Fidelity announced its less-than-groundbreaking entry into the booming world of smart beta in April with the launch of a large-cap, value ETF. Now the mutual fund giant is back in the news with another me-too move: It recently cut prices on 27 passive index funds in order to beat or match the already low, low fees that its largest competitor, Vanguard, charges for similar funds.Jim Lowell, editor of the Fidelity Investor newsletter and website, called the move “hugely significant” -- but perhaps that’s a slight exaggeration. The Fidelity Small Cap Index Fund, for example, cut fees from 0.23 percent to 0.19 percent, and the Fidelity 500 Index Fund cut fees -- wait for it -- from 0.095 percent to 0.09 percent.
Still, it’s easy to see why Fidelity felt like it had to do something. Investors are increasingly demanding lower fees, which is somewhat problematic for a fund family like Fidelity that is widely associated with expensive, actively-managed funds. According to Fidelity, investors yanked close to $19 billion (net) last year from its actively-managed stock funds. At the same time, investors poured a record-breaking $236 billion into Vanguard, a bastion of low-cost, passively-managed funds.
Fidelity no doubt wants to get on the right side of fund flows, but let’s get real -- some modest fee cuts to Fidelity’s index funds aren’t likely to transform Fidelity into a go-to passive manager. Fidelity can, however, do something truly significant: It can slash prices on its actively-managed funds.
Investors have every reason to wash their hands of actively-managed funds. Every six months the SPIVA U.S. Scorecard adds another brick to the now towering wall of evidence that the vast majority of active managers fail to keep up with their passive benchmarks. According to the latest year-end 2015 SPIVA scorecard, 83 percent of U.S. stock managers and 80 percent of international stock managers failed to keep up with their benchmarks over the prior ten years. The numbers are similarly discouraging for active bond managers.
The one wrinkle in the SPIVA scorecard is that active managers’ returns are net of their hefty fees, whereas the benchmark returns don't account for the impact of fees. It’s not clear, in other words, how active managers would fare in an apples-to-apples fee comparison with passive managers.
What Should Worry Fidelity? Much More Than Vanguard
Fidelity, for one, would compare much more favorably. I looked at the ten-year returns of 111 actively-managed Fidelity funds that fall into one of the SPIVA fund categories. Only 26 percent of those Fidelity funds beat their benchmarks net of fees, which is roughly in line with SPIVA’s results. Also, the funds lost to their benchmarks on average by a margin of negative 0.8 percent annually.
It’s a totally different result, however, without the fee drag. 55 percent of those same funds beat their benchmarks gross of fees, and this time the funds beat their benchmarks on average by a margin of 0.4 percent annually.
So all Fidelity has to do to compare more favorably with passive competitors is to cut its fees on actively-managed funds.
Many investors seem to agree that the problem with actively-managed funds is the fees, not the underlying strategies, because they aren’t abandoning active management altogether. Instead, investors are moving to a cheaper form of active management known as smart beta.