Fidelity Embraces What It Once Avoided: The ETF


Abigail Johnson once resisted bulking up in exchange-traded funds because of the potential costs of committing to the lower-margin products. But a sea change in the money management industry is forcing the chief executive of Fidelity Investments to alter that strategy.

Fidelity launched six new ETFs in 2016, increasing its lineup of ETFs by 40%, while the firm slashed fees to undercut competitorson price. That push came in a year when clients pulled more money from Fidelity’s traditional mutual funds than in any since 2011, according to fund research firm Morningstar Inc. Investors even withdrew money from some actively managed mutual funds that beat their benchmarks, according to the data provider.

Fidelity’s top executives now say they need to be more competitive in the ETF arena despite thinner revenue from the popular products, which trade like stocks but offer low-fee access to wide swaths of the market. ETFs are less profitable than Fidelity’s bread-and-butter mutual funds.

“If we don’t do that customers will leave Fidelity,” said Charles Morrison, head of Fidelity’s asset-management business. “The revenue impact will be what it will be.”

To be sure, despite being slow to offer its own ETFs, Fidelity remains among the largest U.S. money managers with $2.1 trillion in assets under management and $5.6 trillion in assets under administration. The firm reported record revenue for 2014 and 2015.

The tighter embrace of ETFs by a firm long known for its star stock and bond pickers embodies the cultural shift under way across the money management industry. Many firms that once specialized in active management are experimenting with previously unpopular approaches as they grapple with an unprecedented flow of money to cheaper, index-based products.

A big attraction of ETFs to investors is that they can be bought or sold in real time during the trading day, just like stocks, while mutual funds can be traded just once a day. ETFs, which typically carry lower costs, also have some tax and trading advantages over mutual funds.

During 2016, actively managed funds watched investors pull $358.8 billion while their lower-cost passive rivals, such as ETFs and index-tracking funds, received $479.8 billion in fresh cash, according to research firm Morningstar Inc. All told, there were some $2.5 trillion in assets invested in U.S. exchange-traded products at the end of November, according to London-based consulting firm ETFGI LLP.

That is up from about $1 trillion in assets at the end of 2011.

“We believe flows are a lagging indicator that can be expected to improve as the market enters the next cycle for active outperformance, which we may be starting to see now as interest rates rise and the difference between winning and losing stocks starts to widen,” a representative from Fidelity said.

Few firms are more associated with active fund management than Fidelity, a privately held company founded by the Johnson family in 1946. Fidelity became a household name in the 1980s because of its mutual funds overseen by star fund managers such as Peter Lynch.

Fidelity first sold passively managed index mutual funds three decades ago. But from 2003 to 2013 it had just one Fidelity-branded ETF, even as such funds became one of the industry’s fastest-growing offerings. ETFs and index funds are similar in that both often track the performance of different benchmarks and charge lower fees than actively managed funds.

Within Fidelity there was some disagreement about how to react to the growing popularity of ETFs in the early 2000s, current and former employees say. Edward “Ned” Johnson, then chairman and chief executive, viewed ETF sales as a way to bolster assets under administration in the firm’s brokerage business. But his daughter Ms. Johnson, who led Fidelity’s asset-management unit, didn’t want to spend resources on the firm’s own ETFs, according to former employees.

Ms. Johnson is now Fidelity’s CEO and in December succeeded her father as chairman. The Johnsons control 49% of the company, while employees hold the other 51%.

Over the years, rivals raced ahead with new ETF products while Fidelity hesitated. BlackRock Inc., State Street Global Advisors and Vanguard Group expanded ETF offerings and pulled in assets at a clip. All told, those three firms have about $2 trillion in U.S. ETF assets today.

Fidelity’s dilemma was that ETFs were a low-margin business that required a scale of operation in those products that the firm lacked. Fidelity researched what it would take to start more of its own ETFs, but didn’t proceed with those plans because it concluded it would be too expensive to become a meaningful player in that field, according to people familiar with those discussions.

But Ms. Johnson and top lieutenants later came to view those products as key to retaining clients and gathering new assets from younger investors. A generation of 18- to 34-year-olds that is larger in size than the baby boomers is increasingly opting for lower-cost passive funds. In 2015, investors pulled a net $18.8 billion from Fidelity’s actively managed stock funds even though more than three quarters of its actively managed U.S. stock funds and 85% of its international stock funds beat their benchmarks.

Fidelity’s first attempt to get a foothold in ETFs was a partnership with New York competitor BlackRock in 2010. BlackRock needed access to retail customers and Fidelity lacked its own ETF lineup. Both wanted to take on Malvern, Pa.-based rival Vanguard, which was gathering assets from retail investors rapidly.

That resulted in the 2013 launch of 10 Fidelity ETFs managed by BlackRock’s iShares unit. Fidelity now charges investors 0.08% annually for those funds, less than BlackRock’s own comparable iShares sector funds that cost 0.44%, though Fidelity’s have fewer assets. In agreeing to the partnership, Fidelity said it wouldn’t likely start its own ETFs that compete with so-called “core” iShares funds, according to people familiar with the matter.

Fidelity became even more aggressive in the past 12 months, as it slashed fees on some ETFs, launched its own products that track nonmarket capitalization-weighted indexes, attended ETF industry forums for the first time and started selling a growing number of ETFs commission-free on its brokerage platform. In just the past month, Fidelity even cut short-term trading fees in 75 mutual funds.

Fidelity is also trying to marry its well-known stock-picking mutual funds with tax and trading advantages of exchange-traded funds. The firm filed an application with the Securities and Exchange Commission in August for a nontransparent exchange-traded product akin to a closed-end fund.

Yet Fidelity’s ETF business is still much smaller than its rivals. Its ETF assets under management just passed $5 billion, as compared with $254.6 billion handled by outside firms that sell their ETFs on Fidelity’s platform.

Still, not all longtime Fidelity employees and mutual-fund managers are sold on the firm’s recent shift, according to current and former employees.

But Mr. Morrison, head of Fidelity’s asset management business, said the recent steps didn’t signal a move away from Fidelity’s “commitment to active management.”

“Investor preferences shift over time,” he said. “We have to make sure we respond to that. It’s not an either or.”

Write to Sarah Krouse at

(END) Dow Jones Newswires

01-03-17 1515ET

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