For investment managers, there are two classic approaches. First, there are active managers who argue, “I’m willing to risk underperformance because I think I can beat the market.” Second, there are passive managers who argue, “I can’t beat the market, but I can match its performance perfectly.” Let’s ignore active managers for a moment and just consider the passive managers. Since none of them, at their core, are trying to create additional value, the primary lever they can use to earn business is to lower their fees. So, there’s been an ongoing challenge between large passive products and index funds: who can do it cheapest.
There are some complications around this issue – securities lending to create alpha, tracking cheaper indices to further reduce costs, and so on – but the ongoing fight has been marked by tit-for-tat competitive price reductions between the major players. For instance, if investment manager has an S&P 500 index fund which costs 0.06%, then you can count on a competitor creating an index fund which costs 0.055% - just a little bit less.
Vanguard is the venerable standby, familiar to most investors as one of the first and largest provider of index funds. Not to be outdone, Fidelity has aggressively courted passive investors for the past decade, rolling out passive products which are priced marginally cheaper index funds. Other competitors, like State Street, have found a competitive niche with costless trading for index-based ETFs on several trading platforms.
Fidelity has noted the wave of new investment going towards passive products over the past few decades, which threatens their actively managed products and their dominance as recordkeeping platform and asset custodian. In response to this competitive pressure, Fidelity has thrown down the gauntlet. They’ve declared they will not be undersold. To prove their point, Fidelity just rolled out a series of no-fee – costless – index mutual funds. Also, Fidelity recently cut the prices on existing index mutual funds and allowed retail investors to jump in and open accounts with no minimum balance required. This move is explicitly targeted to attract new customers and retain current assets. It seems to be working thus far, with a cool billion dollars of new investment in the new cost-free funds. We will be doing a clearer analysis on this series and competing products in the weeks to come.