What does the advent of free funds mean for asset management?
Posted by Robin Powell on August 9, 2018
It almost sounds too good to be good true, but Fidelity has become the first asset manager in the world to offer zero-fee funds. There’s one fund that tracks the US stock market and another that track global markets.
Investors who buy the funds directly from Fidelity will genuinely pay nothing, and that includes transaction fees. Nor will any money be spent on marketing the funds.
Fidelity is cutting costs by creating its own indexes, and it also plans to make money from the funds through stock lending.
But what does all this mean for global asset management? Will the cost of passive funds fall even further? And will we see fees for active funds come down too? Here are the views of journalists, authors, bloggers and other thought leaders from around the world.
Jeff Ptak, Global Director, Manager Research, Morningstar, Chicago | Article archive
“Even if the arrival of zero-fee funds is more symbolic than economically significant, this reality will ripple through the investment business. Undifferentiated products and services will be repriced and as that happens weaker hands will leave the industry or merge with others. Beta is officially a commodity.”
“Frankly, it doesn’t mean much. The trend toward low-cost index funds and ETFs has been in place for some time now. A zero-cost index fund was only a matter of time.”
“For an industry which is rightly seeing relentless pressure on its headline fees, the Fidelity move to 0% probably does feel like a ‘cross the Rubicon’ moment. However with the greatest passive flows to market-cap-weighted tracker funds already broadly flowing to the cheapest products — and those biggest index funds already only charging a few basis points in the best cases — we think it’s more symbolic than meaningful in practical terms.
“At this stage it’s just a US move — we continue to be second-class citizens in the low-cost stakes in Europe! And there are other reasons for Monevator readers to be wary of the wholly positive PR, too. Fidelity says there’s no fund charge, no platform charge, and no minimum balance. It looks like a pure loss leader that tracks in-house indices, albeit very low-cost funds may recoup some expenses on stock lending. Even a penny-pinching passive investor understands that you need to pay for the product. The first thought that should always pop into our heads is, what’s the catch?”
“I’m not sure it is that big a deal. I kind of think it is a bad move on Fidelity’s part. Investors are smart enough to know that Fidelity has to make money somehow. If it’s not on the fees, what is it? They may inadvertently be opening Pandora’s box on all that stuff.”
“I think it means little for the asset management industry, because true asset managers — call them ‘active’ if you like — aren’t competing for the dollars of investors who care whether a fund charges 3 bps or 0 bps. We have to keep in mind how small the absolute decline is here. Going from a few basis points to zero basis points is like a piece of celery going from three calories to zero calories. Big deal.”
Andy Agathangelou, Founding Chair of the Transparency Task Force, UK | @TransparencyTF
“There are several reasons why the kind of innovation recently shown by Fidelity should be welcomed. Firstly, anything that genuinely reduces the cost of investing to the asset owner without any detriment to returns and without any greater risk is a valuable step in the right direction. Secondly, we need far more innovation in the way asset management services are priced and provided; the old ad valorem fee model has been stubbornly persistent despite its many shortcomings, so genuine creativity should be welcomed. Thirdly, Fidelity are showing just how powerful scale can be; which shines a bright light on how economies of scale haven’t been shared with investors in the past by the industry as a whole. Fourthly, Fidelity are revealing the inherent profitability of stock lending; hopefully this will encourage other managers to become more open about how fees derived through stock lending are shared with those parties taking on the associated risks.
“I have two caveats. Let’s hope the ‘small print’ on the terms stacks up to scrutiny. Fidelity have a great brand to protect so I would be surprised if they don’t. We also need to remember that whilst transparency on pricing is very important, so too is transparency on the impact of investing; I’m becoming increasingly concerned by the inadequate concern on how the world’s capital markets are affecting economic stability, political stability and the welfare of our planet and its peoples. We need more good innovation in that space too.”
“I think it has broad ramifications. There will be continued downward pressure on fund managers of both active and index funds. I believe the impact on actively managed funds will be significant. The disparity in expense ratios will exacerbate the underperformance of actively managed funds and accelerate the trend towards passive investing.”
