Products August 3, 2018

Reading Into Fidelity’s ‘Zero Expense Ratio’ Retail Mutual Funds

Fidelity this week introduced what it is calling “self-indexed, zero expense ratio mutual funds” on the retail side of its business; the move may not directly touch retirement plans, but it speaks clearly to broader asset management industry trends.

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Fidelity this week announced a sweeping initiative to reduce fees for retail investing customers, including the launch of a series of “Fidelity ZERO Index Funds,” which are billed by the firm as “self-indexed, zero expense ratio mutual funds.”

Coinciding with the launch of these funds, Fidelity says it is implementing “across-the-board zero minimums to open accounts, zero account fees, zero domestic money movement fees, and zero investment minimums on Fidelity retail and adviser mutual funds and 529 plans.”

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As explained to PLANADVISER by a Fidelity spokesperson, the significantly reduced and simplified pricing on the new and existing Fidelity index mutual funds “[is] meant to deliver unparalleled value, simplicity and choice for clients.”

“Right now, these funds are only available to our retail customers,” the spokesperson noted. “However, we’re always reviewing and evaluating our product lineup, and we do currently offer a broad selection of low-cost index funds that are currently available to plan sponsors for their defined contribution [DC] lineups. These [new index] funds are available for IRAs [individual retirement accounts].”

According to the firm, the Fidelity ZERO Total Market Index Fund and the Fidelity ZERO International Index Fund are among the industry’s first self-indexed mutual funds with a zero expense ratio available directly to individual investors.

“This means investors will pay a 0.00% fee, regardless of how much they invest in either fund, while gaining exposure to nearly the entire global stock market,” Fidelity suggests. “The funds will be available on Fidelity.com as of August 3.”

In addition to offering the self-indexed mutual funds with a zero expense ratio, Fidelity is reducing the pricing on its existing stock and bond index mutual funds. Fidelity says it will provide investors the lowest priced share class available, ensuring every investor, regardless of how much they invest, will benefit from the lowest possible fees. The average asset-weighted annual expense across Fidelity’s stock and bond index fund lineup’s will decrease by 35%, with funds as low as 0.015%. These changes will save shareholders approximately $47 million annually, according to the firm.

Implications for the retirement planning market

The news is important for the retirement planning market insofar as it includes the broad pricing cuts on index funds and the new availability of zero expense ratio mutual funds for individual retirement accounts. But these aren’t the only reasons why retirement industry practitioners should take note. As highlighted in the July issue of “The Cerulli Edge, U.S. Asset and Wealth Management Edition,” there are multiple causes of fee compression in the asset management industry today, and the distinct causes of fee compression are compounding upon each other to prompt dramatic industry change.

At a very high level, the increasing importance of asset allocation advice, both within retirement plans and for individual wealth management clients, is perhaps the strongest driver fueling a decline in asset management fees and margins for providers. Bing Waldert, director at Cerulli and lead author of the report, observes that managers “are in many cases actually dropping fees on asset management products to near zero.” Fidelity’s move this week is a perfect example.

“Instead, they are choosing to charge for asset allocation, a task traditionally performed by the wealth manager,” Waldert observes. “The growth of asset allocation advice demonstrates how asset and wealth managers are using these industry trends to enter each other’s value chains and attempt to capture a greater share of a shrinking fee pool.”

While the trend has not yet fully come to pass, Cerulli’s reporting suggests automation is another factor that continues to compress overall management fees.

“Automation will lower the cost of transactions, bringing down fees in wealth management,” Waldert adds. “In addition, digital advice platforms emphasize asset allocation, which pressures fees in individual asset manager products and benefits exchange-traded funds [ETFs].”

Reflections on Fidelity’s position

As readers may recall, Fidelity already made waves once this year with shifts in its fee practices. In February, the firm made an unanticipated announcement that it would begin charging a 0.05% fee on assets invested through its institutional retirement plan recordkeeping platform into Vanguard products, including that firm’s popular (and very low-cost) suite of index-based target-date funds (TDFs) and collective trusts.

The announcement grabbed attention for some obvious reasons, including that Fidelity and Vanguard are two of the largest-volume providers of retirement plan recordkeeping and investment products for defined contribution (DC) retirement plans in the U.S. Speaking then with PLANADVISER, a Fidelity spokesperson confirmed that the nominally small fee “applies only to new clients.” But, given the sheer volume of business conducted by Fidelity and Vanguard in a given year, the fee change could result in a significant amount of new revenue for Fidelity.

Fidelity is still in the process of rolling out the fee on its recordkeeping platform, so it is a little soon to tell how clients may react. However, what is clear is that the move, like the one this week to introduce zero expense ratio mutual funds to retail customers, reflects a fundamental ground shift that is occurring in the way clients perceive the cost-value equation in asset management, both on the retail and the institutional sides. Until only just the last few years, the defined contribution investment only (DCIO) side of the asset management industry remained strongly profitable for diversified providers such as Fidelity, even as clients pushed back on high recordkeeping fees. Today, client expectations are shifting yet again, and there is clear evidence of a similar race to the bottom in terms of costs on the investment management side.

In this respect, it is interesting to ask whether this type of zero expense ratio product could one day work in the institutional space, where it may be harder for a firm to run such products profitably on trading fees alone. This approach is seemingly the bet Fidelity is making on the retail side by offering ostensibly free asset management in its newest funds.

