Fidelity to launch own ETF play but plans to lean on partners

By Ashley Lau and Tim McLaughlin

(Reuters) - As Fidelity Investments prepares to launch its first full line-up of sector exchange-traded funds on Thursday, the Boston-based company is jumping in much later than many of its peers and is not trying to be the largest provider of ETFs.

Instead, Fidelity, which currently has $125 billion (77.2 billion pounds) in ETF assets on its platform largely through third-party ETF offerings, is just as content to be an administrator of ETFs created by rivals, such as BlackRock Inc (NYS:BLK), as it is launching its own ETFs that complement what is already in the market.

"We don't really see ETFs as a business," Jacques Perold, president of Fidelity Management & Research Co, said in an interview. "We see ETFs as a vehicle in which you can deliver investment capabilities and capacity, but we have many other vehicles."

During the past two decades, the U.S. ETF industry has mushroomed to $1.6 trillion in assets while Fidelity looked on, seemingly content to focus mostly on its empire of actively managed mutual funds.

In recent years, Fidelity came off the sidelines. But it has only one ETF to date - the Fidelity Nasdaq Composite Index (NMQ:ONEQ). The firm, however, established partnerships with third-party ETF providers like BlackRock, Pimco and Vanguard to offer their products on the Fidelity platform. And those relationships will not be slowing down even as Fidelity comes to market with its own ETFs.

In fact, in the early going, Fidelity is leaning heavily on BlackRock's iShares to attract ETF investors to its platform.

"BlackRock has about 40 percent of the ETF market so that is a really good partner to have," said Todd Rosenbluth, an ETF analyst at S&P Capital IQ.

Fidelity is using an approach that is similar to Charles Schwab Corp (NYS:SCHW), which had $179 billion in ETF assets on its platform at the end of September. Schwab's proprietary ETFs had $14.2 billion in assets.

In March, Fidelity expanded its three-year relationship with BlackRock's iShares business, promoting 65 iShares ETFs to clients without charging a commission. Previously, Fidelity listed just 30 of such funds.

"We don't see ourselves as offering Fidelity-only products ... nor do we see us not producing Fidelity products," Perold said. "Where we see there is a gap in that choice, we will try to fill that gap, either through providers like BlackRock or by producing it ourselves.

READYING FOR SECOND PHASE

Thursday's ETF launch of 10 sector ETFs will track MSCI indexes in sectors ranging from financials to information technology and energy.

The new ETFs will trade on the NYSE Arca and BlackRock will have advisory role. With expense ratios of just 12 basis points, or $12 for every $10,000 invested, according to regulatory filings, the ETFs will be offered at a discount to competing ETFs. State Street's (NYS:STT) Financial Select Sector SPDR Fund (PSE:XLF), for example, has an expense ratio of 18 basis points.

"Fidelity is clearly coming into a crowded market sector of ETF investing, but it is popular, too," Rosenbluth said.

During the first nine months of 2013, investors added $27 billion to sector ETFs, according to BlackRock data. That was 20 percent of the ETF industry's flows, even though sector ETFs represent only 12 percent of the industry.

"It is sure sign of sector ETFs gathering market share," Rosenbluth said.

With the launch of Fidelity's ETFs, Perold said the firm is already looking ahead to what he calls the "second phase" of their ETF plan, expanding from its partnership with BlackRock beyond passive, straight-forward, index-tracking and into more active strategies.

"We think that the second phase is going to be much more around how you use these (ETFs)," Perold said, referring to mixing the funds in terms of packaged products and managed accounts.

"We also think the active era will be something that will continue to grow over the next ten years," he said.

Fidelity also plans to launch five active fixed-income ETFs, which it filed for earlier this year and expects to launch next year.

TIPTOEING AROUND MUTUAL FUNDS

Fidelity is also constrained to a certain extent from going all-in on ETFs because of concerns about cannibalizing its own mutual fund success.

"We wouldn't want to put an ETF on a product where we are trying to protect the existing mutual fund shareholders or the separate account shareholders, for that matter, where someone could somehow know what we're doing at all times," Perold said.

Fidelity's $101 billion Contrafund (FCNTX.O), for example, returned 8.94 percent in the third quarter, above the 5.24 percent gain for the S&P 500 index. The fund is managed by closely followed stock picker Will Danoff.

"We would be worried about having an ETF that prevented Contrafund from being Contrafund," Perold said. "And it would not be fair to Contrafund shareholders."

(Reporting by Ashley Lau in New York and Tim McLaughlin in Boston)