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Are These ETFs Truly the Best?

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Competition among ETF providers and brokers has never been fiercer. But a recent move from Schwab (NYSE: SCHW  ) to try to re-establish its position as a leading innovator in ETF tools falls short of its history.

Schwab recently released what it's calling its ETF Select List. Arguing that it's too difficult for investors to choose from among the hundreds of exchange-traded funds out there, Schwab is trying to make investors' jobs easier by picking a single ETF for each of roughly four dozen different asset and sub-asset classes.

Who the winners are
Schwab's methodology is pretty simple. First, it filters out unwanted categories like leveraged ETFs, inverse ETFs, and exchange-traded notes. Next, it screens for ETFs with high levels of assets under management and trading volume, looking at trading efficiency and track records to ensure that the ETF does a good job of matching the benchmark it establishes. Finally, from the candidates that pass that test, Schwab picks a single ETF based on cost, risk, and fund structure. It further limits the field by allowing no single provider to have more than a third of the ETFs on the Select List.

Looking at the winners, some trends are obvious:

  • Schwab's own ETFs are well-represented, with 11 of the broker's 13 proprietary ETFs making the list.
  • The three major ETF companies -- Vanguard, BlackRock's (NYSE: BLK  ) iShares, and State Street's (NYSE: STT  ) SPDRs -- also make broad showings. Vanguard funds appear throughout the universe of asset classes, while State Street shows up well in its sector ETFs. iShares appear in fixed-income and also in some special cases, such as single-country ETF iShares MSCI Japan (NYSE: EWJ  ) and iShares Gold Trust (NYSE: IAU  ) .
  • PowerShares also makes the list with its commodity-driven PowerShares DB Commodity Index (NYSE: DBC  ) and related agriculture and base-metals ETFs.

Overall, the list does a good job of providing exhaustive options for just about every type of investment someone might want to make. But it also has some shortcomings.

Self-interest?
Critics wasted no time in slamming Schwab for choosing so many of its own funds for the list. But one thing that Schwab has done that plays in investors' favor is to focus on providing the lowest-cost ETFs possible. Whereas BlackRock and State Street have almost given up trying to undercut Vanguard as an industry cost-leader, Schwab went head-to-head with Vanguard and has done investors a service. Moreover, since the list is intended for Schwab's customers, it makes sense to push the commission-free nature of the Schwab ETFs, especially for cost-conscious investors.

What's disappointing, though, is that Schwab stopped short of matching TD AMERITRADE (Nasdaq: AMTD  ) in offering this wide assortment of ETFs from multiple providers at no commission. Even if an ETF is on the Select List, Schwab customers will still pay commission on it unless it's a Schwab-run ETF.

In addition, although the Select List does a fairly good job of picking out individual ETFs based on the sector classifications Schwab makes, it doesn't claim to give any guidance on how to mix and match ETFs to put together a complete portfolio. Given the difficulty of putting together a one-size-fits-all vehicle, Schwab's reluctance to do so isn't terribly surprising -- but such a tool would have been valuable and again would have set Schwab apart from its competitors.

Keeping out front
Schwab began the commission-free ETF revolution almost a year and a half ago and has since fought to stay at the forefront of innovation in the ETF universe. Its funds have done an excellent job of gaining acceptance despite having to break into territory that was well-covered by competing companies, especially Vanguard.

To maintain its position, Schwab will have to keep innovating. By itself, the Select List doesn't advance the ball terribly far for Schwab. But perhaps as a stepping stone toward a more holistic approach in helping its customers use ETFs better and more efficiently, Schwab's Select List may end up paying off for the discount brokerage giant in the long run.

If discount brokers interest you, see how they stack up against each other. We can help with this handy broker comparison tool -- check it out today.

Fool contributor Dan Caplinger always looks beyond the list. He doesn't own shares of the companies mentioned in this article. Charles Schwab is a Motley Fool Stock Advisor recommendation. BlackRock is a Motley Fool Inside Value selection. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is simply the best.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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