The Fidelity spokesperson declined to specifically address this question, but Kathleen Murphy, president of Fidelity Investments’ personal investing business, shared the following statement: “We are charting a new course in index investing that benefits investors of all ages—from Millennials to Baby Boomers—and at all affluence levels and stages of their lives. The groundbreaking zero expense ratio index funds combined with industry-leading zero minimums for account opening, zero investment minimums, zero account fees, zero domestic money movement fees and significantly reduced index pricing are unmatched by any other financial services company.”

In Practice August 3, 2018

Emerging Wealth Segment Represents Opportunity for Retirement Plan Advisers

Many plan providers are squandering their chance to serve as long-term consultants to a potentially lucrative client cohort by not upscaling their offerings to meet its demands, Cerulli says.

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According to Cerulli Associates, the term “HENRY” is used to describe “High Earners, Not Rich Yet.” It says members of the HENRY cohort represent an emerging wealth opportunity with evolving advice needs, offering retirement plan providers the chance to capture both current assets and future flows.

Cerulli notes that investors in this group frequently share a variety of common financial challenges, such as paying off student loans and facing the intricacies of starting a new household—including merging finances, buying a residence, insurance planning and potentially raising children. “Unfortunately, the wealth management industry’s focus on current investable assets as a widespread prerequisite virtually ensures that these investors will have limited access to personalized comprehensive advice during this period when assistance is most needed,” Cerulli says.

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The first decision that emerging investors face is what type of firm they will use as their primary financial services provider. Investors in the “purest” HENRY segment, with incomes in excess of $125,000 but investable assets of less than $250,000, indicate the highest reliance on both bank deposit (16%) and retirement plan providers (11%) compared with any other cohort, according to Cerulli research.

The firm points out that retirement plan providers have the benefit of incumbent relationships when addressing the HENRY segment. “As employer-sponsored retirement plans serve as widespread introductions to investing for young investors, plan providers have the opportunity to set the standard for expectations for these participants moving forward. However, many of these platforms are squandering their chances to serve as long-term advice providers to the emerging wealth segment by not elevating their advice offerings to meet the demands of these participants,” Cerulli contends.

It notes that, in many cases, enrollment meetings are still part of a retirement plan provider’s service package, but their frequency and importance have declined as employees are now automatically defaulted into enrollment and welcomed by an email or hard-copy delivery. These introductory packages direct participants to their plan’s website or phone center for additional information; however, these options do not align with the preferences of investors within the emerging wealth segment.

According to Cerulli, when investors in the HENRY cohort were asked to identify the type of adviser they would prefer to work with, advisers employed by national firms, independent practices and local firms all ranked well ahead of any combination of online and phone-based advice offerings. Across all wealth tiers, investors chose individual advisers affiliated with a national brand as their preferred advice source.

Cerulli warns that when addressing this issue, retirement plan providers must be sure they do not use the data at their disposal to overtly provide enhanced services to their most promising participants. This practice could put them in violation of Department of Labor (DOL) discrimination standards or employers’ service expectations. Instead, retirement plan providers are well-served by implementing a financial guidance and planning program that helps participants across age and wealth tiers address their most pressing concerns.

In most cases, these programs can be offered primarily online through a combination of an information library, calculators and seminars supported by representatives available through phone or online chat options. Beyond these general advice levels, providers have the option of offering more personalized advice on an opt-in basis. Cerulli says the most common implementation of this model to date has been the use of managed account platforms within retirement plans. “By offering these services on an opt-in basis for an incremental fee, providers limit concerns about inequitable service offerings that would exist through targeted marketing efforts. Instead, these enhanced advice offerings can be offered across the entire participant base, but are most likely to be adopted by those at higher income tiers and [those with] increasingly complicated financial situations,” Cerulli says.

Once investors are enrolled in these programs, they have the opportunity to further engage with individual advisers to address their financial concerns beyond the confines of plan investments. “This type of arrangement has the advantage of being a tangible benefit for all stakeholders: high-earning participants have access to their desired advice model, plan sponsors increase their employees’ benefit set, and retirement plan providers can gain incremental revenue while potentially enhancing long-term client engagement centered on holistic advice,” Cerulli says.

According to Cerulli research, before engaging with an adviser, investors in the HENRY segment are highly concerned about being able to trust their adviser, but, the firm says, by leveraging their incumbent provider status, retirement plan providers can largely minimize this concern.

For providers hoping to engage HENRY investors early in their investing lifecycle, Cerulli says, creating a service model that is both scalable and valued by consumers is a crucial challenge. Given these consumers’ stated preference for human advice vs. purely online models, the firm suggests providers will, at the very least, need to offer hybrid platforms that include a self-service basis for simple inquiries but that will also allow for ongoing engagement with qualified advisers when the investor deems this preferable.

The most important part of building market share within this segment is maintaining relationships as these investors accumulate assets, Cerulli says. “[Therefore], providers must ensure that the younger segment of their client base both recognizes and appreciates their advice offerings as their needs escalate. These clients do not need in-person portfolio reviews on a quarterly basis, but appreciate access to customized advice, not simply education, when facing important economic decisions, many of which will not involve their investment portfolios. Providers targeting this market will need to take the long view and realize that the benefits of reaping what they sow accumulate over years rather than quarters,” Cerulli concludes.

These findings and more are from the August 2018 issue of “The Cerulli Edge – U.S. Asset and Wealth Management Edition.” Information for purchasing the report may be found here.

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