Broker wars forcing managers to shine or get shoved aside

The race to zero commissions for online brokers is not without consequence for exchange-traded fund managers, which could see an uptick in inflows now that a barrier to entry for investors has been removed.

But the decision by several online brokers to drop trading commissions for stocks, ETFs and options, may also heighten investor scrutiny of ETF costs and drive money managers to take a hard look at their product lineups in an effort to stand out in a zero-commission environment, sources say.

Announcements in October that Charles Schwab Corp., Fidelity Investments, TD Ameritrade Holding Corp., and E-Trade Financial Corp. are going to zero commissions is a "net positive," for both investors, who will have a larger choice of ETF products, as well as smaller ETF issuers that no longer need to be concerned about being on a commission-free platform, said Matthew J. Bartolini, managing director, head of SPDR Americas research at State Street Global Advisors, Boston.

"Costs to own or to trade (ETFs) have now been lowered," Mr. Bartolini said. "So, I think it's going to be one of those factors that supports the tailwinds driving the usage of ETFs." State Street had $698 billion in ETF assets under management as of Sept. 30, according to its recent earnings report.

As result of the zero commissions announcements, however, money managers might also find retail and institutional investors putting other ETF costs under a microscope.

For example, investors may ask: "If everything's in a commission-free world, what is my execution cost?" Mr. Bartolini said.

"There will be a tighter, more focused scrutiny on trading costs, but also what execution analysis looks like. (For instance), did I get best execution for this, or has that commission somehow been passed along on a different variable?" he said.

To this point, Jonathan de St. Paer, president and CEO of Charles Schwab Investment Management Inc., San Francisco, said, for ETF managers, broker price wars "further increases the focus on the product itself," which will include investors assessing ETF liquidity, pricing, tracking error and spreads.

Charles Schwab manages more than $150 billion in ETF assets.

"By eliminating trade commissions … it further democratizes access to all of those products," he said.

A spokesman at J.P. Morgan Asset Management, New York, said in an email: "Cutting trading commissions on ETFs continues to bring down overall costs for investors." Still, "trading costs like commissions are only one component of the total cost of ownership of an ETF — it is important to evaluate all costs as part of robust due diligence process," he added.

Michael Wong, director of equity research, financial services, North America, at Morningstar Inc., Chicago, said that the rollout of zero commissions for ETFs by online brokers will "further accelerate inflows to ETFs over mutual funds," as firms are still charging commissions on mutual fund trades.

He also said that broker price wars are leveling the playing field for ETF managers.

"Now that essentially all ETF managers have a no-transaction fee platform, it can be harder for ETF managers to differentiate themselves," Mr. Wong said of the trend.

The move to zero commissions on ETF trades comes as the ETF industry has seen further concentration of assets among the largest managers.

In Pensions & Investments' annual survey of index and ETF managers, the three largest ETF/ETN index managers by worldwide assets managed internally were once again BlackRock Inc., with $2.01 trillion; Vanguard Group Inc., $1.02 trillion; and SSGA, $666.3 billion managed as of June 30.

Among the 10 largest ETF/ETN index managers in the survey, BlackRock and Vanguard together managed around 70% of worldwide assets reported in these investment vehicles.

Vanguard expects that brokers' move to free trading for ETFs will not only level the playing field for managers as investors consider ETF products, but prompt firms to make tough decisions on closing products if they don't gain interest from clients, said Rich Powers, head of ETF product management at the Malvern, Pa.-based money manager.

"If all ETF products are leveled, that does make it simpler for the buyer as to what to consider," Mr. Powers said.

"We expect there to be a lot of product rationalization when the product launch hasn't really landed and served a broader array of investors," he later added.

A recent analysis by CFRA Research of 1,662 ETFs listed in the U.S. as of December 2014, which tracked outcomes for the products through August 2019, found that 25% of ETFs experienced rapid asset growth, while 24% closed down during the period, the September report said. Among the sample, another 7% of ETFs experienced rapid asset declines.

The CFRA report noted that "closures should also not always be viewed negatively — they can reflect the pruning of product portfolios to make room for more viable alternatives."

Executives at ETF giant BlackRock said during the firm's Oct. 15 earnings call that the commission-free trend would benefit the firm's iShares ETF business.

Robert Kapito, president and director at New York-based BlackRock, said "the elimination of barriers to investing simply means that more and more investors are going to have the ability to use ETFs. And as the ETF market leader, this has got to be good for BlackRock."

BlackRock had $2.05 trillion in AUM in its iShares ETF business, as of Sept. 30.

As for whether price wars within the retail industry will indirectly put pressure on asset managers, Mr. Wong said it depends.

There could be an impact on money managers that are part of larger financial services firms if companies begin pressuring managers to make up for some of the revenues lost via trading, Mr. Wong said.

Moody's Investors Service, New York, expects that brokers' commission cuts "will begin to take a bite out of (their) profit in a less favorable interest rate environment," according to a Nov. 6 report it published.

In fact, the decisions by Charles Schwab, TD Ameritrade and E-Trade to offer free trading on U.S. stocks, ETFs and options was described as the "final leg in a decades-long race to zero commissions," which will create "a combined revenue hole at the three rated online brokers of around $1.6 billion per year, a credit negative," the Moody's report said.

In comparison, the impact of lowered commissions in 2017 price wars between online brokers was masked due to the rising interest rate environment at the time, according to the report.

Mr. Wong added, however, that most of the competitive pressures on asset managers are coming from their peers — "active vs. passive or active players competing against each other to lower their fees. I see more of the pressures coming from other money managers (as opposed to) brokers vs. money managers."