TD Ameritrade’s $4 billion takeover of Scottrade merely delays the inevitable. Uniting the two U.S. online stockbrokers stacks up financially, thanks to cost cuts, a tax break and a sale of a banking unit. Income and margins should rise, too. But it still leaves TD Ameritrade and rivals like Charles Schwab facing the twin longer-term dangers of index investing and robo advice.
These two forces could upend the business of so-called discount brokers – those charging just a few dollars a trade. That’s because they can obviate the need for either individual stock trading or a broad suite of tools to help investors play in the market – or both.
There is already evidence that investing in index funds is taking market share. Assets in passive mutual funds and exchange-traded funds grew by nearly $1.3 trillion in the three years to the end of August, according to Morningstar. Over the same period, active funds lost more than $250 billion of money to manage.
Ameritrade has weathered the storm better than some: it averaged 463,000 trades a day in the financial year that ended on Sept. 30. That’s slightly higher than the previous 12 months, although volume fell 7 percent in the final quarter. The latest figures for its privately owned new partner show a 3 percent year-on-year decline for the three months to June.
The impact of a newer phenomenon – dubbed robo advice – is still in its infancy. Ameritrade has its own offering and is by no means shut out of creating passive investing services, either. The problem is, both services can either be cheaper for clients or require less trading. The bigger these investment strategies become, the greater the potential hit to discount brokers’ margins.
Buying Scottrade will help for a time. Ameritrade reckons it can cut $450 million of costs. Once taxed and capitalized, these are worth some $2.5 billion to shareholders after stripping out merger expenses. That virtually pays for the deal as Ameritrade is selling Scottrade’s deposits arm to TD Bank for $1.3 billion. It’s also getting a tax break that effectively brings its purchase price down further to $2.2 billion.
All in, the Scottrade trade gives the firm run by Tim Hockey extra bulk to fend off – or invest in – these growing threats. They cannot, though, be avoided.