Even before the COVID-19 pandemic, there was an expectation of significant consolidation in the asset management industry over the next five years. The pandemic will likely accelerate that as more companies turn to M&A to bolster flagging assets totals and slowing growth.
This will benefit the industry behemoths like Charles Schwab (SCHW 1.20%). The asset manager and brokerage firm has been active on the M&A front and made one of the biggest acquisitions in the space last year, purchasing one of its main brokerage competitors, TD Ameritrade (AMTD), for $26 billion. Schwab is down about 25% year to date but has outperformed the financial sector. There are a few good reasons it will continue to do so.
The benefits of scale
Schwab is in the process of closing on three acquisitions, including TD Ameritrade, the assets of USAA Investment Management, and fixed income separate account manager Wasmer, Schroder and Co.
As of March 31, 2020, the company was already one of the largest in the industry with $3.5 trillion in client assets. When these purchases close, Schwab's assets will increase by more than $1 trillion. At the time of the TD Ameritrade deal, Schwab couldn't have expected the coronavirus to crash the markets and economy and drive down interest rates, but despite the hurdles, and the $37 million spent on acquisitions-related costs in the first quarter, the company expects to benefit in the long run from the added scale.
"[W]e can see the benefits of our ongoing investments in scale and efficiency reflected in Schwab's ability to support client activity levels which could have overwhelmed a less capable platform," Schwab CFO Peter Crawford said in the first quarter earnings release.
The company added $73.2 billion in net new assets in the first quarter, up 42% from the previous year and a record for the first quarter. It also opened a record 609,000 new brokerage accounts, bringing the total at quarter's end to 12.7 million, up 8% from the previous year. Furthermore, trading volume was through the roof, with 27 of the 30 highest-volume days in Schwab's history occurring in the quarter. On March 12, the firm handled four million trades.
"In addition to the record new accounts, asset flows, and trading ... during the quarter we also handled over 190 million more client interactions across web, mobile, chat, and messaging versus a year ago, increases ranging from approximately 28% to 80%, with essentially the same headcount," Crawford added. "Our long-standing focus on scale and efficiency has helped us begin the year with a 40% pre-tax profit margin and remains an important strength as we balance near-term profitability with continued reinvestment for long-term growth."
The competitive advantage of Schwab's size and scale will be even more pronounced during this market and economic downturn, as smaller players will have a more difficult time serving customers due to cutbacks and investing in their business.
Innovation by the slice
Schwab has continued to invest in new technologies and services, including its most recent innovation, Schwab Stock Slices, which was introduced on May 1. This new service, which goes live on June 9, "democratizes investing" by allowing people to buy fractional shares of larger companies, like those in the S&P 500, for as little as $5 each. Investors can purchase up to 10 different "stock slices" at once, commission-free. Fidelity Investments and Robinhood also offer fractional shares investing.
"We developed Schwab Stock Slices to meet two important needs we heard from clients -- newer investors who want the ability to buy multiple stocks in small dollar amounts and older more affluent investors who want to more easily gift stock ownership to younger generations," said Neesha Hathi, executive vice president and head of Schwab Digital Services.
Schwab is a company that is built to last. It has been one of the steadiest performers in the financial sector, with an average annual return of about 9.7% over the last 10 years through 2019. Right now it is a bargain, trading at about $34 per share with a price-to-earnings (P/E) ratio of 13 times earnings. Schwab will emerge from the recession in an even stronger competitive position, so it is definitely one to keep on your radar.