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Fidelity tries luring investors with 2 no-fee funds. So what's the catch?

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"If you examine the recent history, we've had Schwab, Vanguard and Fidelity all make moves to try to gain an edge by removing fees and barriers. It's shaping up as a slugfest, with these firms trading blows." - Jeffrey Ptak, analyst with Morningstar.

INVESTING just became even cheaper - free, actually.

Fidelity introduced two new index mutual funds last week that have no fees whatsoever, taking the democratisation of investing to a whole new level.

Consumers now have access to domestic and international stock markets without any hurdles, including no required minimum investment amount.

The move continues an industry trend towards lower-cost investing, with several giant firms - Fidelity, Schwab and Vanguard among them - all but daring one another to push their already rock-bottom fees even lower.

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But when companies start to dangle free offers, one can't help but ask: What's the catch?

It's simple, analysts said. If Fidelity can lure investors in with a promise of no fees, it is in a position to sell other products and services - a money-market account, say, or financial advice - that offer fatter profit margins. And given its size, the company can afford to sell no-fee funds below cost.

"They're bait," Jeffrey Ptak, an analyst with Morningstar, said of the new funds.

The good news is that the bait - Fidelity Zero Total Market Index Fund and Fidelity Zero International Index Fund - is as advertised: There are no hidden fees, and costs are not simply waived temporarily. (The funds track indexes created by Fidelity.)

"It is not a rebate, it is not temporary, it is not a promotional offer," Kathy Murphy, president of Fidelity's personal investing business, said. "It is permanent."

Beyond the free funds, Fidelity has introduced other changes that make it easier and cheaper to invest. It has eliminated its minimum investment requirements for opening brokerage accounts (previously US$2,500), 529 college savings plans and the vast majority of its indexed mutual funds when bought through Fidelity.

The company has also cut prices on nearly two dozen existing stock and bond index funds, so all investors now have access to its lowest-priced class of fund shares.

For people already invested in these funds, according to Fidelity, that translates to a reduction of roughly 35 per cent, with some funds costing as little as 0.015 per cent of assets, or a penny and a half for every US$100 invested.

Fidelity's latest changes come after another consumer-friendly move: The company significantly expanded the number of commission-free exchange-traded funds available on its platform, to 265 from 95.

(Generally speaking, ETFs are similar to index funds, but trade like stocks on an exchange, meaning investors must pay commissions whenever they buy or sell shares, which also carry underlying investment fees). Vanguard also recently expanded its stable of commission-free ETFs.

Lowering costs and easing access to investing is a universal good for consumers. But analysts and others who work in the industry said they expected Fidelity would try to sell more of its other wares - at least one of them probably in the form of advice.

That is, the company may try to get investors to pay a separate fee to manage their money or perhaps try to entice them aboard its digital-investing platform, Fidelity Go, which charges 0.35 per cent of assets total, including investment costs.

None of that is necessarily bad if the advice is needed, the financial adviser is truly acting in the investor's best interest (not, for example, motivated by a push to meet sales goals) and any fees are reasonable. But as some costs come down, the possibility of a sales pitch in other areas is something to watch for.

Investors have flocked to lower-cost index funds, which generally focus on a selection of investments that track the stock or bond markets (or segments of them).

Over time, index funds tend to outperform actively managed mutual funds that hold investments hand-picked by humans, in part because the active funds often cost significantly more.

The average index fund costs 0.52 per cent of assets, compared with .87 per cent of assets for actively managed mutual funds, according to a Morningstar analysis, which excluded funds that carry sales charges in addition to the underlying cost of the investment.

Fidelity introduced its latest price cuts as it grapples with broader challenges to its mutual fund business. Investors have been fleeing its actively managed funds in favour of cheaper index funds.

The company crows on its website that its index funds are now cheaper than Vanguard's - "There's no match for Fidelity in index investing - not even Vanguard."

Vanguard, the indexing pioneer, has long been heralded as the lowest-cost provider, and Morningstar says, overall, it still holds the crown when comparing its universe of actively managed and index funds with Fidelity's total collection of funds.

But Fidelity's index funds are now a few pennies cheaper than Vanguard's when looking at only passive investments, according to a Morningstar analysis: Investors are paying 0.04 per cent of assets on average at Fidelity versus 0.07 at Vanguard.

Whether others will try to match Fidelity's no-fee funds is unclear.

The company's move not only puts pressure on other index-fund providers, analysts said, but also has implications for actively managed funds, which may need to do even more to justify their much higher fees.

"This is now a game of inches, with firms trying to gain supremacy one basis point at a time," Mr Ptak of Morningstar said.

The difference can be counted in pennies.

Fidelity's free domestic fund, for example, competes with Schwab's Total Stock Market Index fund, which charges just 0.03 per cent of assets, or 3 cents for every US$100 invested; Vanguard's Total Stock Market Fund, which, depending on the amount invested, ranges from 0.02 per cent of assets, or 2 cents per US$100, to 0.14 per cent of assets.

"If you examine the recent history, we've had Schwab, Vanguard and Fidelity all make moves to try to gain an edge by removing fees and barriers," Mr Ptak added.

"We're now at a point of diminishing returns, so these firms will have to find other ways to differentiate, but it's shaping up as a slugfest, with these firms trading blows."

For now, consumers appear to be winning that fight. NYTIMES