Wall Street's Last Hope for Profits

Until recently, investors had more than enough money for financial firms on and off Wall Street to earn monster profits. In the midst of this major recession, however, money managers have started fighting for every penny they can get.

The latest evidence of how the fight for assets continues to intensify comes from recent announcements from Charles Schwab (Nasdaq: SCHW  ) and the Pimco unit of Allianz (NYSE: AZ  ) that they both intend to offer exchange-traded funds. Schwab's offering will use the Dow Jones U.S. Total Stock Market Index as its benchmark, while the Pimco fund will track an index of Treasury bonds.

The move may seem relatively innocuous, especially since both firms have only registered a single fund with the SEC. Yet the decisions could have ripple effects throughout the industry.

ETF domination
Currently, a few firms dominate the ETF scene. Barclays (NYSE: BCS  ) has its iShares line of ETFs, with $254.7 billion under management as of Dec. 31, 2008. State Street (NYSE: STT  ) , meanwhile, has its well-known SPDR offerings, which make up $159.5 billion. Those two firms make up more than three-quarters of the ETF universe.

Smaller competitors, such as Vanguard, ProShares, and Invesco's (NYSE: IVZ  ) PowerShares, have found niches of their own to fill. Vanguard focuses on low-cost offerings, while PowerShares has tried to use less traditional indexes to track. ProShares has had great success from its leveraged funds, especially on the bear-market side.

Where Schwab and Pimco will fit into the picture remains unclear. Of course, a single ETF is unlikely to do any lasting damage to their competitors. But the move could represent an opening salvo in a much larger war.

A captive audience
In particular, the potential for Schwab to get into ETFs could start a trend among brokerage firms. Until now, brokers have largely been content to build relationships with other mutual fund and ETF providers, cooperatively selling shares of other managers' funds with -- or sometimes without -- a transaction fee. With traditional funds, shareholder servicing fees often compensate brokers for the expense of handling fund transactions.

But with a huge existing customer base, it only makes sense for Schwab to want to retain more of its customers' money for itself. That way, it can maximize its asset-based revenue, earning not just custody and servicing revenue but also management fees, which can be much more lucrative.

What it means for you
Of the two offerings, though, Pimco's is the more interesting one for most investors. Schwab's fund won't add much to the investing universe; ETF shareholders already have a wide range of broad-market investment options. Breaking the chokehold of popular funds like the S&P 500-tracking SPDR Trust (NYSE: SPY  ) will likely prove impossible.

On the bond side, however, Pimco has a strong reputation for fixed-income expertise. Moreover, it's much easier for a newcomer to compete in the bond ETF market, as even one of the most popular bond ETFs, iShares Barclays Aggregate Bond (NYSE: AGG  ) , weighs in at less than $10 billion in assets.

Stick with the basics
For general all-purpose ETFs, you'll often find that there aren't many big differences among funds. But there are several keys to comparing funds from competing managers:

  • Cost. Especially if ETFs track the same or similar indexes using similar techniques, you should only have to pay a small fraction of a percent in annual management fees.
  • Liquidity. At the same time, however, fund expenses are only one element of cost. Because the most popular funds have higher trading volume, it's easier to buy and sell shares without paying huge bid-ask spreads that can eat up your profits.
  • Structure. With huge credit risk worries, make sure you understand how your fund is structured. While ETFs typically hold assets that are separate from the fund management company, other similar vehicles, such as exchange-traded notes, may carry credit risk of the issuing company. That can leave you out in the cold even if you seemingly made the right call in picking an investment.

Don't expect new ETFs from Pimco, Schwab, and potentially others to change the ETF playing field overnight. But in time, increased competition among ETF firms may lead to lower costs, more selection, and better service for you.

For more on investing and ETFs, read about:

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Fool contributor Dan Caplinger thinks Wall Street will make out just fine. He owns shares of SPDRs. Invesco is a Motley Fool Income Investor selection. Charles Schwab is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy may not be your last hope, but it's definitely your best one.


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