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What Fidelity's ETF Move Means for Investors

Jeremy Glaser

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. Fidelity shook up the ETF world today by announcing 25 commission-free iShares ETFs that will be available on their platform. Here to see the impact that this will have on investors is associate director of ETF Research, Paul Justice and Editor of the Fidelity Fund Family Newsletter, Christopher Davis. Thanks for joining me gentlemen.

Christopher Davis: Thanks.

Glaser: Paul, were you surprised to see Fidelity offer these funds for no trading fee.

Paul Justice: No, I wasn't really surprised. We had speculated back in November when Charles Schwab announced that it would be doing commission-free ETFs on its own platform that some of the other providers would have to come out and offer the same. Fidelity did that.

We speculated maybe they would issue their own funds or potentially partner with someone. So picking iShares is actually, I think, a great venture for them. iShares already controls about 50% of the assets under management in the ETF industry in the United States, so they're clearly getting a premier provider, and now you are simply eliminating a $7.95 fee to purchase these 25 core ETFs.

I view these as more like asset allocation ETFs, not the rapidly trading ETFs, so it will attract investors who want to build that core base of a portfolio at low expenses and with some tax advantages that ETFs offer.

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Glaser: So what do you think about the 25 funds that they've selected?

Justice: I think they're a great suite of funds. We own several of those in our hands-free portfolio in the ETFInvestor newsletter. They offer a very low cost way to really diversify your portfolio across the entire equity in the fixed-income spectrum.

So you're picking up most of the style indexes, the S&P base style indexes, also the S&P 500 with their domestic equity funds. You got a suite of about five international equity funds and fixed-income funds. So really it covers the whole portfolio.

Glaser: Christopher, for current Fidelity investors, do you think it would make sense for someone who's invested in a Fidelity index fund to move their assets over to one of the iShares products now?

Davis: No, I think for most folks it wouldn't make sense, especially if you're investing in a taxable account because if you're going to make the switch, yes the ETF is going to be cheaper, but you might have to pay a capital gains taxes if you've actually made money on your investments and so that would swamp the minuscule expense benefit.

But if you're a Fidelity investor and you're thinking about buying a core index fund, it might be a better idea to go with the ETF, especially since there's no commission, and as Paul mentioned, all of the great tax advantages, especially if you're investing for a taxable account, the iShares offerings might make some more sense.

Glaser: Why do you think Fidelity decided to add these particular 25 funds, were they trying to fill a hole that they don't get through active management?

Davis: Not really. I mean Fidelity has over 300 funds. So I think there aren't very many holes left to fill, quite frankly. But I think for Fidelity investors, it could fill some holes on their portfolio. I think on the value investing side of the ledger, Fidelity is less strong. And so if you went to buy one of the iShares value offerings, which are pretty solid and low cost, that really is pretty appealing.

Glaser: One of the things that wasn't included in the 25 were lot of sector funds, why do you think that those were excluded from the list as of now?

Davis: Well, there's been some speculation that Fidelity is going to be going the ETF route and taking some of its active sector funds and making them ETFs, but also the funds they have are very distinctive. They're actively managed. Many have really strong performance. I think they feel that they can stand up to ETFs and that there's really a good value proposition in choosing the active management in that case.

Glaser: So Paul, do you think there's still a chance that Fidelity will come out with their own line of exchange traded funds down the road or do you see this as their solution to not having a ton of ETF assets on their platform?

Justice: Sure. I can see that. I'd say active ETFs are still in their infancy across the entire industry. So it may be sometime before we see that offering, besides the active funds are already available to all the Fidelity investors.

So I would say that if I were going to see this expand anymore, it would probably be in further partnership with iShares or someone else, but I would say that they would still focus on some of these core portfolio holdings, some of the style-based indexes rather than bringing in more of the kind of sector funds or more of the thematic ETFs, because those are the ones that people trade more rapidly, and Fidelity would kind of be hurting its own bottom-line to offer those for free.

Glaser: With Schwab and Fidelity now offering the free ETFs or no-commission ETFs, do you expect the other platforms TD Ameritrade, E*Trade to have to fall in line?

Justice: Well, I think the competitive response is going to develop. You can't stand pat in this industry. Everybody will realize that if you can find lower cost options elsewhere, assets will migrate. So I think it's a win-win for investors when this news comes out.

Glaser: Great. Thanks for talking to me today, gentlemen.

Justice: Thanks, Jeremy.

Glaser: For Morningstar.com, I'm Jeremy Glaser.