A Cheaper Way To RAFI

October 03, 2007

A mutual fund launches that's cheaper than the ETFs.

Don't slam the coffin lid on the traditional index mutual fund just yet! New funds are still being launched. Charles Schwab has filed for two such funds based on FTSE RAFI indexes that it will add to its existing suite of fundamental index funds based on the FTSE RAFI series. The two proposed funds seem like they go a long way to helping Schwab complete the family.

The Schwab Fundamental Emerging Markets Index Fund will track the FTSE RAFI Emerging Index, while the Schwab Fundamental International Small-Mid Company Index Fund will track the FTSE RAFI Developed Ex-U.S. Mid Small 1500 Index.

Schwab already offers U.S. funds covering the small/mid and large segments of the market as well as an international large-company fund. The funds are available as Investor shares, Select (or retirement) shares, and Institutional shares. The institutional shares, with a $500,000 minimum investment, have an expense ratio of 0.35%, while the Select shares have an expense ratio of 0.44% and require a minimum $50,000 investment. The investor shares, with a minimum $100 investment, have an expense ratio of 0.59%. For the emerging markets and ex-U.S. small/mid company funds, the fees could be higher, because those types of funds are often more expensive than large-cap or domestic funds due to higher trading costs.

PowerShares already offers exchange-traded funds (ETFs) on the indexes underlying the three existing Schwab funds and the two proposed funds. However, Schwab's products are priced significantly lower. The PowerShares FTSE RAFI ETFs charge between 75-85 basis points (0.75%-0.85%).

Interestingly, while the Schwab funds win on price, PowerShares wins on assets. The PowerShares FTSE RAFI US 1000 Portfolio (NYSE: PRF) has accumulated $1.2 billion versus $431 million for the Schwab fund based on the same index. Meanwhile, the PowerShares FTSE RAFI US 1500 Small-Mid Portfolio (NASDAQ: PRFZ) has $125 million versus $76 million for the corresponding Schwab fund. Of the existing funds, only Schwab's large-company international fund has more assets than its PowerShares counterpart—$189 million versus roughly $21 million.

This presents a bit of a conundrum. Is it simply that investors are sometimes willing to pay a premium for the ability to trade funds like stocks? Or has PowerShares simply marketed its ETFs more aggressively? Another explanation could be inception dates. PowerShares launched PRF in December 2005, and PRFZ more than a year ago; in contrast, the Schwab funds were only introduced in April of this year.

It will be interesting to see how the asset race plays out. The Schwab funds are likely included as options in retirement plans, which means they have exposure to an entire section of the investing marketplace that largely excludes ETFs. And with lower fees, they could steal some of the core market from PowerShares as well.

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