Source of the gap between the market leader, JP Morgan Asset Management, and Fidelity

“Ever since I’ve worked in the ETF industry, there has been a very big first mover advantage,” said Stefan Kuhn, head of ETF distribution Europe at Fidelity International. He explained that as the fund gets bigger, it improves liquidity. It then enters a virtuous circle.

When the European active ETF business started three or four years ago, Kuhn noted that JPMAM benefited from a longer track record than its competitors, thanks to its US strategies. “They could say: ‘this is a proven investment approach. We’re bringing this to Europe.’” In addition, he thinks that the corporate strategy had strong support from its CEO, Jamie Dimon, who promoted the firm as a “go-to player in active ETF.”

Fidelity going its own way

It decided to offer “all kinds of variants” from “high octane, highly concentrated active funds through more systematic approaches. And we have active ETFs.” Fidelity does not offer passive ETFs in Europe. It believes that its competitive advantage lies in its brand, research and client connectivity. On the latter, Kuhn commented that being an active manager enables his firm to speak with “a lot of investors” across Europe.

Kuhn observed that the rise of passive ETFs in Europe was prompted by the notion from many investors that “active doesn’t work, because over a certain time period… the vast majority, if not every fund manager, does not earn their cost.” Besides, Kuhn said that Fidelity assessed that the passive ETF business was a “scale and a price game and that’s not in our DNA.”

Keep cost-focussed clients

Kuhn noted that Fidelity’s clients fleeing towards passive ETFs were motivated by cost and their ability to perform the index minus the fees. In other words, he argued that clients will always underperform the index by “a tiny bit.”

The conclusion at Fidelity was not only to reduce cost, but also risk. “What [clients] don’t like is active research that gives you plus 5% one year, minus 7% the next year against the benchmark,” said Kuhn. He thinks that clients did not like that volatility and that they considered that they paid too much for it.

Consequently, the asset manager started working on active ETFs that could offer the expertise of its research analysts in a “much more constrained way around an index” while targeting a performance of the index plus 100 basis points (bps) for all their “research-enhanced ETFs.”

Accounting for ESG considerations, Fidelity removes non-appropriate companies from a sustainability perspective and can underweight or overweight individual companies by no more than 100 bps versus the benchmark. Moreover, the country and the sector exposure are allowed to deviate by no more than 200 bps.

Using the MSCI Index World as a starting point, Kuhn outlined that Fidelity currently offers six equity strategies: world, USA, Europe, emerging markets, Japan and Pacific ex-Japan.

Have developments in Ukraine changed guidelines when investing in defence industries? “No. We have opted to exclude it. I do not think we’re changing it, but I’m not privy to that discussion, because I’m not in the sustainable committee.”

Efficient and stable product

“From a characteristic standpoint, [the active ETF] is very much like the underlying index,” argued Kuhn. He reported that 85% of the risk is driven by single security selection and therefore he thinks that “it’s one of the purest ways to deliver our research.”

Contrary to active ETFs, Kuhn argued that the usage by several passive ETFs of an ESG index bears significant deviation risk, also called basis risk. On the other hand, he argued that an “active sustainable research-enhanced ETF” can reduce the risk against the ESG benchmark compared to a passive ETF as Fidelity optimises the stock allocation while taking sustainability into account. He pointed out that once “exclusions are out of the way,” Fidelity tilts the portfolios towards ESG, but “the main driver is fundamental research.”

Besides, he stressed that contrary to investment funds, active ETF restrictions make it unlikely that the change of portfolio manager or research analyst will result in a significant dent to the investment approach. In other words, he thinks that their active funds are “more repeatable and it’s less risky.”

“ETFs are not per se passive,” said Kuhn. He often argues with clients that buying passive fixed-income ETFs is equivalent to buying active fixed-income ETFs: “you manage the portfolio actively with a goal of hitting the index performance as best as you can.” Fidelity goes one step further by arguing that: “we’re not going to hit the index. We’re trying to outperform the index.”

This article was written for the to the , published on 26 February. The content of the magazine is produced exclusively for the magazine. It is published on the website as a contribution to the complete Paperjam archive. Click here to subscribe to the magazine.

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