In early August, Fidelity announced the launch of two, zero-cost, core equity index funds in the US. It’s been heralded as a pivotal moment in asset management, another nail in the coffin of the Actives whose business depends on beating indices or making uncorrelated wins for their fee-paying clients. Blackrock, Franklin, Invesco and others saw their share prices jolt dramatically. Vanguard, for so long the driver of commoditisation in the passive sector, suddenly looked old hat, with its equivalent ‘total stock market’ index fund charging 14bps.
How does it make commercial sense for Fidelity to offer funds for free? We know that passive, index tracking ‘management’ can be done increasingly cheaply – but are they not just giving these funds away? Not entirely. Apart from the headline-grabbing value of the story, there’s also the sense that a brand that appears to champion the (ever more powerful) end-investor is going to attract inflows cross-sold to other, more revenue-bearing, funds. A loss-leader, in old marketing money. First movers, perhaps, in today’s.
And the commercial short-term downside isn’t too painful, either. According to the FT, Fidelity made a record $5.3bn operating profit on revenues of $18.2bn last year. The overall cost of this move (including cutting the cost of all their passive, index-tracking mutual funds, announced at the same time as the ‘free funds’) is just $47m. And within the new free funds themselves, sufficient scale will mean securities lending can likely generate more than cost-covering revenues anyway.
So, perhaps unsurprisingly, Fidelity can make brand point gains without any real financial pain.
As noted above, other large Asset Managers are looking a little wrong-footed by Fidelity’s move. But it is the passive players (and especially the smaller ones) that look most vulnerable. If Fidelity has called the race to the bottom in index trackers, then it’s going to be hard for other passive peers to justify anything above zero. Arguably, Fidelity’s call will even take ‘actively’ managed ETFs and all manner of passive-related vehicles down with it (albeit unlikely to absolute zero), leaving the dominantly passive houses staring into a revenue void. Compensatory securities lending will soon fuel a buyers’ market and those lacking the scale to do it in sufficient volume will likely be among the first casualties. Roll on the robots.
But ironically, amongst all the perennial flack that flies over performance fees and performance in general compared to the trackers, active houses may actually have been thrown a bit of a lifeline by Fidelity’s move. By calling out the zero-cost (implicitly zero-worth) of index tracking, the US behemoth has put passive practitioners, and perhaps those that add an ‘active’ management gloss to it, under the spotlight. Relatively quickly, the associated worth of any passive-core vehicles will be eroded to the point where only truly pure-play active managers will be able to demonstrate a tangible value for judgement and timing, unconnected with index tracking. Assuming they outperform the ‘worthless’ trackers, of course …
Active brand opportunity
As with an increasing number of markets and sectors, a move like Fidelity’s serves to point up the importance of brand. If products and services are commoditised to zero pricing, so there has to be some other characteristic, functionality or attribute by which to differentiate between them and thereby command both premium and loyalty.
At least in European markets, the correlation between a fund provider’s popularity or brand image and its fund sales is proven*. Larger scale specialist active managers, whose value is built upon human skill, insight, timing and judgement, are ideally placed to imbue their businesses with personality (beliefs, principles and purpose) that can attract and engage ahead of cold statistics. When this sort of brand appeal is established and enjoined, the commoditising forces of price competition can be kept more easily at arms’ length.
*1) Mackay Williams: Fund Buyer Focus 2017, 2) The Lure of the Brand: Evidence from the European Mutual Fund Industry. Hazenberg, Irek, van der Scheer and Stefanova, 2015