Last Updated: 29 May 2021
Who hasn’t been caught by a deal that looked too good to be true? As I call into my local office suppliers for printer ink every few weeks – the machine seems to drink the stuff and runs out after every hundred pages – and then find that the ink seems to cost more than the printer did, I wonder why I didn’t sign up for a Which subscription to check the total cost of ownership.
So I notice that my colleagues Matt Hougan and Dave Nadig (Matt in particular) are taking a “wait and see” approach on this one in their latest podcast – and rightly so. Let’s see how these funds trade in the market, whether they have acceptable bid-offer spreads and if they grow to a decent size.
I also understand that Schwab has a clear commercial interest in trying to lock its extensive client base into the firm’s own funds and in encouraging investors to trade more rather than less, in which case it will obviously make up from dealing spreads some of the money that it loses by removing commission.
Having said that, as a European ETF investor I still look at developments in the US market with some envy.
Having traded in US ETFs using a brokerage account there, I know how liquid the market is, how lightning-fast execution can be, how easy it is to place and execute limit orders, and how straightforward it is to short sell ETFs. In effect, you can become your own mini hedge fund at minimal cost.
Although things are getting better in Europe, it seems as if we’re still quite a way from attaining the US standard.
The survey I conducted a couple of months ago on the cost of retail trade execution in the UK showed that there is now a range of stockbrokers offering dealing costs of around £10 per trade, less if you sign up for a regular savings plan. Brokers’ costs have come down substantially over the years, even if there’s nothing comparable with Schwab’s offer.
But falling headline commission rates don’t tell the full story. None of the UK-based retail brokers in ETFs that I surveyed offer their clients direct access to the London Stock Exchange’s order book (although I understand that a couple of brokers that were not included in the original survey, idealing.com and Interactive Brokers, do offer this service).
What does this mean? Retail client orders are typically executed at the best price supplied to the relevant broker by a network of market makers, who are classified as retail service providers (RSPs). However, unless your broker gives you direct market access (DMA), you cannot access the LSE’s central order book directly. The bid-offer quotes that market makers show to their brokers will of course generally reflect the bids and offers listed on that central book. But if you want to trade using a limit order – and there might be good reasons for wanting to do so, such as when a bid-offer spread seems wide and you want to try and trade inside it – your order will not be shown to the whole market unless your broker offers you DMA. This, in turn, significantly decreases your chances of getting filled at the price you specify and in effect forces you to trade on the market makers’ terms rather than your own.
Why retail investors in the UK have to trade via a secondary network that’s a step away from the real liquidity pool is a mystery to me, but that’s the way most of the market operates.
In the US, by contrast, everyone’s orders, large or small, are typically shown on the same electronic trading networks, creating a vast pool of liquidity for retail and institutional investors alike, and in my view a more efficient system overall.
Add to that the familiar European complexities of multiple listings and currency classes, which affect retail investors above all (since, again, institutions can typically choose where, how and when in Europe they trade) and it’s clear that the average individual investor on this side of the Atlantic is still the poor relation of his American cousins.
I’m an optimist; in time, there seems to be a decent chance that things in Europe will change for the better and secondary market inefficiencies will gradually disappear as a result of competition and increased transparency.
All the same, it’s good to see an initiative in the world’s largest ETF market that continues to set the standards for the rest of us. Welcome, Mr Schwab!