Fidelity's 2-Pronged ETF Strategy

Firm inhabits the ETF space as both a platform provider and an issuer.

Reviewed by: ETF Report Staff
Edited by: ETF Report Staff

[This article appears in our May issue of ETF Report.]



Greg Friedman, head of ETF management and strategy for Fidelity, says the 73-year-old company has a two-pronged strategy when it comes to ETFs: attracting investors to the platform and launching new products.

Because of that, Friedman says he wears two hats when talking about ETFs, delivering what customers want in terms of platform tools, number of ETFs available and other trading needs, plus launching Fidelity-branded ETFs and keeping up with client demands for product innovation.

“The ETF story for Fidelity … is about the client experience as well as a quality product,” he said.

Friedman says Fidelity has about $380 billion in ETF assets on its platform, which he says represents 11% of all U.S. ETFs traded. Fidelity has a strong partnership with BlackRock, and offers iShares ETFs commission-free. The company will also be expanding its commission-free trading list soon, but Friedman declined to say who its new partners will be.

Cheapest Not The Goal
In an atmosphere where there’s a race to who can be the cheapest, whether as an ETF issuer or as a platform, offering a host of commission-free ETFs is one way the firm is competing with the Vanguards and Charles Schwabs of the world, although Friedman says Fidelity’s aim is not to be the cheapest.

But being cheap helps—on the product side, Fidelity just launched its ZERO Total Market Index Fund, a mutual fund, which has $2.5 billion in assets after a February launch.

“Our goal is not to be the cheapest,” Friedman explained. “We want to bring choice, value, innovation; that’s our mission and our value. We want to bring out innovative products that are fairly priced, that perform well and that do right by our customers. That’s how we measure ourselves.”

The idea behind offering commission-free ETFs is to lure users to the platform, as they’re more likely to stay once they’ve opened an account. It’s why Friedman can be brand-agnostic when it comes to getting clients on the platform.

“If they’re on our platform and the customer may want to trade a competitor’s ETFs and happen to have good experience and we’re providing good quality, that’s just as important to me as them buying a Fidelity ETF,” he noted.

Launch Plans
Fidelity is busy launching ETFs. It has a total of 28 U.S. ETFs with total assets under management (AUM) of $13 billion. The ETF with the largest AUM is the Fidelity MSCI Information Technology Index ETF (FTEC), with $2.2 billion.

It has a mix of passive sector and smart-beta equity ETFs, as well as four actively managed fixed-income ETFs. But its focus is on smart beta and active, Friedman says, having rolled out three such funds in February: the Fidelity Small-Mid Factor ETF (FSMD), the Fidelity Targeted International Factor ETF (FDEV) and the Fidelity Targeted Emerging Markets Factor ETF (FDEM). There are also plans to launch active equity ETFs, in addition to the active fixed-income funds.

The push behind the smart-beta and active ETFs is to compete in what Friedman calls “chapter two and chapter three” of the ETF story.

This is Fidelity’s third foray into the ETF universe, having launched the Fidelity NASDAQ Composite Tracking Stock (ONEQ) in 2003, and then 11 passive sector funds in 2013 (see Figure 1).



Why return now? “I think Fidelity’s place in the ETF industry is obviously much stronger,” Friedman said. “People see us as a leader. They like our insight. They like our brand heritage, they like how we’ve always done the right thing for the client.”

He adds that the move to launch smart-beta and active products makes sense for Fidelity (see Figures 2 and 3): “Our heritage is active; it’s the quantitative research we’ve been doing since 1965 that feeds into our mutual funds.”



Quant Approach
That same research gets codified into an index that Fidelity uses for smart beta. Bobby Barnes, quantitative analyst at Fidelity who works on the firm’s factor ETF products, says Fidelity’s general approach to passive is to minimize what he calls the “unintended risks” when creating factor products, which he says separates Fidelity from the crowded field of smart-beta offerings.

Barnes says stocks that score high on certain factors can be concentrated in a particular sector versus the broader market. Additionally, size can have a bigger impact than expected. “Factor products have a much smaller weighted average market cap than, say the S&P 500,” he said, meaning that ETF holders may be inadvertently making a midcap or small-cap bet in addition to the factor they’ve selected.

Finally, Barnes says the team considers security-specific risks, making sure they equally weight across attractive names. In factor ETFs, the index shouldn’t have a very large weight in a particular stock. “Once you’re in the top 10% or 20% of attractiveness on each factor, each of those stocks has similar odds of outperforming. You’re better served if you spread out that weight equally,” he said.

Another way Fidelity separates its smart-beta offerings from other issuers is its proprietary models it uses for value, quality and momentum. “We’re very transparent on what goes into them, such as what we use to define momentum,” Barnes noted. “We put it on our website. These factors we use come from our internal models we’ve used for decades to make investment decisions. We just offer these same insights into passive products.”

Clients Looking For More
Friedman says he believes clients are looking for excess return now, which smart-beta and active ETFs can offer. Another trend Fidelity can ride is client interest in models. “ETFs are phenomenal building blocks for models,” he said, noting investors are less interest in buying single stocks.

“People aren’t saying ‘I need to buy a particular ticker.’” Friedman added. “They’re saying, ‘How do I get yield? How do I get lower volatility?’”

Flows are strong this year, he says, noting the first six U.S. equity factor ETFs have more than $1 billion in total, and flows are going into both the smart-beta/active ETFs and the passive sector funds. Their fixed-income active ETFs are also seeing more flows lately, with Friedman noting the Fidelity Total Bond ETF (FBND) has AUM above $540 million.

Although Fidelity uses the same in-house research for ETFs it uses for mutual funds, he’s not worried one vehicle may become more popular than the other.

“Each client is different; clients don’t want the same product,” Friedman said. “It’s never a mutual fund versus an ETF story. It’s never an ‘are we worried about cannibalization?’ story. Our story’s always been what vehicles our clients want, what solutions we can provide them and making sure we bring them choice, value and innovation as we do that.”