Vanguard’s commission-free ETF trades draw a surge of investor interest

Vanguard’s free ETF trades a big early hit

CHICAGO — Vanguard appears to have a hit on its hands. The index mutual fund pioneer is seeing a strong initial response to its offer of commission-free trades in its exchange-traded funds, a fast-growing business where Vanguard is playing catch-up.

Vanguard stopped charging commissions for its lineup of 46 ETFs on May 4, after previously charging most of its clients $12 and up per trade. The move came after Fidelity Investments and Charles Schwab recently eliminated commissions on smaller lineups of ETFs, which are alternatives to traditional mutual funds.

ETFs are baskets of stocks, bonds or commodities that can be traded like stocks during daily trading sessions. Mutual funds are only priced once a day. The ability to trade ETFs freely is a big draw, but many investors can also rack up significant trading costs, eroding their returns.

In May, ETF trading activity by Vanguard brokerage customers was up 150 percent over a year ago, according to data Vanguard provided to The Associated Press.

The commission-free offer also is bringing in new clients. New brokerage account growth was up 90 percent in May.

The offer is accelerating the already rapid flow of money into Vanguard’s ETFs, which are gaining on the largest ETF asset managers, BlackRock Inc.’s iShares ETFs and State Street’s “SPDR” ETFs.

Investors have put more than $14 billion into Vanguard ETFs this year through the end of May, bringing its total ETF assets to $102 billion. That’s more than double the total a year ago. With its recent ETF push, the Valley Forge, Pa.-based company says it has taken in more than half of the investor cash flowing into ETFs industrywide this year.

“The numbers show that Vanguard’s marketing plan has gotten off to an excellent start,” said Doug Dannemiller, an analyst with the research firm Aite Group. “The next test for Vanguard is whether this is a spike in activity, or the start of a trend.”

Jim Lowell, editor of the newsletter ETF Trader, notes Vanguard is still playing catch-up behind iShares and State Street, who got into ETFs in the 1990s, before Vanguard. IShares alone accounts for 50 percent of the entire U.S. ETF market.

Lowell says Vanguard “missed the biggest index investing trend of the decade — ETFs — and isn’t even playing second fiddle in the business as a result.”

Vanguard helped usher in an era of low-cost investing with its introduction of index mutual funds in the 1970s, and it remains best known for those alternatives to pricier actively managed funds.

Despite their recent growth, ETFs are still a long way from catching up with mutual funds. At about $700 billion, U.S. ETF assets are dwarfed by the $11 trillion in mutual funds.

And ETFs aren’t without controversy. The ease with which investors can trade throughout the day has drawn criticism that ETFs can encourage ill-advised attempts to time the market by moving in and out too quickly. One of the critics has been Vanguard’s retired founder, John Bogle.

The elimination of commissions could make frequent ETF trading even more tempting.

But Vanguard says its move to drop commissions shouldn’t be taken as an invitation to trade frequently. The company says it continues to back a traditional buy-and-hold approach.

“Like Mr. Bogle, we share a philosophical belief that active trading can often be counterproductive,” said Melissa Nassar, a principal in Vanguard’s financial adviser services group.

In eliminating commissions, Vanguard is reserving the right to block an investor from further trading in a specific ETF if the individual has traded in and out of it more than 25 times over 12 months.

“We don’t normally see a lot of trading in our ETFs, but since it’s free, we want to make sure people are not overtrading, and essentially hurting themselves in the long run,” spokeswoman Rebecca Katz said.