Fidelity Investments is best known for its mutual funds, but the company is no stranger to exchange-traded funds.

The Boston-based asset manager rolled out its first ETF in 2003 with the Fidelity Nasdaq Composite Index Tracking Fund (ONEQ). This passive fund has racked up $1.9 billion in assets, but it seemed almost like a trial balloon because the company waited 10 years to introduce its next ETFs—specifically, a suite of 10 passive equity funds that track MSCI indexes tied the major GICS (Global Industry Classification Standard) industry sectors.

That was followed in 2014 by three actively managed fixed-income ETFs, along with other launches in subsequent years. Today, Fidelity is the 15th-largest ETF provider in the U.S. with roughly $12.6 billion in assets scattered across 25 funds.

The company’s push into ETFs is part of its strategy to become a multi-faceted financial services operation. It’s also an effort to try to counter the trend of cheap, passively managed index-based ETFs stealing market share from higher-cost actively managed mutual funds, of which Fidelity is more or less a poster child. But Fidelity’s ETF strategy isn’t about rolling out cheap beta products.

While its suite of GICS-related funds—since rejiggered and expanded to 11 products to reflect changes made to the GICS system—are passive and inexpensive (all have expense ratios of 0.08 pecent), the rest of Fidelity’s ETFs—with the exception of ONEQ—are either actively managed (on the fixed-income side) or factor-based products tracking in-house indexes developed by Fidelity’s research team.

“Fidelity wasn’t ever going to be a pure beta player like Vanguard, Street Street and iShares. It’s not who we are,” says Greg Friedman, Fidelity’s head of ETF management and strategy. “What makes us unique is our active and our fundamental research. We've entered the space in what I think is the right time, which is chapter two of the ETF playbook.”

Chapter one was based on passive, market cap-weighted ETFs, Friedman notes, adding that chapter two centers on what he calls “solutions.”

“Clients are saying, ‘I’ve got a lot of good market-cap exposure, now how do I get specialized? How do I get a solution outcome?’” he explains.

As such, Friedman says, Fidelity’s ETF strategy is based on trying to become an industry leader around active management and smart beta, or factor investing.

In September 2016, it debuted a group of factor-based equity ETFs that each track a Fidelity-built index and come with a competitively priced expense ratio of 0.29 percent. Five of these funds target a single factor from among dividends, low volatility, momentum, quality and value.

The sixth product in this group, the Fidelity Divided ETF For Rising Rates (FDRR), targets the dividend yield factor with the idea being that higher-yielding companies tend to outperform lower-yielding companies over time. FDRR is weighted based on a composite score that considers dividend yield, dividend growth, dividend consistency and correlations to 10-year treasury yields.

FDRR is the largest fund from the Class of 2016, with assets of $367 million.

The Factors Maze

A number of ETF providers have jumped on the factor bandwagon in recent years, but many financial advisors—and retail investors at large—still aren’t sure how to employ them in investment portfolios.

“I think there's a lot of education that still needs to be done because people know ‘enough’—they understand low-vol and they understand dividends and they understand some of it,” Friedman says. “But if you really want a complete low-vol strategy there's more to it than just low-vol. So you might want some quality. There's a lot of education needed on how to use these tools. These are pretty sophisticated tools, and now us and other providers are bringing the institutional quality of investing theory into the hands of all investors, which is what we should be doing.”

Sounds great, but as investors learn about factors and come to realize that some factors work better in certain market environments than others, some observers wonder if this will encourage people to jump in and out of factor-based funds as conditions change—in other words, market timing.

Friedman doesn’t see it that way, and equates factor-based investing with sector-based allocations.

"Just like with sector rotation, you’re not going to choose just one factor,” he says. "For example, you’ll choose multiple sectors based upon where you think we are in the business cycle. No one should ever use just one [factor-based] product. These are tools that people can have either in a very simple allocation or a complex allocation. You have to think about what your objective is, talk to your advisor, talk to your financial planner and really create a sound investment strategy using these products.”

Active ETFs

In August, Fidelity filed its third amended application with the Securities and Exchange Commission for actively managed ETFs that wouldn’t disclose their holdings on a daily basis. Instead, these so-called non-transparent products would disclose their holdings on a monthly basis with a 30-day lag.

As described in the filing, each fund would have a tracking basket comprised of its recently disclosed portfolio holdings and representative ETFs. These baskets are designed to closely track the performance of a fund, and Fidelity anticipates the deviation in the returns between a fund and its tracking basket will be “sufficiently small” so that the tracking basket “will provide arbitrageurs with a reliable hedging vehicle that they can use to effectuate low-risk arbitrage trades in shares.”

In simpler terms, Fidelity posits this system will facilitate the arbitrage process needed for the funds to trade at market prices close to their net asset value. 

“I don't have a date for when they're going to be approved,” Friedman says. “But we are excited about that progress” regarding talks with regulators.

It’s likely these active ETFs, if and when they get approved, would mirror existing strategies in Fidelity’s active mutual funds. That raises the question of whether these products would cannibalize comparable strategies in the mutual funds.

“We've got a good case study in that we have 11 passive sector ETFs which compliment our sector strategy where we have over $80 billion in the sector mutual funds,” Friedman says. “Both mutual funds and ETFs have grown over the last five years. We haven't seen cannibalization.”

Ultimately, he notes, Fidelity sees its ETF strategy as part of its “wrapper agnostic” model.

“ETFs fit really well in some places, but there are also places where mutual funds work better, so we're not either/or ETFs or mutual funds—the answer is both,” Friedman says.