As their first birthday nears, Scottrade is finally putting some marketing behind its young Focus Morningstar family of exchange-traded funds.
The big Town and Country-based online brokerage hopes to lift the pint-sized funds out of obscurity and send them tilting at Charles Schwab, Vanguard, iShares and other giants of the ETF trade.
Like traditional mutual funds, ETFs invest in a basket of stocks and other financial instruments. However, ETF shares are priced throughout the day and traded on stock exchanges like stocks; traditional mutual funds buy and redeem their shares through a mutual fund company, which prices the mutual fund shares once a day.
Scottrade is also joining the investment equivalent of an airline fare war, in which mushrooming competition is driving ETF expense ratios ever lower.
“It’s fair to call it a race to the bottom,” says Erik Liik, chief executive of Scottrade’s FocusShares unit, which runs the funds. “There’s been fee compression for the past five or six years.”
That’s good news for the investor, who pays those expenses. But it’s bad for the investment firms sponsoring the funds. They take their profits as a percentage of mutual fund assets, and that slice is getting slimmer.
Scottrade is banking on such cheapness to give it a leg up with investors. Its Focus Morningstar US Market ETF has an expense ratio of 0.05 percent, a quarter of the 0.2-percent bite taken by the iShares Dow Jones U.S. Index Fund. Both funds track the broad American stock market.
“From a marketing standpoint, that gives Scottrade something to talk about,” said Adam Bold, CEO of the Mutual Fund Store, an advisory service based near Kansas City. But such a tiny advantage probably won’t swing too many decisions, he said.
Today’s cut-rate funds are a far cry from the start of the ETF boom in the late 1990s, when some broad-market ETFs had expense ratios of 1.25 percent.
Tiny expense ratios make it hard for a fund sponsor to turn a profit. So, the goal is to grow funds large enough so that a thin slice of the assets equals a lot of money. At $100 million in total assets, the 15 Focus Morningstar funds are still tiny.
Scottrade is subsidizing the funds’ expenses, something common with startup ETFs. Officially, Scottrade promises to keep the subsidy going only through this year, although Liik says there are no plans to raise costs to investors later.
Hence the marketing campaign, which is timed for the funds’ March 30 birthday, when they will have a one-year record to show investors.
Scottrade is a giant of the discount brokerage business, with online trading, 500 offices nationwide and 1,000 independent investment advisors who place trades through Scottrade. The firm makes its living offering low-priced services, but little personalized investment advice.
Independent advisers are a main target of the new promotional push, since they can swing their affluent clients’ money toward Scottrade’s ETFs.
The company plans to advertise in investment magazines and websites, and to sponsor financial shows on cable TV no faxing payday loans. The company wouldn’t put a figure on its marketing budget.
“It’s open-ended,” said Liik.
The fate of ETFs can be fickle, and it’s hard to tell if the push will work, says Paul Baiocchi, an analyst at IndexUniverse, which tracks the ETF industry. “They can slog along and then something happens and before you know it, they can have $500 million in assets,” he said.
Nationally, the growth rate for ETFs would put rabbits to shame. There were 113 funds in 2002, compared to 1,155 this year. Twenty-one new ones were born in the month of January. All told, they hold $1.15 trillion in assets, according to the Investment Company Institute, the mutual fund trade association.
“There is an awful lot of product being created, probably more than needs to exist in the world,” said Bold. “At some point, we will have a shakeup, and some will go away.”
The last such shakeup happened after the crash of 2008. About 150 funds liquidated between 2008 and 2011, all while new funds were forming, according to the Institute.
ETF births tend to follow investing fads, says Bold. If dividend stocks, for instance, is doing well, new dividend ETFs will pop up.
“The vast majority of these are being created by the marketing departments, in exactly the way that Frito will bring out 10 new brands of Doritos hoping one will stick,” said Bold.
Unlike traditional mutual funds, ETFs don’t need a bureaucracy to handle share purchases and redemptions, so they can pass on some savings in the form of lower expense ratios for investors.
On the other hand, ETF investors pay commissions when they buy and sell shares. Scottrade, like some other brokerages, waives commissions on trades of its own name-brand ETFs.
There are other quirks to ETF investing. Some funds are small and thinly traded, and that can mean a wide spread between the bid and asked prices, raising the cost of trading.
The vast majority of ETFs track indexes, and there are lots and lots of indexes, which has led to a cottage industry of people selling ETF advice.
Scottrade follows indexes run by Morningstar, the well-regarded mutual fund analysis company in Chicago.
Some indexes are broad — tracking value stocks or growth, and companies big, small or in between. Even those tend to vary; for instance, some big-capitalization stock funds will track bigger companies than other big-cap funds.
Lots of funds track narrow sectors of the market, and they slice those sectors differently.
For instance, the Materials Select Sector SPDR has no coal investments. A competing basic materials fund, Dow Jones US Basic Materials ETF has coal stocks. By contrast, the Dow Jones fund has Monsanto as its second-largest holding, while the SPDR fund doesn’t own it, according to a Morningstar analysis.
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