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Fidelity poised to be an ETF juggernaut

With 15 funds in the pipeline, mutual fund giant takes on Pimco, Vanguard

Aug 1, 2013 @ 11:38 am

By Jason Kephart

Fidelity Investments has only dipped its toe into exchange-traded funds so far, but the groundwork has been laid for a splash that could shake up the ETF industry.

Last week, Fidelity stuffed its product pipeline with 10 passively managed sector ETFs and three actively managed bond ETFs. That brings the total number of ETFs that Fidelity has awaiting approval from the Securities and Exchange Commission to 15.

The proposed lineup of ETFs puts Fidelity on a head-on collision course with its fellow asset management powerhouses Pacific Investment Management Co. LLC., the world's largest bond manager, and The Vanguard Group Inc, the largest mutual fund provider in the world. Both companies have already carved out their ETF footprints.

Fidelity's ETF gambit has some pretty big stakes tied to it. The Boston Behemoth has been looking much less behemoth-like in recent years.

Fidelity's market share of the fund industry has been whittled down to 9%, from 12% a decade ago, according to Morningstar Inc.

The rise of ETFs has played a large role in that decline, and the funds are only gaining steam.

Financial advisers plan to allocate as much new money to ETFs as to mutual funds next year, according to the Cogent Research LLC 2013 Advisor Brandscape report.

It is the first time since the research firm started releasing the report in 2007 that ETFs and mutual funds have been neck and neck.

Even old mutual fund money could be at risk of being shifted to lower-cost ETFs, according to the Spectrem Group.

In a recent survey of 567 high-net-worth investors, nearly two-thirds said that they plan to move money from mutual funds to ETFs.

For Fidelity, winning in ETF-land with actively managed bond ETFs and passive sector ETFs may seem like a daunting task, given that it was built primarily on the shoulders of its actively managed funds. Still, there is plenty of reason for optimism in Beantown.

On the bond side, Fidelity's plan is sneaky smart. Most people probably don't know this, but Fidelity's investment-grade-bond teams are among the industry's best, despite the lack of a star personality such as Pimco's Bill Gross.

“It's a hidden gem,” said Jim Lowell, editor of the Fidelity Investor Newsletter.

The $12 billion Fidelity Total Bond Fund (FTBFX), for example, has three-year annualized returns of 4.45%, handily outpacing the 3.9% annualized returns of the $268 billion Pimco Total Return Fund (PTTAX).

With five actively managed bond funds in registration, Fidelity has the ability to challenge Pimco as the premier actively managed bond ETF company.

The success of the Pimco Total Return ETF (BOND), which has grown to more than $4 billion in assets, has shown that there is clearly a market for exchange-traded income solutions.

“Fidelity does have the ability to dominate the actively managed ETF space if they want to,” Mr. Lowell said. “They are aggressively going after the active ETF income space.”

The equity side is a little more complicated.

The planned sector ETFs will track the same MSCI indexes as Vanguard's sector ETFs. To get investors' attention, the ETFs will have to be cheaper than the already cheap Vanguard ETFs, which charge 14 basis points.

Because these sector ETFs represent Fidelity's first real equity ETF launches, you can bet that they aren't just going to dip below Vanguard's price, Mr. Lowell said.

“When you share the same index, price is the only thing that matters,” he said. “The difference is going to be notable.”

The sector ETFs also are likely to trade commission-free on Fidelity's platform, given that investors can already trade 65 iShares ETFs commission-free at Fidelity.

And lest anyone would be worried about how well the ETFs will track their indexes, given the newness of the enterprise, Fidelity has hired BlackRock Inc., which manages iShares, the largest provider of ETFs in the world, to subadvise the funds.

Those three factors should be enough to help the ETFs gain traction in what has historically been a tough market to crack.

Success with the passively managed sector ETFs could set the stage for Fidelity to enter the actively managed equity ETF space, which has yet to be attempted on a large scale.

Ever since Fidelity said that it was, finally, entering the ETF world, speculation has centered on the possibility that it might bring its actively managed sector mutual funds to the arena.

“The [passive-sector ETFs] help them build a platform to do just that,” Mr. Lowell said.


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