Fidelity Takes Fee War to New Front

Fidelity Takes Fee War to New Front

For years now, Fidelity has been duking it out with Vanguard on the low-cost battlefield with each competitor attempting to claim the least expensive investment vehicles on the market. The war has been waged with elaborate publicity campaigns boasting passively managed index funds carrying fees getting closer and closer to zero.

In recent years, the fee wars have been fought in the trenches, as the two fund providers are clawing to gain minimal advances against the other, down to the smallest slivers of percentage-point territory. Fidelity’s website boasts that its 500 Index Premium funds, at 0.035%, are cheaper than Vanguard’s 500 Index fund’s Admiral shares, at 0.040%. That’s a difference of 0.005%—do the math, it’s a savings of just 50 cents a year on a $10,000 investment! There’s really not much more ground to gain there. So Fidelity has attacked on another front—charging retirement plan sponsors on its platform administrative costs for including Vanguard funds as options for participants.

Last month, Fidelity announced that starting this year it will apply a 0.05% fee on new 401(k) plansA 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn. Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn. with less than $20 million in assets that invest in Vanguard funds. The fee will not be levied on current Fidelity clients and will only be billed to the employer sponsoring the plan, not the individual participants.

Fidelity is the country’s largest provider of record-keeping services, with about $1.6 trillion of defined contribution (DC) plan assets, which include 401(k)s and 403(b)s among other plan types. That figure towers above its next closest competitor, TIAA, by more than $1 trillion.

On the flip side, Vanguard—propelled by the popularity of its low-cost funds—has overtaken Fidelity as the largest manager of DC mutual fund assets, overseeing $717 billion invested in its funds as of June 30, 2017. Fidelity, which has been in second place since Vanguard knocked it off its perch in 2015, had $524 billion invested its mutual funds through DC plans as of the middle of last year.

Vanguard is an outlier in the business in that it does not pay brokerage firms to distribute their funds, known in the industry as “paying for shelf space.” This unwillingness to pay brokerages has irked competitors in the past; Morgan Stanley cut Vanguard funds entirely from its platform last May, disallowing its brokers from selling Vanguard mutual funds to new customers.

According to Fidelity, Vanguard is one of a small number of fund families that have not been paying them for their administrative services, even as Fidelity’s platform provided toll-free access to its competitor’s low-cost funds. The 0.05% fee may help address that issue, but plan sponsors will certainly notice the cost, and may be forced to change tacks as a result.

At the top end of the scale, the 0.05% fee amounts to a $10,000 annual charge on a $20 million plan that sponsors will need to add to the budget (or find a way to pass on to participants, something they may be hesitant to do after a number of high-profile lawsuits in recent years have made clear that failing to keep costs low can make sponsors a target for litigation). In today’s competitively priced investment marketplace, it gives not-so-subtle encouragement to plan sponsors to drop Vanguard funds (or perhaps to seek a different plan platform), and makes Fidelity’s similar offerings a bit more appealing.

As we’ve covered extensively, Fidelity has been expanding its index fund options in recent years, looking to catch up with the popularity of Vanguard’s low-cost, passively managed options. Imposing a fee on Vanguard’s offerings likely seeks to push expenses higher than on similar Fidelity products as the Boston-based fund giant seeks to pry back market share.

We’ll be watching to see how Vanguard responds to this latest development in the fee wars. Fidelity’s vast record-keeping market share and administrative dominance enable it to levy charges on competitors who want access to its broad reach. Time will tell how Vanguard returns fire.

Vanguard Factor ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. Hit the Market

“Smart beta,” “enhanced indexing,” “factor investing,” call it what you will. Regardless of your buzzword preference, Vanguard has stepped onto the playing field by launching a suite of ETFs (and one mutual fund) that each focus on exposure to a desired investment factor. The ETFs became available to investors on February 13.

As we discussed in December when the funds were first announced, Vanguard may call them factor ETFs, but that’s really just creative semantics to recast what they really are: Actively managed funds.

How so? “Smart beta” or “factor” funds have one foot in active management and the other in the passive realm. Instead of picking stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. by company size (i.e., large-cap, small-cap) or sector (e.g., energy, technology), they follow rules based on factors such as sales growth, dividendA cash payment to investors who own stock in the company. payouts, lower valuations or price momentum. Each factor is then employed to screen a universe of stocks with the desired factor(s) for each strategy. That’s what we mean by an “active” element; quantitative models that select the stocks in each strategy that are tweaked and (ostensibly) refined by the funds’ portfolio managers over time.

Vanguard’s Quantitative EquityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. Group—led by Antonio Picca and Liqian Ren—will oversee the investments. Here are the “factor” funds Vanguard has brought to the market:

• U.S. LiquidityThe ease with which an asset can be bought or sold. Assets for which there are many buyers and sellers at any given time are highly liquid (for example, a stock which trades on a public exchange). Assets which trade rarely are illiquid (for example, a Picasso painting or a high-end home). Factor ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index.: Invests in stocks with lower measures of trading liquidityThe ease with which an asset can be bought or sold. Assets for which there are many buyers and sellers at any given time are highly liquid (for example, a stock which trades on a public exchange). Assets which trade rarely are illiquid (for example, a Picasso painting or a high-end home).
• U.S. Minimum VolatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. ETF: Seeks capital appreciation with lower volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. relative to the broad U.S. stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market
• U.S. Momentum Factor ETF: Invests in stocks with strong recent performance
• U.S. Quality Factor ETF: Invests in stocks with strong fundamentals
• U.S. Value Factor ETF: Invests in stocks with relatively lower prices compared to fundamental values
• U.S. Multifactor ETF: Invests in stocks with strong recent performance, strong fundamentals and low prices relative to fundamentals. At the outset, this sounds like a combination of the momentum, quality and value strategies listed above into a single portfolio.

The Multifactor ETF will also be available as a mutual fund with Admiral class shares, with the ETF and Admiral shares each carrying a 0.18% expense ratio. The other factor ETFs are available in just the one share class and cost 0.13%.

The funds mark Vanguard’s first foray into active ETFs in the U.S., a little more than two years after testing the demand for such products in the U.K. Will investors here have an appetite for Vanguard’s factor ETFs? And is “smart beta” anything more than smart marketing? We’ll be watching.

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Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To.

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