Fidelity's new service charge poses 'existential' threat to some ETFs

By Christine Idzelis

Managers may 'eat the cost' of a new service fee faced by investors when buying some ETFs on Fidelity's platform, says Jason Hsu, founder of Rayliant

Some asset managers may decide it's worthwhile to hand over some of the revenue that their exchange-traded funds collect via Fidelity Investments' brokerage platform to pay for its support agreement - if they haven't decided to do so already.

Otherwise, some managers may wind up passing on a new fee on to investors - a $100 servicing charge when placing buy orders for a group of ETFs on Fidelity's surcharge-eligible list. That's a hefty disincentive for investors, worries Jason Hsu, founder of Rayliant. His firm, which provides actively-managed ETFs, is on that list, which may be updated periodically.

In some ways, it's an "existential" threat, Hsu said in a phone interview. "If no one buys your ETF, you just die."

The new service fee, expected to take effect in early June, will apply to a relatively small group of ETFs issued by firms that don't participate in a so-called maintenance arrangement with Fidelity. But ETF managers on the firm's surcharge-eligible list could spare investors the $100 servicing charge, as they could "eat the cost" by paying up for Fidelity's "maintenance," or platform, fee under a support agreement, says Hsu.

And to his thinking, that's the "sensible path," as a $100 service fee would represent an "enormous obstacle" for investors considering buying ETFs subject to that charge. Although a maintenance fee would eat into the revenue managers may get from having their funds on Fidelity brokerage platform, Rayliant expects to pay it as a kind of toll, said Hsu.

Rayliant has launched three ETFs in the last few years, and investors can buy them via Fidelity.

Shares of the Rayliant Quantitative Developed Market Equity ETF RAYD have gained 12% this year through Tuesday, according to FactSet data. That compares with the S&P 500 index's SPX 9.1% gain over the same period.

The actively managed Rayliant Quantitative Developed Market Equity ETF has benefited in particular from its exposure to stocks in the U.S. and Japan, said Hsu. The fund has a net expense ratio of 0.8%, according to Rayliant's website.

Shares of the Rayliant Quantamental China Equity ETF RAYC have gained 7.9% this through Tuesday, while the Rayliant Quantamental Emerging Market ex-China Equity ETF RAYE is up 6.2% in 2024 over the same stretch, FactSet data show. RAYC has a net expense ratio of 0.8%, while RAYE's is slightly higher at 0.88%, according to data on Rayliant's website.

The Rayliant Quantitative Developed Market Equity ETF and Rayliant Quantamental Emerging Market Ex-China Equity ETF, which each have around $46 million of assets under management, began trading in December 2021, FactSet data show. The Rayliant Quantamental China Equity ETF, which has $37 million of assets, listed a year earlier.

Hsu said he expects other brokerage firms will be watching to see how successful Fidelity may be in getting ETF managers on its surcharge-eligible list to pay up to use its platform under an agreement where investors don't end up having to pay a service fee when buying their funds.

Fidelity uses such support fees paid by fund managers to cover costs such as servicing operations and technology enhancements, according to a person familiar with the matter.

Such support agreements aren't new to the asset management industry, with many in place for almost a decade on the ETF side - and decades before that for mutual funds, the person said.

Managers that decline to participate in Fidelity's support agreement will pass the fee on to the end investor. This impacts less than 0.5% of ETFs and mutual funds on Fidelity's platform, according to the person.

-Christine Idzelis

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04-03-24 1344ET

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