Fidelity is winning ETF revenue-sharing deals after its service fee shook the booming industry

By Christine Idzelis

'Everyone is fighting to preserve their slice of the economic pie'

Fidelity Investments has been winning more revenue-sharing agreements with managers of exchange-traded funds after its fee policy for the booming sector created an industry stir.

Investors and their advisers turn to the firm's brokerage platform to buy ETFs. Managers of the ETFs charge fees for investing in their funds and Fidelity is looking for a piece of that revenue.

Fidelity reached agreements with nine ETF issuers that a little over a month ago were on a list of firms whose funds were slated to be potentially hit with a new surcharge on its platform that would be incurred by investors, according to a person familiar with the matter. That surcharge would only apply if the firms decided not to participate in a revenue-sharing arrangement with Fidelity.

The new surcharge - or a service fee charged by Fidelity - amounts to up to 5% of a buying position with a $100 cap, the person said. The fee would help cover costs such as servicing operations and technology enhancements should ETF managers decline to participate in its revenue-sharing arrangement, according to the person.

Revenue-sharing agreements aren't new to the asset management industry, but they are to many mangers in the booming ETF market.

"This is a big undertaking," said David Young, founder and chief executive officer of Regents Park Funds, in a phone interview. "Fidelity has to contact, and work with, many, many ETF providers."

His firm was on the list of the nine ETF issuers faced with the decision of entering such an agreement or letting its clients get slapped with a $100 service fee that in Young's view, would have been "prohibitive." Ultimately, such a fee would have spelled "death" for Regents Park's ETF business on Fidelity's platform, he said, so the firm decided to accept the cost of participating in the firm's revenue-sharing arrangement.

But his firm's profit margins are getting "hammered" by it, said Young.

ETFs in the U.S. have a total of about $9 trillion of assets under management, the vast majority of the $12 trillion of ETF assets globally, according to a Citigroup research note this month. The industry has ballooned since the launch of the first ETF in the U.S., the SPDR S&P 500 ETF Trust SPY, in 1993.

Because Fidelity's new service-fee policy for ETF issuers remains in place, the firm has been in talks with many more managers about entering into revenue-sharing arrangements, according to the person familiar with the matter. Many asset managers beyond those nine issuers have already entered into such agreements with Fidelity, which entails 15% of their total revenue arising from the firm's brokerage platform, said the person.

The founder of Rayliant, an asset manager that also was on the list of nine firms, told MarketWatch in April that paying up for the support agreement to avoid the service fee was a "sensible path."

While it's not unusual for a brokerage firm to have revenue-sharing arrangements with asset managers that use its platforms to generate business, the growth of the ETF industry means that more managers will be participating in them, Andrew Beer, founder of investment firm DBi and co-portfolio manager of the iMGP DBi Managed Futures Strategy ETF DBMF said, in phone interview.

Registered investment advisers, or RIAs, that operate independently from major Wall Street brokerage firms such as Morgan Stanley (MS) use platforms like Fidelity's to trade on behalf of individual investors who hire them to manage their wealth, Beer said.

While investors may go directly to a brokerage platform to buy exchange-traded funds, he said that ETF managers stand to win significant assets when advisers who have approved their funds turn to brokerage firms to buy them for their clients. But "as a general rule, advisers will not buy an ETF if they have to pay a costly surcharge to do so," said Beer.

ETFs are popular with individual investors and the financial advisers who manage their money.

U.S.-listed ETFs saw more than $320 billion of inflows this year through May, according to State Street Global Advisors. "Investors were big buyers in May," said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors, in a note on last month's flows.

U.S.-listed ETFs took in $92 billion last month, marking their best May flows ever, he said.

More boutique managers have been getting into the ETF business, which long has been dominated by massive asset managers such as BlackRock (BLK), State Street (STT) and Vanguard. These smaller firms have been adding to the growing number of actively managed ETFs.

Active ETFs, which aim for market-beating returns, are a small but fast-expanding part of the U.S. industry that was built on the back of passive funds tracking indexes such as the S&P 500.

"Active ETFs have now taken in over $108 billion for the year, or 33% of all ETF flows - off a 7% share of overall ETF assets," Bartolini said in the State Street note. "This pace is unlike anything we have seen - and active ETF inflows could hit a record $260 billion if the year-to-date average flow trends continue."

In Young's view, Fidelity's revenue-sharing agreements are "a troubling development" for ETF managers as well as investors.

While ETF issuers may now absorb the service fee, that additional cost may mean some "smaller managers won't be able to survive," leaving investors with fewer choices within the industry, he said. Also, managers whose profits are being squeezed by Fidelity's revenue-sharing agreements may decide to increase fees on new ETFs they issue, he said.

For Young, it's new to see a custodial platform like Fidelity's ask for a piece of ETF managers' revenues.

But in demanding revenue sharing from ETF firms, "Fidelity is reverting to the economic model that is standard in the broader wealth-management industry," according to Beer. "It's pretty standard for asset managers to pay access fees for platforms and to receive data packages in return," he said, explaining such packages may include data on who is buying and selling the funds.

"All of this is a battle for economics between the people who control the platforms and the asset managers who want to raise money on the platforms," said Beer. "Everyone is fighting to preserve their slice of the economic pie."

-Christine Idzelis

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06-08-24 0800ET

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