Fidelity Claims the Lead in Fee Fight August 11, 2017 Adviser Fund Update Print Fidelity Returns Fire in Fee Wars On August 1, Fidelity reduced fees on its higher-minimum premium share class for 14 index funds, undercutting rival Vanguard on expenses charged on comparable funds’ Admiral share class, which share a $10,000 minimum initial investment. This is another blow in the fee war that’s been ongoing in the index mutual fund space for over a decade now—though after all the fee cuts, each advance gains the combatants less and less territory. For example, the average expenses for Fidelity’s index-based funds are 0.099% following the move, down 0.011% from before the reductions. Clearly this is a tiny amount—just an average of an 11-cent reduction in fees on every $1,000 invested, but in the race to zero in the competitive index fund space, Fidelity is seeking to stand out from the pack. Fidelity introduced the fee cuts with a big ad in The Wall Street Journal and launched an unsubtle web page, “www.fidelity.com/beatsvanguard,” that presents a head-to-head comparison of its index and sector 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. products against similar funds at Vanguard. Fidelity’s fee cuts made all 28 of its index funds and each of its 11 sector 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. cheaper than comparable funds offered by its main competitor. Fidelity Fund (Premium Share Class*) Former Fidelity Expense Ratio Current Fidelity Expense Ratio Current Vanguard Expense Ratio Vanguard Fund (Admiral Share Class*) 500 Index .045% .035% .040% 500 Index International Index .080% .060% .070% Developed Markets Index Total Market Index .045% .035% .040% Total StockA financial instrument giving the holder a proportion of the ownership and earnings of a company. Market Index U.S. BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. Index .050% .045% .050% Total Bond Market Index Large Cap Value Index .070% .050% .060% Value Index Large Cap Growth Index .070% .050% .060% Growth Index Mid Cap Index .070% .050% .060% Mid Cap Index Small Cap Index .070% .050% .060% Small Cap Index Total International Index .110% .100% .110% Total International Stock Index Global ex.-U.S. Index .080% .060% .110% FTSE All-World ex.-US Index Emerging Markets Index .140% .130% .140% Emerging Markets Stock Index Short-Term Treasury Bond Index .090% .060% .070% Short-Term Government Bond Index Interm.-Term Treasury Bond Index .090% .060% .070% Interm.-Term Government Bond Index Long-Term Treasury Bond Index .090% .060% .070% Long-Term Government Bond Index *Premium and Admiral share classes both have a $10,000 minimum initial investment. Expense ratios as of 8/1/2017 (Fidelity) and 7/31/2017 (Vanguard). Sources: Fidelity Investments, The Vanguard Group. If you’re wondering why Fidelity, Vanguard and other fund providers have all been making such a big deal out of relatively small amounts of savings at the individual investor level, just look at the popularity of index funds, which have seen massive inflows of cash in recent years. 2016 was a record year, as investors put nearly $505 billion into passively managed stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. and bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. funds. While Fidelity is best known for its celebrated active managers, it also touted nearly $300 billion in passive assets as of June’s end, about 13% of its $2.3 trillion under management. Fidelity Providing Savings on Active Funds, Too Although the index-fee reduction got the most press, the cost savings for investors in Fidelity’s index funds pales in magnitude next to the shareholder-friendly move they’ve made on five of their actively managed funds. In fact, you could make an argument that the real story of Fidelity’s ongoing challenge to Vanguard is the changes it’s making in its actively managed fund lineup. The Boston-based fund giant recently launched identical Z share classes of five of its retail funds for financial advisers and their clients that carry expense ratios that are 0.09% to 0.14% cheaper (or about 14% to 22% less on an absolute basis) than their investor-class shares. (Adviser Investments uses Z shares for our clients where they are available and when it’s to the client’s benefit.) Fidelity Fund Name Annual Net Expense Ratio (Z Shares) Annual Net Expense Ratio (Retail Shares) Difference International Discovery 0.85% 0.99% -0.14% International Growth 0.84% 0.98% -0.14% Mega Cap Stock 0.53% 0.68% -0.15% Stock Selector All Cap 0.54% 0.63% -0.09% Total Bond 0.36% 0.45% -0.09% Source: Morningstar. There are also no transaction fees for buying or selling these funds. By shifting into the new shares of these five funds, investors could save more than $54 million combined. Fidelity’s custodial business also dropped trading costs on many of the non-Fidelity, institutional share-class funds it makes available to investors. Institutional shares typically cost 0.25% less than other share classes because they don’t charge a 12b-1 fee, but transaction costs had made them prohibitive for smaller investors. Those are starting to go away, and if the industry followed Fidelity’s lead, some $2.3 billion in savings would be passed along every year. Hardly chump change. Fidelity’s Z shares are available through eligible employer-sponsored retirement plans and accounts where advisers charge an asset-based fee. While the debate over passive versus active management rages on, we see an important ongoing trend in investors’ steady drift from high-fee to low-fee funds. And as passive investments’ expense ratios continue to inch toward 0.00%, we’ll be watching closely to see how active funds drop their fees to remain competitive. Vanguard Adds International Manager Vanguard has announced that it is adding a third sub-adviser, TimesSquare Capital Management, to its International Explorer fund’s ranks by the end of August. Is the fund giant’s only actively managed international small-cap fund running up against its capacity limits? And if that’s the case, will adding another manager help the fund or kneecap the performance of those already managing assets there? TimesSquare’s Magnus Larsson will come aboard to manage less than 5% of the firm’s assets at first, which will be ceded by the fund’s current sub-advisers: Schroder Investment Management and Wellington Management. If history is any indication, we would expect to see Larsson take on more responsibility going forward, and at Schroder’s expense. After all, when Wellington joined the fund in 2010, manager Simon Thomas only oversaw 1% of the portfolio to begin with. As of April 2017, the most recent data we have, Wellington oversaw 30% of total assets. It is too soon to say whether this hiring is Vanguard’s attempt to handle a capacity issue and keep a popular and profitable fund open by adding a new manager or if there is something else going on. Vanguard does not provide much of a rationale for adding the new-to-the-firm sub-adviser in their press release regarding the move, other than to broadly state “a multimanager structure enables each manager to focus on longer-term opportunities where they have the most conviction,” so we can only guess as to the motive. Cash has just recently started to flow back in to the fund after a full year of steady outflows, but TimesSquare is joining the ranks as International Explorer’s assets near $3.5 billion—slightly more than its previous high-water level in May 2007. The addition of another manager to International Explorer continues a multimanager trend at Vanguard we’ve written about before. Adding a third sub-adviser risksThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. turning International Explorer into an index fund charging active management fees, but, again, it’s too early to determine what TimesSquare will bring to the table and how the fund will be affected from a holdings and performance perspective, particularly with the new manager starting out with a tiny, 5% portion of the fund. The firm has seen the multimanager strategy be successful in a few cases, but we’ve also seen where it can be to shareholders’ detriment. One only needs to look at International Explorer’s namesake bigger brother, Explorer, which has underperformed its benchmark and Vanguard’s indexed options since fattening its management ranks years ago for an example of multi-management’s downside. About Adviser Investments 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, trusts, 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. Our minimum account size is $350,000. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868. This material is distributed for informational purposes only. 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