- The Washington Times - Monday, October 3, 2005

Once available only to clients of the discount brokerage, a number of Schwab mutual funds are now being sold through third-party distributors, making them more widely accessible than before — and some of them might be worth a look.

The move includes most of Schwab’s active equity funds, all 10 of its fixed income funds and the Laudus MarketMasters Funds. They will be available to non-Schwab clients for the first time via fund supermarkets Fidelity, Ameritrade and TD Waterhouse, among others, and through several clearinghouses used by registered investment advisers.

For Schwab, the decision “is all about growth,” said Evelyn Dilsaver, president of Schwab Investment Management. The funds involved currently hold about $35 billion, and Miss Dilsaver is hoping the move will bring in another $3 billion in the first year. Schwab’s overall fund portfolio is worth about $145 billion, including some $105 billion in money funds.

Schwab is also contemplating broader distribution in the retirement savings market via 401(k) platforms, though Miss Dilsaver said that isn’t likely to come until 2006.

“At the end of the day, the client buys performance, and I have to compete on performance within Schwab for the reps to recommend us,” she said. “If I have to compete on performance inside Schwab, I may as well do it on the outside as well.”

For small investors, this may open up some interesting choices, though each offering deserves a careful evaluation, said Sonya Morris, a fund analyst with Morningstar Inc. One thing to watch for is fees. Schwab has a reputation as not being the cheapest fund shop on the street, but it’s not the most expensive either, Miss Morris said. On this point, there could be a beneficial side effect to broader visibility: If more assets are drawn in, expenses might come down.

The actively managed equity funds employ a quantitative strategy, which means the manager makes decisions about which stocks to buy and sell with the help of a computer. Schwab’s equity rating system sifts through a universe of 3,000 U.S. stocks, evaluates their fundamentals, valuation, momentum and risk, and grades them from A to F. As you might imagine, A-rated stocks are expected to outperform over the next year, while F-rated stocks are expected to underperform. Some of the funds are relatively new, but the system has generally shown good results overall, Miss Morris said.

The most established of Schwab’s actively managed equity funds, and the only one currently covered by Morningstar, is the Schwab Core Equity Fund (SWANX). It opened in 1996, but has been following its current model, focusing on A- and B-rated stocks, since 2002. It seeks to outperform the Standard & Poor’s 500, and has succeeded so far, rising 5.6 percent year-to-date and 16 percent over the last three years. It’s also reasonably priced, with a 0.75 percent expense ratio.

“It’s a good, solid core fund and has a good, long track record, so all of that provides an extra measure of comfort, and it’s reasonably priced,” Miss Morris said. “Given the pleasing results there, we wouldn’t be surprised if the newer offerings are attractive as well.”

Among them is the Schwab Small-Cap Equity Fund (SWSIX), which has outperformed its category since it was introduced in 2003. This may draw the notice of investors looking for viable small-blend options since so many funds in this area have closed over the last several years, following the surge in the market’s smallest issues. Its 1.3 percent expense ratio could put off bargain hunters, however.

There’s also the Schwab Hedged Equity Fund, (SWHEX), which attempts to outperform the S&P; 500 with less volatility. To do this, the managers establish long positions and then sell stocks short to reduce, or “hedge,” the market risk of the portfolio. Total assets including all share classes stand $216 million, and its expense ratio remains a pricey 2 percent. Not many funds employ this strategy, however, so if it’s what you are looking for, it’s nice to have another choice — though the average investor could probably do without it.

In addition to these, there’s the Schwab Dividend Equity Fund (SWDIX), which invests in about 100 A- and B-rated dividend-paying stocks, a trio of sector funds focused on financial services, health care and technology, and a soon-to-be-launched large-cap growth fund.

Among the 10 offerings in Schwab’s bond portfolio, which includes four taxable, three tax-free and three California tax-free funds, Morningstar currently covers only one: the ultrashort bond fund, Schwab YieldPlus (SWYPX). Created to fill the gap between the money market and short-term bond funds, this offering has posted above average returns compared to its peers in the trailing three- and five-year periods.

The Laudus funds consist of 14 offerings broken up into two groups: 10 funds sub-advised by AXA Rosenberg, which Schwab adopted in 2003 and which were already widely available, and four MarketMasters that were previously available only to Schwab clients. Of these, the Laudus International MarketMasters (SWOIX) has garnered an impressive record and gathered the most assets. But its 1.65 expense ratio is far from cheap, and the recent departure of a key manager has Morningstar concerned about future performance.

With the addition of the Laudus funds, Schwab has “added heft,” Miss Morris said. “They’re putting a concerted effort into their funds,” she said. The move to make them more widely available “is further confirmation of that. It’s clearly becoming a more important part of their business.”


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