Charles Schwab, the money management firm that now ranks as the 10 th largest ETF provider in the U.S., is launching next week on Aug. 15 its new line-up of six fundamental ETFs that will come to market with what the firm says is competitive pricing, even if not the cheapest in class.
Ranging from 0.32 percent to 0.46 percent in annual fees, the six ETFs built around Russell fundamental indexes that rely on Rob Arnott’s RAFI methodology, will indeed come to market with price tags that are some 25 percent cheaper than the average fundamental ETF on the market today. But there are some “smart beta” funds that outdo Schwab on pricing in this segment, according to IndexUniverse's ETF Classification System.
Among them are funds like the iShares MSCI USA Value Factor ETF (VLUE), which came to market in April and costs 0.15 percent a year. VLUE weights its securities based on fundamental metrics such as earnings, revenue, book value and cash earnings, but not on stock price. That means that like the new Schwab ETF, iShares is looking to give investors exposure to a portfolio of U.S. large- and midcap securities that ignores a company’s market capitalization in its weighting.
From a business perspective, backing away from its commitment to being the lowest ETF provider in the market is a somewhat surprising move for Schwab. The San Francisco-based company has made it clear that, regarding its lineup of 15 proprietary core ETFs, it would compete on price even if it meant having its ETFs be loss leaders for the firm.
Marie Chandoha, president of investment management at Schwab, said the expense ratios on these fundamental ETFs would be higher than the firm’s market-cap-weighted ETFs because the costs to manage them are higher. Chandoha stressed that Schwab’s “commitment to offer the lowest expense ratios in their Lipper categories” remained intact for the firms’ 15 core ETFs.
The firm’s decision to roll out fundamentally indexed ETFs reflects growing demand for so-called alternative beta strategies that complement market capitalization funds, and even active management in an investor’s portfolio.
“Asset allocation and portfolio construction need to reflect new market realities,” Schwab’s Tony Davidow said. “There’s a value in combining active and passive strategies, and we believe fundamentally weighted strategies represent an evolutionary step forward.”
Arguing that each individual investor needs to have a portfolio that’s organized around risk appetite and goals, Davidow said that there’s a lot of value in combining market-cap and fundamentally weighted strategies—and even including actively managed funds in the mix for better risk-adjusted returns and a “smoother ride” over time. Active management, he told IndexUniverse, serves as a good downside protector in times when the markets—and the passive ETFs tracking them—turn south.
“Fundamental strategies break the link with price and have historically delivered excess returns relative to market-cap equivalents,” Davidow said.
The six funds, five of which already exist in mutual fund wrappers with a combined $4.5 billion in assets gathered since their launch in 2007, include:
The new ETFs include:
- Schwab Fundamental U.S. Broad Market Index ETF (NYSEArca:FNDB), which seeks to track the Russell Fundamental U.S. Index. It costs 0.32 percent.
- Schwab Fundamental U.S. Large Company Index ETF (NYSEArca:FNDX), which seeks to track the Russell Fundamental U.S. Large Company Index. It costs 0.32 percent.
- Schwab Fundamental U.S. Small Company Index ETF (NYSEArca:FNDA), which seeks to track the Russell Fundamental U.S Small Company Index. It costs 0.32 percent.
- Schwab Fundamental International Large Company Index ETF (NYSEArca:FNDF), which seeks to track the Russell Fundamental Developed ex-U.S. Large Company Index. It costs 0.32 percent.
- Schwab Fundamental International Small Company Index ETF (NYSEArca:FNDC), which seeks to track the Russell Fundamental Developed ex-U.S. Small Company Index. It costs 0.46 percent.
- Schwab Fundamental Emerging Markets Large Company Index ETF (NYSEArca:FNDE), which seeks to track the Russell Fundamental Emerging Markets Large Company Index. It costs 0.46 percent.
The new ETFs will join Schwab’s lineup of 15 core ETFs, with more than $12 billion in ETF assets under management. The first Schwab ETFs launched in November 2009.
The Schwab U.S. Broad Market ETF (SCHB) is the firm’s largest strategy, with $2.22 billion in assets, and, including SCHB, five of the Schwab’s 15 proprietary ETFs have more than $1 billion in assets each—among them, the Schwab U.S. Large Cap ETF (SCHX), with $1.8 billion, and the Schwab U.S. Small-Cap ETF (SCHA), with $1.5 billion.
Schwab also sponsors some of the cheapest ETFs in their respective classes. SCHB, for instance, costs only 0.04 percent, or $4 per $10,000 invested.
The PowerShares MatchUp
PowerShares also offers an extensive roster of RAFI-linked ETFs—18 in total—that look to provide investors with access to fundamentally weighted strategies that complement market-cap approaches.
The most successful of those competing funds is the $2.24 billion large-cap PowerShares FTSE RAFI US 1000 (PRF). PRF, which costs 0.39 percent, looks to be comparable to FNDX, the new Schwab ETF targeting large U.S. companies.
FNDX comes in with a cheaper expense ratio that, again, is 0.32 percent, and it looks like Schwab will have bragging rights of having cheaper Arnott-linked fundamental ETFs than does Wheaton, Ill.-based PowerShares.
Like Schwab’s new lineup, the PowerShares family of fundamental ETFs also has Rob Arnott’s methodology behind it. But Schwab’s Russell-linked ETFs go about measuring value a little differently, as Arnott himself pointed out this morning.
While the PowerShares RAFI fundamental ETFs screen securities by book value, cash flow, sales and dividends, Schwab’s roster of funds using the Russell variation will focus on adjusted sales, operating cash flows, dividends plus buybacks.
“It’s a different flavor,” Arnott said, noting there are several market-cap indexes out there that also track similar segments of the market. “We wanted to make very sure we just didn’t introduce clone product. We wanted to give customers a choice, so we made sure the individual measures were different.”
“What we find is that the year-by-year performance of the two series is different—the character of the two series is different,” he added. “The Russell series has a bit less of a deep value tilt, and that shows up in having, on average, less in financials over time than FTSE RAFI. But in the long run, their performance is nearly identical.”
In both cases, they break the link between a company’s price and its weight in a given portfolio, Arnott said.
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