Schwab aims to grab index fund assets from competitors

Having slashed its equity index fund fees, Charles Schwab Investment Management Inc. is hoping to undercut its rivals in an attempt to take away index fund assets. It is the same strategy that Fidelity Investments of Boston used with limited success in 2004 when it dropped fees on its index funds in a bid to pull index fund assets from The Vanguard Group Inc. of Malvern, Pa. San Francisco-based Schwab cut fees on all six of its equity index funds on May 5. Most notably, it reduced fund expenses on the $4.59 billion Schwab S&P 500 Index Fund (SWPPX) to 0.9%, from 0.19%, and the $946 million Schwab Total Stock Market Fund (SWTSX) to 0.09%, from 0.38%. The cuts put those funds — which like all of Schwab's retail index funds require a minimum investment of just $100 — into direct competition with investor-class shares of comparable funds from Fidelity and Vanguard. Schwab also cut the fee on its $2.47 billion Schwab Institutional Select S&P 500 Fund (ISLCX) to 0.09%, from 0.10%. Select Shares are a special class of Schwab funds available to individuals with initial minimum investments of $50,000. Investor Shares of the $11.25 billion Fidelity Spartan 500 Index Fund (FSMKX) and the $6.99 billion Fidelity Spartan Total Market Index Fund (FSTMX) have expense ratios of 0.1%. And Investor Shares of the $73.34 billion Vanguard 500 Index Fund (VFINX) and the $84.98 billion Vanguard Total Stock Market Index Fund (VTSMX) have expense ratios of 0.18%. Fidelity Investor Shares require a minimum investment of $10,000, while Investor Shares from Vanguard require a minimum investment of $3,000. Cheaper Advantage Shares from Fidelity (0.07%) and Admiral Shares from Vanguard (0.10%) require a minimum initial investment of $100,000. Financial advisers said that Schwab's fee reductions are smart business. It is a good move for Schwab because it helps the company become known for being an investment manager, not just a discount broker, said Richard Ferri, founder of Portfolio Solutions LLC of Troy, Mich., which manages $625 million. And the decision gives investors the opportunity “to save a buck or two,” he said. But will investors take that opportunity? Many investors will move their assets out of more expensive index funds and into Schwab funds, but the index fund landscape isn't likely to change, industry experts said. It didn't change when Fidelity lowered the fees that its index funds charge, in some cases undercutting Vanguard's index funds. Part of that has to do with corporate philosophy, said Mark Hebner, president of Index Funds Advisors Inc. in Newport Beach, Calif., which manages $820 million. “Vanguard is going to attract "Bogleheads,' who like what [Vanguard founder John Bogle] created and want to support him and his former company,” he said. “Also, there's a certain level of trust that they won't be lured into some actively managed product.” Given that Vanguard manages just about as much money in actively managed funds as it does in passively managed funds, that trust may be misplaced, Mr. Hebner said. Vanguard manages $475 billion in index fund assets in 56 stock, bond and balanced index funds. It manages nearly $1.1 trillion in mutual fund assets overall. It is hard to see Vanguard losing its position as the top index fund manager, said Ryan Leggio, a mutual fund analyst with Morningstar Inc. of Chicago. Investors could do worse than to invest in the Vanguard 500 Index and Total Stock Market funds, he said. But when it comes to evaluating index funds, particularly those that follow a well-known index such as the Standard & Poor's 500 stock index, “the two main things that we look at are cost and tracking error, and most of the funds that we cover have a very low tracking error,” Mr. Leggio said. That means a good argument can be made for investing in the Schwab S&P 500 Index Fund and Schwab Total Stock Market Fund over their rivals.

NOT THE CHEAPEST

The case for Schwab's other index funds, however, is a little less clear. The $3.71 billion Schwab 1000 Index Fund (SNXFX), $970 million Schwab Small-Cap Index Fund (SWSSX) and $1.04 billion Schwab International Index Fund (SWISX) have new lower fees — 0.29%, 0.19% and 0.19%, respectively. But while the fees are low, they aren't always the lowest available, industry experts said. “There are definite mutual funds and [exchange traded funds] that are cheaper,” said Jonathan Rahbar, a mutual fund analyst at Morningstar. E-mail David Hoffman at dhoffman@investmentnews.com.