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Fidelity Offers iShares ETFs Commission-Free

Platform provider competition keeps making ETF investing less expensive.

Paul Justice, 02/03/2010

Fidelity announced on Tuesday that it will be offering a suite of 25 iShares ETFs commission-free. In our view, the 25 ETFs selected are among the most relevant product offerings from the largest ETF provider and will allow investors to build high-quality, transparent, liquid, and tax-efficient portfolios without the single-largest cost burden they previously faced when comparing ETFs with indexed mutual funds--trading commissions.

Partnering with ETF industry behemoth iShares, which holds a 50% market share of ETF assets, is a well calculated competitive response to the commission-free ETF offering from Charles Schwab announced in November. We are still big fans of Schwab's move, but Fidelity's partnership brings the competition to a new level.

Chuck's offering of eight ETFs, which the firm manages, have collected roughly $550 million in total assets since their recent launches. In contrast, the 25 iShares products have collected over $212 billion in assets, and no single iShares offering on the list has attracted less than $765 million in assets. This gives Fidelity's lineup of iShares funds much greater liquidity, which should lead to greater trade execution and a better investor experience. Additionally, having more assets under management typically leads to lower fees because of the product scalability, so even retail investors should reap the rewards of institutional-level pricing on these funds. Furthermore, the diversity of the product offering provides an abundance of choice and value to ETF investors utilizing the Fidelity trading platform.

We are already big fans of the iShares products that Fidelity will be featuring commission-free: In our ETFInvestor newsletter's Hands Free portfolio, five out the 11 funds we own are on this list. (See the full list below.) Having the ability to purchase these funds commission-free would simply allow us to add to these positions without paying the price of admission. This is particularly relevant to investors who make frequent contributions to their portfolios.

So What's in It for Fidelity?
When Schwab made its own ETFs commission-free, its motivation was more obvious. Since the firm issued the ETFs, it was able to capture the management fee for itself instead of letting the other providers reap the rewards. In Fidelity's case, it may appear that iShares is the true beneficiary. After all, if ETFs are commission-free, sport tax advantages over traditional mutual funds, and offer institutional pricing, what is Fidelity's motivation?

One could speculate that iShares is providing Fidelity with an explicit commission kick-back, but that is not the case. The only relevant compensation between the two is a joint marketing agreement. We view this as a win-win for the two firms, since both are among the largest and most relevant players in their intertwined and complementary industries.

Fidelity most likely selected this lineup of funds because they are extremely relevant to building core portfolios, but they are also not the funds that are most frequently traded by individual investors. These are, for the most part, buy-and-hold funds that asset allocators covet. Fidelity likely wouldn't make a killing on the commissions from these products anyway. Instead, they attract cost-conscious investors to their platform, allow them to park a majority of their assets in these quality offerings, and hope that the same investors generate commissions for Fidelity when trading other products.

In conjunction with the iShares partnership announcement, Fidelity has also set a level ETF trading commission for all investors using an Internet platform at $7.95, which makes Fidelity a competitive low-cost platform for trading any ETF (the rate also applies for most U.S.-listed equities). So if investors choose to use Fidelity's platform for both their "core" and "explore" portfolios using ETFs, it looks like investors will still be getting a great bargain.

Paul Justice is an ETF strategist with Morningstar and a contributor to Morningstar's ETFInvestor newsletter.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), Claymore Securities, First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

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