Thursday, March 14, 2013

Fidelity's Deal With iShares is a Disaster For RIAs

Yesterday Fidelity supposedly upped the ante in the ETF war with Schwab and TD Ameritrade by expanding its commission free iShares lineup to 65 ETFs. Every article I have seen on this so far has lauded the move. For buy and hold retail investors who are looking for a place to build passive ETF portfolios then Fidelity's new offering might make sense, but for RIAs who use ETFs to manage money tactically this deal is a disaster.  What Fidelity has done is on the front end they have appeared to improve their program with the hopes that nobody notices that what they took away actually makes it much weaker.  We see three major problems with the deal:

1. They are taking 10 ETFs off the list as of 4/30. This could generate unnecessary capital gains from replacing those ETFs in client accounts.

2. They are replacing high trading volume ETFs with low trading volume ETFs.

3. They are charging short term redemption fees on ETFs held for less than 60 days.

Removing 10 ETFs

For some reason Fidelity has decided to remove 10 ETFs from its commission free lineup. This could create unnecessary capital gains for investors. For example, we currently own the iShares MSCI Emerging Markets ETF (EEM) in some clients accounts. Because we are tactical managers we could sell this ETF at any time. We bought it commission free with the expectation we would be able to sell it commission free. Now, as of 4/30 client accounts will be charged a commission when/if we sell. If we still own it on 4/29 we might be forced to replace it, and potentially generate capital gains, with the iShares Core MSCI Emerging Markets ETF (IEMG), which replaces it on the list.

Replacing high trading volume ETFs with low trading volume ETFs

Another problem with the 10 ETFs that Fidelity is taking off the list is that many of them are actively traded while many of their replacements are not.  For example, we often trade the iShares Russell 2000 ETF (IWM).  According to an analysis from BlackRock  IWM trades around $3billion/day so orders of pretty much any size should be able to be executed within the bid/ask spread.  Now IWM is being replaced with iShares Core S&P Small Cap (IJR).  This ETF trades an average of $65 million/day so larger orders would probably have to be done a few cents outside of the spread, costing us and clients money. 

Short Term Redemption Fees

Buried in the small print of this deal is that Fidelity will charge short term redemption fees on ETFs held less than 60 days.   Again, not a big deal for the buy and hold retail investor but for tactical managers this is a deal breaker.  We will often be in and out of ETFs within 60 days.  The back end charges could substantially eat into returns, especially for smaller accounts.  I can understand why actively managed mutual funds might want to scare off active investors with redemption fees but I can see no reason why Fidelity should care if RIAs don't hold an ETF for 60 days. 

To us, this looks like a decision made by the retail side of Fidelity with no thought to how it would impact the institutional side.  For buy and hold retail investors this could be an attractive offering.  For RIAs who are tactical or active and have decided to partner with Fidelity then this deal is a slap in the face.

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