Why ETF sponsors are ponying up big fees to get on Schwab's ETF OneSource in a bid for access to ticket-averse RIAs

In the cutthroat world of asset management, enough RIA assets are never enough.

So when Charles Schwab & Co. created ETF OneSource, a supermarket where RIAs and investors may buy ETFs without paying a ticket charge, executives at Direxion Investment wanted in. See: Schwab makes play for ETF-distribution domination but not without risks.

Since its start in 2013, ETF OneSource’s assets have more than doubled from $14 billion to $31 billion as of Aug. 31. Year-to-date flow into ETFs in the program totals $5.9 billion, representing 45% of the total ETF flows at Schwab.

Those kinds of numbers got New York-based Direxion’s attention and nine months ago executives began to lobby Schwab to include the company’s products.

Significant movement

The result: In September, four of Direxion’s Strategic Beta ETFs, representing $173 million of assets, appeared on the platform, making Direxion one of seven new providers representing 65 ETFs for a total of 182 ETFs.

RIA reaction came quickly for Direxion: September was one of the best months on record for these four Direxion funds. Direxion, a maker of institutional-style indexed ETFs and mutual funds, has about $9 billion in assets — $8.5 billion of which are assets in ETF funds.

“We saw significant movement,” says Brian Jacobs, president of Direxion. “There was also evidence a large RIA team that had been looking at VSPY [Direxion S&P 500 Index Volatility Response Shares] as a strategy for the past six to nine months told us they’re thinking of buying it now that they don’t have to pay a ticket charge. That’s why it is so helpful to be on the platform. It doesn’t guarantee that someone will buy the ETF but it’s a positive. It can maybe nudge an advisor into potentially using it if they like it.”

Bill comes due

Nicholas Gerber: They let us go
to their conferences and talk with
advisors and they let us go
branches and talk with staff there.

But of course there is always a cost to be borne somewhere down the line.

ETF OneSource roughly mimics Schwab’s explosively successful mutual fund program, Schwab OneSource, in which San Francisco-based Schwab typically collects 40 basis points from mutual funds listed — albeit with discounts to charter members and other companies with the heft to swing deals. See: Schwab and T. Rowe Price finally strike a OneSource deal with help from an ex-Fido exec.

Although Jacobs, who joined Direxion in March, declined to offer specifics of the deal with Schwab, he allows that “it’s a substantial portion of our management fee. It’s not coming out of clients’ pockets. There’s no cost to the clients. They’re getting a good deal. We’re making up the difference. We hope that reflects our commitment to the RIA marketplace in a small way.”

The cost of the ETFs to consumers, he explains, ranges from 45 to 60 basis points.

The ADV for Schwab Private Client Investment Advisory says that ETF sponsors and affiliates pay an annual “program fee” of up to $250,000 for each ETF. In addition, the ETF sponsor pays an annual asset fee up to .15% based on the percentage of that total ETF asset purchased by customers after the ETF was added to ETF OneSource.

Getting in the door

The four ETFs available now from Direxion are: Direxion Zacks MLP High Income Shares (ZMLP), Direxion All Cap Insider Sentiment Shares (KNOW), Direxion NASDAQ-100 Equal Weighted Index Shares (QQQE) and Direxion S&P 500 Index Volatility Response Shares (VSPY).

“We designed Schwab ETF OneSource explicitly to meet the needs of our clients. To be included in the program, ETFs and providers must meet criteria around AUM, tenure and performance,” writes Schwab spokeswoman Anita Fox, in an e-mail. “Certain types of ETFs are ineligible, including inverse/leveraged ETFs, ETNs and ETFs that are regularly traded by clients that use margin,” she added.

That means that Direxion’s leveraged and inverse ETFs are not eligible for inclusion.

Direxion did not participate in the first phase of the ETF OneSource rollout as most of its funds at the time fell into that category, says Andy O’Rourke, managing director and chief marketing officer.

“We were not included in the first phase of the OneSource launch, primarily because we only really had leveraged and inverse ETFs at the time, and that was not a product that they (mostly compliance people) wanted to include in the program,” he writes in an e-mail.

“Since the launch of the strategic beta products David [Fajardo, senior vice president of marketing] has been working with them to get them to see the value in them and hopefully include them. We are glad that they did.”

The cost of access

Getting on Schwab’s OneSource platform is a coup for up-and-coming funds despite the having to pick up the tab, says Nicholas Gerber, president and chief executive of United States Commodity Funds LLC, who now is in ETFs with TOFR, which was originally on Schwab’s Mutual fund OneSource platform.

