Fidelity Investments raised near-$1 billion in the launch of the mutual fund industry's first-ever no-fee index funds in August, and it is now doubling down on that success. On Sept. 18, Fidelity will launch two additional zero-expense ratio index mutual funds that further slice and dice the U.S. stock market, going beyond the no-fee ZERO Total Market Index Fund (FZROX) that came first.
Just as competition for investor assets among other low-cost leaders, including Vanguard, Charles Schwab and BlackRock's iShares, has led to years of fee pressure in funds, don't expect the no-fee index fund lineup to stop expanding.
"As investors focus more on low-cost, index-based strategies, Fidelity is aiming to gain market share on its platform using its own ETFs and mutual funds and in partnering with iShares. We would expect additional investment styles to be launched by Fidelity in the coming months that are also free," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA.
The new funds are the Fidelity ZERO Large Cap Index Fund (FNILX) and Fidelity ZERO Extended Market Index Fund (FZIPX), which provides investors with multiple ways to gain core exposure to the U.S. stock market. The large-cap fund is akin to an S&P 500 index fund, while the extended market fund — a portfolio also offered by Vanguard — is a complement to the S&P 500, focusing on the small- and mid-cap stock universe.
The total stock market approach that was the first no-fee U.S. stock fund from Fidelity — it also launched a no-fee core international fund — has become a popular choice for long-term investors. In June, Vanguard Group made its own total stock market index mutual fund the default choice for its employee 401(k) plan, removing the S&P 500 index fund as a choice. But both index options remain viable for long-term investment asset allocations and the additional no-fee funds give investors more choice over core allocations. Fidelity noted that the market exposure across the three no-fee U.S. stock funds covers over two-thirds of industry index assets.
"There are investors who are more comfortable with large-cap U.S. stocks rather than the broader total market exposure that the earlier fund provides," said Neena Mishra, director of ETF research at Zacks Investment Research, in particular, investors who like to trade more often rather than buy-and-hold for the long-term. "And then there are others who want to increase exposure to mid- and small-cap stocks as they have done better than their large-cap counterparts this year."
Investing experts have questions how Fidelity can make money offering no-fee funds, but many ETFs are already offered at an expense ratio that is close to free. Mishra noted that ETFs from iShares — a key Fidelity brokerage partner — like the iShares Core S&P Total Stock Market ETF (ITOT), and ETFs from Vanguard, including its S&P 500 ETF (VOO), charge just three to four basis points, and "are almost as good as funds with zero fees."
Schwab also offers a series of U.S. stock index funds as low as low as 0.03 percent and 0.04 percent.
Fidelity's move to be the first mutual fund company to offer a no-fee fund came amid this intense competition over investing fees, not only at the level of the portfolio expense ratio, but over trading commission. Fidelity's announcement in August came out shortly before Vanguard Group launched commission-free trading on almost all ETFs. Fidelity raised near-$1 billion in the month after the launch of its first two no-fee funds.
Fidelity launched a range of "zero" incentives for investors in addition to the index funds: zero minimums for account opening, zero investment minimums on Fidelity retail and advisor mutual funds and 529 plans, zero account fees, and zero domestic money movement fees.
These moves should bring in more new business for Fidelity, but shouldn't compel investors already in low-cost funds to move. "Investors who currently own other ultra-cheap ETFs or index funds are fine staying where they are, particularly if there are tax implications in switching. Not only is the cost difference trivial, but also there are chances that your ETF provider would cut fees further," Mishra said. "For Fidelity, having new clients who will likely spend on other products once they join its platform is worth sacrificing some money on these loss leaders."
She said investors need to understand that while expense ratios are important in investment decisions, they become insignificant when the difference is just a few basis points. In fact, tracking error of a fund — the inability to perfectly replicate an index return — could be more than that.
But Mishra said Fidelity is proving that one basic marketing principle is working in the fund industry's first experiment with it: "Who doesn't love free stuff, and that applies to investing as well."