Schwab is the largest discount brokerage in the United States with trillions in client assets, enabling them to be the lowest cost producer in their industry. In other words, they are able to offer the largest selection of products and services relevant to the financial industry at the lowest prices possible. This scale advantage is a virtuous cycle, allowing them to continue to gather assets at a quick pace, which in turn, allows them to continue to offer the best-in-class technology and suite of wealth management products and services. Instead of having a traditional cost of entry with pricing power, Schwab’s cost of entry is the low rates it offers on deposits where they can earn a spread. They further increase their earning power by charging third party vendors, such as mutual funds, to access their massive network of users. Thus, even though asset allocation is much like a commodity service where prices are being driven down, because Schwab has created a virtually unrivaled network of investors, financial advisors, and wealth management products and services, it has pricing power through low cost deposits as well as fees to its third-party sellers. As a result, we believe Schwab is well positioned to essentially act as a toll taker on growing global wealth and to continue to increase market share of deposits and financial assets. Finally, their business benefits from rising interest rates, so they may act as an interest rate hedge to the overall portfolio should interest rates surprise to the upside.
To read a more detailed description on SCHW as discussed in a prior investment letter, click here.
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