“Schwab was the first to offer a platform for ETFs. They charge us to be on the platform and obviously, the disadvantage is all of the management income is not yours. But they are very large. They let us go to their conferences and talk with advisors and they let us go branches and talk with staff there.” See: Schwab IMPACT 2013 is another great bash but picketers and Fidelity siphoned off some precious RIA attention.

Fox also declined to disclose ETF OneSource fees but she confirms that membership confers the conference access that Gerber describes.

RIAs have long had a love-hate relationship with OneSource and the mutual fund supermarkets of other big custodians. They love to keep their trading costs or those of their investors at zero. But advisors at RIAs are aware of the dent that 40 basis points, largely hidden from view, makes in net returns from the fund. The difference with mutual funds is that they typically charge 12(b)-1 fees to defray supermarket distribution costs. See: The basic ETF trading practices that can save your clients money.

Strategic timing

In addition to OneSource’s distribution power, Direxion’s success in getting RIAs to invest in its strategic (also known as smart) beta ETFs can be attributed to the prevailing wind toward that product, says Tom Lydon, president of Global Trends Investments, an RIA based in Irvine, Calif. and editor of ETFtrends.com.

“There is a fast adoption of smart beta ETFs with RIAs, so this seemed like a good move for Direxion. ProShares and Direxion were initially known as the inverse and leverage ETF providers. But now they have developed suites of smart beta ETFs at a very opportune time. Smart beta has more of a level playing field. The Schwab ETF platform is doing very well and those initial participants are very happy that they paid the fee to play in the space.” See: Fidelity and BlackRock are cooking up a (de facto) de novo ETF company deep in the Rockies.

Before Direxion’s inclusion of four of it funds on the ETF OneSource platform they could be purchased by RIAs it on the Schwab platform for a ticket charge.

But such charges are sitting less well with RIAs as 2015 approaches.

“As we think about where the business is going, everyone is concerned about fees and advisors have fee budgets,” Jacobs says. “In the old days, those ticket charges may not have been a big deal, but now if you’ve got 200 clients at $8 a ticket charge, it really can add up.” See: Schwab makes play for ETF-distribution domination but not without risks.

RIAs have invested with Direxion Investments since 1997.

Niche wars

Tom Lydon: The Schwab ETF platform
is doing very well and those
initial participants are very happy that
they paid the fee to play
in the space.

With the emerging market for ETFs, the game is largely about marketing niches for smaller players.

“There are just a handful of ETF sponsors with a lot of different funds. But there will be more and more funds and everyone is trying to be active,” Gerber says. “Everyone knows that’s the way the industry is playing. Schwab has to decide if they want a large competitor on their platform or do they want funds that are complementary. They want a nice portfolio of available funds but they don’t seem to be trying to build up more ETF funds than anyone else.” See: RIAs surpass wirehouses in ETF asset distribution and it’ll mean change.

Direxion’s strategy comes down to trying to fit into two niches simultaneously.

“You’ll be seeing more of Direxion at RIA events,” Jacobs says. “We think we’re big enough to be an important player yet we’re small enough that we can shape our business and company to how advisors are managing their business,”

In an e-mail, Schwab’s Fox says: “We offer ETFs in both core and explore asset classes, with basic strategies as well as more sophisticated ones. Our goal with the Schwab ETF OneSource program is to offer a broad selection across asset categories to meet the different needs of clients, not to offer every ETF commission-free.”

Right sized

As a new player on the ETF OneSource lineup, Direxion finds itself in an increasingly populated field. Recent additions are: ALPS Funds Dividend Dog Series and Energy Infrastructure ETFs, Global X Funds IndexIQ, PIMCO, ProShares and WisdomTree.

These new funds join popular ETF firms such as ETF Securities, Guggenheim Investments, PowerShares, State Street SPDR ETFs, United States Commodity Funds and Charles Schwab Investment Management.

Overall, Fox says OneSource has been a success.

“Schwab ETF OneSource was designed to be a win for investors and for providers. Most importantly, investors win: No commissions, and no unpleasant surprises like the need to register to participate or to pay early redemption fees. Providers benefit from the resources that Schwab has to offer as well as a new level of access to Schwab’s clients.” See: RIA custodians charge steep new ETF-related fees that can range into the tens of thousands of dollars for big trades and advisors are working to deal with them.