U.S. Markets close in 6 hrs 27 mins

Fidelity Arrives Fashionably Late to ETF Boom

Michael Santoli
Fidelity Arrives Fashionably Late to ETF Boom

Fidelity Investments has been somewhat slow to embrace the exchange-traded-fund boom, reflecting its pedigree as an active fund management shop built on traditional mutual funds that seek to beat their benchmarks.

But in launching a new array of industry-sector ETFs, Fidelity is signaling its intent to be aggressive in grabbing a bigger piece of the low-cost, index-based traded funds business.

Fidelity on Thursday introduced ten sector funds with rock-bottom expense ratios, charging just 12 basis points (or $1.20 a year for each $1,000 invested). State Street Corp.’s (STT) Select Sector SPDRs, the incumbent family of sector ETFs, charges slightly more, with its popular Financial Select Sector SPDR (XLF), for example, charging 18 basis points. The Select Sector SPDRs have a combined $60 billion in assets, giving them a massive head start, and creating a challenge for any new entrant in the industry.

As Anthony Rochte, president of Fidelity’s SelectCo sector-fund business, says in the attached video, the new Fidelity funds differ from existing funds on the market, in that they track MSCI’s industry indexes, which include stocks of all market-cap sizes. The Select Sector SPDRs include components of the large-cap Standard & Poor’s 500 index.

The Boston firm manages $1.9 trillion in assets and oversees of $2.5 trillion more in client accounts through its online brokerage and retirement business, yet only about $125 billion of that is in ETFs; a $1.4 trillion industry that has hogged asset flows from retail investors in recent years. Most of those assets are sub-advised by ETF specialists. The new group of sector ETFs, in fact, will be directly managed by BlackRock Inc. (BLK), owner of iShares and the leading ETF manager in the business.

All of this clearly shows that Fidelity is offering ETFs purely as an accommodation to its financial-advisor and retail-investor customers, carefully trying to avoid cannibalizing its core actively managed funds or undercutting its culture of fundamental stock and bond-picking.

While Fidelity is a relative upstart in ETFs, the firm actually pioneered sector-based investing through its 44 actively managed industry-specific funds. In the years before ETFs were invented, such funds as Fidelity Select Electronics (FSELX) and Fidelity Select banking (FSRBX) were as close to the market had come to industry bellwethers. These were often the funds that promising young analysts at Fidelity were given to run to prove themselves, on the way to being entrusted with larger, diversified funds.

Rochte takes pains to emphasize that Fidelity remains fully committed to the active sector-fund game, viewing ETFs purely as a complement to its main business of trying to deliver “alpha,” or good risk-adjusted performance, to investors and the thousands of investment advisors who use the company’s platform.

Fidelity has registered with regulators to offer five actively managed fixed-income ETFs to be managed internally, a promising new realm for the industry. Truly active ETFs are tricky to engineer, because near real-time disclosure of portfolio holdings is necessary to make them trade efficiently. Bond ETFs, though, are a promising field, often with less turnover and greater opportunity to outrun standard indexes.

The new Fidelity funds won’t revolutionize sector investing or Fidelity’s business, but offer efficient, cheap exposure to sectors that can be used to build portfolios and modulate one’s market bets. Mostly, they are an acknowledgement that the ETF is a core product with too many advantages – from cost to tax-efficiency to liquidity – for even a hard-core mutual fund giant to ignore.