ETFs & Mutual Funds Growing Together

Fidelity is well-known for its active mutual funds, but in the past 2 1/2 years, the firm has found significant success in the ETF space. Its lineup of sector funds launched in 2013 has amassed some $2.5 billion in assets, and its ETF platform boasts about $200 billion in assets under administration.

Anthony Rochte, president of Fidelity’s sector-investing unit known as SelectCo, tells us how things are going, and who’s driving that demand.

ETF.com: Fidelity came into the ETF space in a really meaningful way about 2 1/2 years ago with a lineup of sector funds. There’s about $2.5 billion in assets today. Who’s driving that demand?

Tony Rochte: Let me give you a bit of background on how we arrived at this launch. In 2012, we formed a new division within Fidelity's asset management business, SelectCo, and that division was primarily focused on sector-based investing.

The initial focus of that initiative was our active sector mutual fund business. We've been investing specifically in sector-based investments for over 30 years. Today we have 44 actively managed sector and industry mutual funds. And at the end of 2015, just over $82 billion in assets.

Why that's interesting is that this has been a significant focus for us over the past four year. When we started this initiative, our assets in our active sector mutual funds were about $45 billion. So, we've seen significant growth in our active sector mutual fund lineup.

I give this background because the ETF effort around sectors was launched within SelectCo. What we realized is that there are certainly investors who still want active management, and they want active sector mutual funds.

But there's a subset of investors—both individual investors and financial advisors—who want to be more tactical with the way they use these sector exposures. And for that reason, we launched the now-11 sector Fidelity ETFs.

The asset growth in the ETF business has come in parallel to growing our active sector mutual fund lineup. For us, this has been a story about investors, retail and advisors looking at sector-based investing more and more, and we've seen growth in both categories.

ETF.com: There have been a lot of mutual fund shops coming into the ETF space, and some say it’s more about survival, as mutual funds continue to lose assets to ETFs. What you’re saying is that, in Fidelity’s case, ETFs weren’t about survival, because both sides are growing?

Rochte: Yes. Our single focus is on providing a great investor experience for all types of investors, whether it's financial advisor, institutional investors or the self-directed retail investor.

Several years ago, we thought investors used mutual funds and ETFs very differently. But in many cases—particularly in the financial advisor market—it's not uncommon to see them using active mutual fund exposure alongside passive ETF exposure. Perhaps there's a tilt or an overlay to a well-diversified asset allocation strategy.

ETF.com: Sector investing isn’t new. Why has demand for this type of investing grown in recent years?

Rochte: I think it's actually been growing the last 10 years. Sector-based equity investments in mutual fund and ETF format have actually grown faster than broad-based equity diversified mutual funds and ETFs.

Part of it has to do with the precise exposure they allow for in a well-diversified portfolio. We hear a lot from financial advisors a core-and-explore type of mindset. They certainly have a core lineup of exposures, many times through actively managed mutual funds, or even ETFs, but then the satellites may be a precise exposure to a sector or some type of factor they're interested in.

In the past 10 years, we’ve seen different market periods. In some markets, energy has led. In some markets, commodities have led. The point is that investors now have the ability to leverage unique exposures, and sectors are a complement to the core part of the portfolio.

ETF.com: Fidelity is known for active management. It seems investors are using your ETFs in a very tactical way. Are you attracting passive investors?

Rochte: If you look at the ETF platform at Fidelity, it's well over $200 billion in assets under administration. That's not just Fidelity ETFs; that's all other competitor ETFs on our platform. When we look at behavior, it's tough to split apart. There are self-directed investors who use ETFs for buy-and-hold and tactical. And we see the financial advisor market the same way.

We do tend to see more tactical activity in the registered investment advisor market of the financial advisor space. But it certainly varies. We see both tactical and strategic exposures using these.

ETF.com: Where do you see opportunities in the ETF space going forward? On that note, what concerns you the most—regulation? What's on your radar?
Rochte: I don't know if there's anything different today versus three or four years ago when we launched this initiative. I think the most important thing is focusing on our key customer base. In the advisor market, one trend that’s been occurring for several years now is the transition from a commission-based environment to a fee-based or fee-only environment. That trend is accelerating the acceptance and interest in all exchange-traded funds.

The retail investor is interesting. If you go back to '93 when the first ETF came out, and look at the first 10 or 15 years, it was really an institutional and financial advisor-driven market. We have seen individual investors express interest in owning more ETFs over the last five years. And that's a trend that will continue. But it’s not uncommon to see investors own ETFs alongside actively managed mutual funds.

ETF.com: Since the first Fidelity ETF launched, has anything surprised you in either acceptance of Fidelity’s ETF effort, usage or trends?

Rochte: We feel good about the strategy. But you have to remember that we tend not to look at the wrapper—whether it’s a mutual fund or an ETF. We're focused on meeting those customer needs.

It's very encouraging to see that many different types of constituents are using ETFs and mutual funds, and in many cases, they’re using them for very different reasons. What I take from that is that all these investors can peacefully coexist in an exchange-traded fund format. Whether you're tactical or buy-and-hold, your activity's not going to disrupt any other shareholder.

Investors now have more choice today than they did 10 or 15 years ago in terms of the types of exposures. The financial advisor has become more focused on asset allocation. And with this trend, ETFs and/or sector mutual funds fit quite nicely.

But what we also sometimes forget—and it’s obvious—is that sector investing is often a simpler way to identify companies that give you that sector exposure. Rather than buy one individual technology name or one individual energy name, the sector fund—be it an ETF or mutual fund—allows you more diversified exposure. That diversification has been an important component of these strategies, particularly since 2008/09.

Contact Cinthia Murphy at [email protected].