leader BlackRock Inc. — on the heels of the introduction of Schwab’s OneSource platform for ETFs — are clear signs that this battle will have numerous cost and accessibility benefits for the investing public. Read more: With BlackRock deal, Fidelity bets on ETFs.

ETFs are essentially index mutual funds that trade like stocks. While the ETF industry holds a fraction of the assets in traditional mutual funds, ETFs’ popularity is growing rapidly and are clearly seen as the product of the future for the average investor.

Moreover, ETFs typically have lower costs, are more tax-efficient and unlike traditional funds can be bought and sold throughout the trading day.

The one area where ETFs have lagged in this battle — not inconsequentially — is on trading fees, where even a discounted commission can add up when an investor wants to make regular, small purchases.

On the attack
But now the biggest providers are making ETFs even more attractive. This is war, so pay attention to how you can be the winner.

The action started last fall when BlackRock (NYSE:BLK) cut costs on its iShares line, a shot at the Vanguard Group, which had long been acknowledged as the industry’s low-cost leader.

In response, Charles Schwab Corp. (NYSE:SCHW) dropped fees on its ETFs to make them the lowest-cost entries in their categories; for example, the expense ratio on Schwab U.S. Large Cap (NAR:SCHX) was halved to 0.04%, which — like most of the issues that saw costs trimmed — was 0.01 points better than Vanguard’s entries in similar spaces.

Vanguard countered with new benchmarks for nearly two dozen index funds, cutting costs and suggesting its methodology was better.

This year the conflict has escalated. In February, Schwab unveiled its ETF OneSource platform, which allows customers to buy and sell more than 100 ETFs with no online trade commissions.

While Schwab and other firms had offered limited free ETF trades up to this point, Schwab’s move represented a significant expansion. More important, while the program was started with 105 funds, it holds the promise of drawing more ETF providers into the fold and making ETF sales charges largely a thing of the past. Read more: The pros and cons of Schwab’s ETF OneSource.

Now comes the Fidelity-BlackRock deal, which marries the leader in passive ETF construction with the leading active manager of traditional mutual funds. Read more: Could BlackRock and Fidelity alliance go deeper?

Officials at both companies say the timing was coincidental — done now because a prior three-year arrangement was set to expire — but the impact is undeniable: Fidelity has brought a gun to a knife fight.

Focus on Funds: The ETF price war
Brendan Conway explains that Fidelity has doubled the number of no-commission ETFs it offers, and Schwab has cut fees.

While the Fidelity-BlackRock arrangement makes just 65 of BlackRock’s iShares funds available without transaction fees, the funds on the list hold more than 18% of all ETF assets, and represent heavily traded, highly sought-after products.

Where Schwab’s ETF OneSource portends the movement of many fund firms onto a fee-free platform, the rival deal signals something much more important: Fidelity making a splash in the ETF space. Fidelity has been late to the ETF game; now its connection with industry-leading iShares allows it to bring new issues to market.

“Late entrants to the ETF business — with the exception of Schwab — have not done really well, because they don’t have the distribution,” said Timothy Strauts, an ETF analyst for investment researcher Morningstar Inc. “Fidelity has the distribution through its brokerage, but with iShares they can focus on bringing out new products and starting out from a position of strength. It’s a very powerful combination that should, over time, deliver good and interesting new products.”

Saving private retirement
What’s more, combining the power of the two leaders is likely to make ETFs more readily available — most notably in retirement plans.

Currently, an investor who wants to use ETFs in, say, a 401(k) plan, can only do that if his employer has a self-directed brokerage option. Fidelity, of course, is the largest provider of retirement plans, and the BlackRock deal gives it new and additional incentives to make self-directed brokerage options available.

Industry watchers say the push of ETFs into a more prominent role in retirement plans is now inevitable, as is the continued ascent of this form of mutual fund.

“We’re still in the early stages of the ETF game, and the money has been coming out of the traditional funds and going into ETFs,” said Tom Lydon, editor of ETF Trends. The ETF Wars, he added, make it easier and cheaper to buy ETFs.

“By itself, that doesn’t change the game,“ Lydon said, “but the real decision-maker for people is going to be ‘Are my traditional mutual funds performing?’ If they’re not, that’s when people are going to take another look at ETFs, and when they see that they can save some money and perhaps improve performance — or at least not hurt it — and when they see that what they have been doing just doesn’t feel so good, that is when they will make the move to ETFs.”

What should investors do? Look for the best options for your portfolio, and act on it.

Fund sponsors and brokerage firms are doing their best to make ETFs more attractive, said industry consultant Geoff Bobroff. He added: “If they are taking less out of our pockets — leaving us with more — while they fight with each other, we ought to sit back and enjoy this.”

  1. What an interesting article! I have noticed that after financial collapse in 2008, there were not a lot of investment options. Interest rate was very low and companies were reluctant to give credits to individuals. This was very bads for businesses and individuals.

    Today, companies want to earn the trust of the public again and competition between these companies create many opportunities for consumers. I think when companies complete, consumer always win. I hope improvement will get to pre financial times.

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