Lesley Curwen, business and financial journalist for the BBC | @Elcurwen
“Whatever this means for competition between asset managers, in my view the most important thing is that headline stories about zero charges will attract the attention of investors who haven’t yet woken up to the importance of charges at all. The big round zero has a lot of pulling power. So in that way all this publicity may help raise awareness in those consumers who have not previously been aware of how charges can erode their savings.”
“When it comes to low-cost financial products, the United States continues to lead the world. Fortunately, British and expatriate firms are catching up quickly. Expatriate Americans can’t invest with Fidelity USA. But their zero-cost index funds will set a ripple effect. Ultimately, not charging fees on index funds will be a loss leader for Fidelity. It’s akin to a supermarket selling bananas (on special) at a price that’s below what the supermarket pays. The supermarket hopes its customers come into the store for bananas, while leaving with so much more. Fidelity hopes the same.
“Some of Fidelity’s actively managed funds will show higher performance ratings (until they don’t). But Fidelity hopes to snare investors who jump into their zero-fee indexes, before switching into their much-hyped actively managed funds. This is how Fidelity hopes to improve their bottom line. At some point, British and expatriate financial companies might offer something similar. Smart investors, however, will stick to the low-cost (or zero-cost) index funds instead of foolishly jumping ship into higher-cost products.”
“In one way, this is quite remarkable. Beta is now officially free. We’ve been heading that way for sometime but who would have thought that Fidelity, whose founder derided indexing for being on American, will be the firm to make this a reality.
“In another way, investing in US equity has been virtually free, when you consider that Vanguard US large cap fund has an OCF of less than five basis points, and with revenue from stock lending factored it, the effective cost to the investor is virtually zero.
“What Fidelity has done here is to make the OCF zero and earn their revenue from stock lending. This has serious implications for the asset management industry. Now that beta is zero, what’s the cost of elusive alpha? I’ll wager it’s way less than 100 basis point that many active funds charge.”
“The race to zero is complete. Firms will probably compete for assets by offering several of their products as loss leaders. Unfortunately, this creates an enormous barrier to entry for new and small asset managers. I expect to see more consolidation amongst asset management firms who will need size and scale to compete.”
“It’s a brave move, and it’s clearly cross subsidised by the active fund management. I don’t personally think that Fidelity has funds under management to make the stock lending work but they know their own business better than mine.
“If the cost of fund management is zero, why do we pay fund managers?”
“On one hand this is just an incrementally cheaper product than some of the index funds and ETFs already in the market. The price of simple beta has in practice been virtually zero for some time. This is more about Fidelity wanting to suck assets into its brokerage platform, and I doubt that any rivals will immediately follow it.
“But this is clearly a symbolically important moment, that both reflects and will ultimately reinforce the intensity of the price war in the investment management space. One of the oldest and biggest asset management companies in the world is saying that the price of an investment portfolio staple — large cap equity beta — should probably be zero.”
“Fidelity’s move is just the beginning. Other fund companies will follow with their own market cap-weighted indexes and related zero-fee funds, sidestepping iconic indexes such as the S&P 500 and Russell 2000. Index providers will pivot to specialised indexes that deliver hedge fund strategies and traditional active styles more cheaply. The number and variety of low-cost index funds will grow, and most traditional active managers will fail to compete.”
“With turnover of $18bn Fidelity can afford to offer a couple of zero fee funds as loss leaders, and they’ll no doubt recoup some of the costs by stock lending. What it means for the asset management industry is that this is no longer simply a case of active versus passive — it’s high cost versus low cost. Investors are cottoning on to this and the flood of outflows from high-cost funds into low-cost funds isn’t going to let up any time soon.”
If you’re a financial adviser, you may be interested in what people are saying about the likely impact of zero-fee funds for the advice profession:
The Evidence-Based Investor is produced by Regis Media, a boutique provider of content and social media management to financial advice firms around the world. For more information, visit our website and YouTube channel, or email Sam Willet or Christina Waider.