By Grant Engelbart, CFA, CAIA – Director of Research & Sr. Portfolio Manager, CLS Investments
Where were you on Oct. 1, 2019? This was the date when Chuck Schwab released his new book, “Invested.” Oh, and he also eliminated commissions on stocks, ETFs, and options for the second-largest online brokerage in the U.S. This sent shockwaves through the online brokerage community.
TD Ameritrade responded by cutting commissions to zero that same day, in what must have been quite the boardroom conversation. E*Trade followed suit on Oct. 2, and Fidelity also ended up going to zero after some speculation that they would go a different route. Many saw this as inevitable.
Silicon Valley start-up Robinhood and some new offerings from the big banks were already offering free stock trades. Interactive Brokers cut commissions to zero a couple weeks ago, and Vanguard made thousands of ETFs commission-free on its platform more than a year ago.
Right now, at least to me, there are more questions than answers. Yes, this is a great move for investors, but these companies are all capitalists, and most are publicly traded. Although they have appeased their clients, they also have investors to appease in an ever-competitive marketplace. Schwab has limited revenue (albeit still high) from commission business, less than half that of competitors such as TD Ameritrade and E*Trade. What will firms do to recoup lost revenues? Sell order flow? Increase the push for financial advice? Increase mutual fund commissions? Pay even less on cash? Nickel and dime with other fees? Or just deal with the losses and try to grow their businesses in other ways?
Finally, where do ETFs fit into this? The supposed elimination of commission-free ETF lists is a wild idea to happen, quite literally, overnight, but it is also a great development for the industry. Smaller funds — with potentially great strategies — may not be able to pay the necessary fees to be on a commission-free ETF list. That hurdle is now eliminated, but there are other hurdles for smaller ETFs. Certain positioning has occurred, for better or worse, across the commission-free lineups. Some areas of the market have been “cornered” and others left alone. A couple hundred ETF options, maybe one or two per asset class, just exploded to thousands! This will change the due diligence game for many ETF users.
What Does the Future Look Like?
Here are some ideas that online brokerages could embrace to enhance the user’s experience with ETFs and maybe gain some assets in the process.
ETF-Specific Order Types
We all hopefully know that market orders are bad news when it comes to ETFs, particularly those that don’t trade as often as SPY. But why are the options for placing an ETF order still just “market” or “limit” (and usually stop and stop limit)? In my simplified world view, couldn’t an order type like “End-of-day NAV” be beneficial to investors who are used to buying mutual funds? Or, if you want to get really crazy, an order type like “ETF order” would simply pass on the order to an ETF market-maker or trading firm (combined with many other similar orders) to be executed within a specified window, say two hours. Those trading firms would receive a large block of various ETF orders that they could execute in a responsible manner. Competition among trading firms would ensure that orders are being executed appropriately.
Maybe these are too far outside the box, and I’m sure there are circumstances keeping this from happening (exchanges?), but it seems like a way to bring assets both into the ETF industry and to that specific online platform.
Customized Model Portfolios/Indexes
What if technology allowed investors to piece together a model portfolio online? An investor could select a risk tolerance or asset allocation, determine how they want to be allocated along certain perspectives, maybe include or exclude some companies they do or do not want to own, hit a button, and voila! A portfolio of ETFs could be generated for them to allocate their wealth. Yes, many investors don’t know what they should be invested in, so ideally this would be hidden behind an advisor portal so the advisor and client can fill this out together (for a fee). But in a commission-free world, the possibilities are endless here.
Differentiated Portfolio Analysis
Some services provide a rundown of what a portfolio looks like, all in, but they only tap the surface. Allocations — countries, sectors, etc. — are important for some more experienced investors, but they may not mean much to others. What about an analysis of total costs – internal, taxes, etc.? How about some kind of simplified factor analysis? The possibilities are endless, and again these features may reside behind an advisor portal of some kind.
I’m sure there are many more ideas for online brokers to enhance ETFs and all users’ experiences. I don’t mean to be overly dramatic, but the end of trading commissions (or at least the near-end) is a huge deal. It’s important for investors to take full advantage of the ETF universe but also be conscious that costs may still show up in unexpected places.
This information is prepared for general information only. Information contained herein is derived from sources we believe to be reliable; however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a guide to investing. 1324-CLS-10/23/2019