Fidelity Takes Fee War to New Front - Adviser Investments

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) plans 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 ETFs 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 stocks 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, dividend 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 Equity 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. Liquidity Factor ETF: Invests in stocks with lower measures of trading liquidity
  • U.S. Minimum Volatility ETF: Seeks capital appreciation with lower volatility relative to the broad U.S. stock 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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