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Cheap And Cheaper

Cheap And Cheaper

Schwab and Fidelity are cutting commissions-again. Discounting can drive up trade volume, but risks remain.

The latest salvos in the price war between the giant custodians are all about attracting more clients by offering rock-bottom commissions on equity trades. Don't be surprised to see still more discounting later this year.

The price-cutting battles that began last year between Charles Schwab and Fidelity Investments have continued into 2010. In January, Schwab started charging retail investors and clients of Schwab Advisor Services $8.95 per online trade in stocks or non-Schwab exchange traded funds. Before the price drop, investors with less than $1 million in assets at Schwab, or who traded fewer than 120 times a year, paid $12.95 per trade (with an extra fee on trades of more than 1,000 shares). The new pricing is available to Advisor Services clients who use Schwab's e-Delivery services for electronic statements and trade confirmations, and to clients who trade in some other proprietary Schwab programs.

Less than a month later, Fidelity fired back with reductions of its own. It said it would eliminate tiered pricing and cut on-line equity commissions to $7.95 for all customers, institutional and retail alike. Pricing on the discontinued tiers ranged from $19.95 to $8 a trade, depending on asset and trading volume. Fidelity also cut its on-line options commissions along the same schedule as equities, plus 75 cents per contract.

“It is an extremely competitive environment right now for custodians trying to win the loyalties of advisors,” says Dan Inveen, principal and director of research at FA Insight in Tacoma, Wash. “I would not rule out future price cuts if only for their ability to grab attention. Every player is trying to stand out and this is a good way to get some publicity in the trade press. That said, I think these moves are more about raising profile than substantive measures that will have a direct impact on attracting additional business for the custodians.” Indeed, for advisors who evaluate custodians on a range of issues, including business management services and technical support, the price cuts “are probably more symbolic than anything else,” he says.

Price wars are not without risks. Discounting between 2003 and 2006 pushed per-trade commissions down by 36 percent, according to a January report from Brad Hintz, a senior analyst who follows Schwab for BernsteinResearch. It also increased pressure to build scale, contributing to the merger of TD Waterhouse and Ameritrade, he adds. In pricing its commissions, Schwab is seeking a sweet spot where both its most valuable clients and its most price-sensitive clients will find the choice of brokerage firms in the market to be immaterial, Hintz writes.

Price cuts historically produce modest pickups in trading volume. Schwab enjoys an edge in this strategy since just 20 percent of its revenues come from trading commissions, compared to TD Ameritrade, where the share is closer to 40 percent. “It is not clear that [Schwab's] pricing cut was sweeping enough or extreme enough to warrant an immediate response, but then again, the e-broker business is all about maintaining seemingly trivial edges in mass-market appeal,” he says. “And if nothing else, it is clear that Schwab's pricing cut was aimed down market to the client segment traditionally targeted by its competitors.”

Some of these competitors are feeling the heat. E*Trade Financial, the online brokerage that focuses on the retail market, said last month it was eliminating its $12.99 commission tier and reducing trades to $9.99 or less. Chip Roame, managing principal at Tiburon Strategic Advisors, said he expects TD Ameritrade will ultimately lower prices as well. “My guess is that Schwab is looking to drive out TD Ameritrade and/or E*Trade,” or to acquire one or both of the competitors, he says. “Schwab wants to win in both the advice game but also to control huge numbers of trades. Those firms threaten Schwab's dominance of trades. And those firms are vulnerable to this move.”

TD Ameritrade offers flat-rate $9.99 commissions for on-line trading and isn't looking to cut prices reflexively, says Brian Stimpfl, managing director for advisor advocacy and industry affairs. “We think that from a pricing standpoint, from a solutions standpoint, and an overall value standpoint, we have a winning strategy. We really at this point don't see any need to change,” he says. “The reason for that really is, this is not a business with a one-size-fits-all solution. We think the fact that in servicing RIAs, there's a need to be flexible, there's a need to offer advisors what comes down to a customized offering. And that includes pricing.”

Obviously, cost cutting isn't free. Schwab, with 2009 revenues of $4.19 billion, estimated its new pricing will reduce revenues by $15 million to $20 million in this year's first quarter. But the cost is worth it, according to Chief Financial Officer Joseph Martinetto, who says the new pricing and ETF initiatives should help it attract clients. Privately-held Fidelity didn't disclose how its new pricing structure would affect the top line. Ron Fiske, executive vice president at Fidelity Institutional Wealth Services, says the most recent cuts are less about the firm's price war with Schwab and more about equalizing charges for retail clients and advisory clients. But he wouldn't close the door on further price cuts later this year. “We've made a large variety of announcements around technology, tech pricing, securities products pricing. If you take everything in context, we are working to bring the highest-value platform to advisors,” he says.

Both Fidelity and Schwab used their pricing announcements to promote new ETF initiatives, as well. Schwab launched a low-cost fee-based portfolio advisory program, Schwab Managed Portfolios-ETFs. It provides diversified holdings in up to 20 asset classes, with investment minimums of $100,000, the company said. Fidelity said it will allow on-line investors to trade 25 iShares ETFs commission-free. As ETFs become a growing part of discount brokerage offerings, attention will be paid to pricing, analysts say. “Schwab's move was savvy again — waive commissions on your own ETFs to drive in AUM for which you earn annual fees. Very smart,” Roame says. “Fido needed to do something else as they do not have proprietary ETFs. Financial advisors and consumers both love iShares, so what better than waiving (fees) not on your own ETFs, but on the industry leader?”

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