by David Fabian | November 7, 2013 10:54 am
ETFs’ success in their relatively short existence has largely been attributed to their transparency, daily liquidity and innovative index strategies … but perhaps above all else, their low fees. ETFs have been gaining an edge[1] on traditional stodgy mutual funds, which is why companies such as Vanguard, State Street (STT[2]) and BlackRock (BLK[3]) have been quick to carve out a niche with these innovative products. However, Fidelity Investments has long lagged behind.
As one of the largest mutual fund providers in the world, Fidelity has always touted its strength as an active fund manager which just didn’t fit into the typical mold of a passively managed ETF.
Those days are over.
Fidelity recently launched a suite of 10 sector ETFs that are touted as having the lowest expense ratios of any sector funds in the industry at just 0.12%. (The full list of Fidelity ETFs can be viewed here[4].)
In addition, they are available to be traded commission-free for any participants that currently use the Fidelity brokerage platform. According to recent data[5], Fidelity has more than 18.6 million brokerage accounts that can now access these funds. That’s a very large pool of resources.
The funds are based on passive MSCI indices and sub-advised by BlackRock, who they have partnered with in the past. At first look, the indices appear to be as vanilla as they come. They employ a market-cap weighting methodology that gives the largest allocations to the stocks with the biggest market valuations. They also cover each major S&P 500 sector, from healthcare to financials and everything in between.
The majority of the Fidelity ETFs are well diversified, with eight of the 10 funds containing more than 100 underlying holdings. The exceptions are the Fidelity MSCI Telecommunications Services Index ETF (FCOM[6]) and Fidelity MSCI Utilities Index ETF (FUTY[7]), which have more concentrated positions in fewer stocks.
One impressive measure of initial response to these ETFs is the amount of trading volume that they have accumulated in just two short weeks. Several of these new Fidelity ETFs that I have screened are trading between 25,000 and 100,000 shares per day. That likely shows the strength of the low-cost offering combined with the built-in demand on their broad platform.
Fidelity made a real statement by undercutting the expense ratio of every other sector ETF in the industry. Typically these fee wars have been dominated by the likes of Vanguard and Charles Schwab (SCHW[8]) trying to outdo each other by offering the lowest-cost products. For comparison purposes, the Vanguard Energy ETF (VDE[9]) charges an expense ratio of 0.14%.
Clearly there is room for more competition, and many industry experts believe there is an opportunity for expense ratios to fall even further.
The benefit of investing in sector ETFs is that it gives your portfolio concentrated exposure in an area of the market that you feel will outperform over time. As a portfolio manager, I like to use these types of funds to strategically position my asset allocation to add alpha over a core holding[10] such as the Vanguard Total Stock Market ETF (VTI[11]).
Growth investors looking for exposure to areas that are continuing to lead the market higher might want to consider an allocation to either the Fidelity MSCI Consumer Discretionary Index ETF (FDIS[12]) or Fidelity MSCI Information Technology Index ETF (FTEC[13]). Both of these high-octane segments are benefiting from the strength of positive earnings momentum and strong cyclical demand[14]. If the market continues to churn to new highs, these sectors will likely outperform in the fourth quarter.
More conservative investors might be attracted to the pace of the Fidelity MSCI Consumer Staples Index ETF (FSTA[15]), which focuses on companies that are engaged in manufacturing or delivering essential everyday products. This sector benefits from inelastic consumer demand and historically tends to be a more defensive area of the market if we hit a rough patch.
It will be exciting to watch future Fidelity ETF launches, as well as to see how the firm continues to integrate these products on its platform. One potential area of future growth would be to offer Fidelity ETFs in 401k plans. This is one spot ETFs have yet to make significant inroads into — and coincidentally, a very big part of Fidelity’s retirement business. They certainly would have the muscle to make ETFs more accepted in employer-sponsored plans and continue to lower retirement savings costs.
No matter what sector you ultimately choose, remember to thoroughly research fees, underlying holdings, index structure, and trading commissions to determine the most suitable holding for your portfolio.
A little bit of legwork ahead of time can significantly improve your fortunes.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. To get more investor insights from FMD Capital, visit their blog.[16]
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