Fidelity heats up ETF battle, but some advisers grouse

Fees, new lineup of commission-free funds, ruffle feathers

Mar 17, 2013 @ 12:01 am

By Dan Jamieson and Jason Kephart

Fidelity Investments last week upped the ante in the battle for exchange-traded assets, but the plan barely got off the ground before some advisers were seeing red.

The mutual fund giant last Wednesday announced that it was bolstering its partnership with BlackRock Inc.'s iShares unit, and offering investors and financial advisers the ability to trade 65 iShares exchange-traded funds without paying a commission on the Fidelity platform, up from 30.

As part of the expansion, Fidelity removed 10 older iShare ETFs from the commission-free list and replaced them with the new, cheaper “core” iShares ETFs that were launched last fall to compete with low-cost offerings from Charles Schwab & Co. Inc. and The Vanguard Group Inc.

The expanded list of commission-free ETFs puts Fidelity in more direct competition with TD Ameritrade Inc. and Schwab, which have been offering such trades for some time.

TD Ameritrade has offered commission-free trading on more than 100 ETFs since 2010. Schwab expanded its platform of commission-free ETFs, including funds from outside providers such as State Street Global Advisors, Guggenheim Investments and PowerShares, to more than 100 last month.

ADVISERS IRKED

Some advisers, such as Chris Lamb, principal at Old Mission Investment & Trust LLC, are miffed at losing free trades on the 10 legacy iShares products that were removed from the no-transaction-fee program.

“They took away 10 of the top ones we use,” said Mr. Lamb, who has about $300 million in assets at Fidelity.

Two of the older products replaced were the popular iShares MSCI EAFE Index Fund (EFA), which had an expense ratio of 34 basis points, and the iShares MSCI Emerging Markets Index Fund (EEM, at 69 basis points). They were replaced by the Core MSCI EAFE Fund (IEFA, 14 basis points) and the Core MSCI Emerging Markets Fund (IEMG, 18 basis points).

Another beef is about a $7.95-per-trade exit fee Fidelity will charge investors who sell the commission-free ETFs within 30 days of buying them. For advisers, the fee kicks in if an ETF is sold within 60 days.

TD Ameritrade charges a similar fee for any ETFs sold within 30 days of a purchase, but Schwab does not.

The exit fees will hit investors and advisers who are active traders, but the most active ETF products are not included on either the Fidelity or TD Ameritrade commission-free platforms.

In addition, more advisers are using ETFs in tactical trading models, said Dennis Gallant, founder of Gallant Distribution Consulting. Trading commissions can add up with an active strategy, so “having a broader breadth of commission-free ETFs helps,” he said.

Lower transaction costs also make ETFs easier to use with smaller accounts or with clients who need to liquidate assets only periodically, Mr. Lamb noted.

Even though Fidelity is offering fewer ETFs commission-free, they might actually be ahead of their competitors because the ones they are offering are more popular, said Ben Johnson, director of passive-fund research at Morningstar Inc.

The iShares ETFs represent about 18% of total ETF assets, Mr. Johnson said. “To that extent, they may actually be ahead,” he said.

Observers expect to see more such deals as ETF providers and brokerage firms look to build assets.

“ETFs have always faced a commission problem,” said Brad Zigler, an industry consultant. “To make these products truly competitive with mutual funds, they've got to let investors buy and sell without cost. The brokers figure that offering commission-free trades will attract more trades, more assets [and] increased subsidies from the sponsors.”

Advisers agree that eliminating commissions is a good way to attract assets.

“We're really excited about” Fidelity's move, said Lynne Kinney, a principal at CKW Financial Group LLC, which advises on about $700 million in client assets and uses Fidelity as its custodian. “It allows us to keep our fees low,” which improves performance numbers for clients, she said.

Ms. Kinney expects that trading volume in the new core iShares products will grow, “and as that builds momentum, we'll allocate more to iShares.”

"ENVIRONMENT IS RIPE'

Fidelity also will be launching managed-ETF portfolios using the iShares products.

Managed portfolios at Fidelity are used primarily by retail investors, but Mike Durbin, president of Fidelity's custody unit for registered investment advisers, said he thinks more advisers will be attracted to managed-ETF products.

“The environment is ripe for that,” he said.

Tom Lydon, president of Global Trends Investments, agrees.

“The managed-account program makes a heck of a lot of sense” for Fidelity, said Mr. Lydon, who also publishes the ETF Trends blog. “It gets them into the ETF game in an active way by running a strategy.”

Assets in model ETF portfolios that Morningstar Inc. tracks have grown to more than $57 billion, up 65% since September 2011, when the fund research firm began tracking the category.

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