Will Fidelity Become the Best Broker?

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Investors have sunk more than $1 trillion into exchange-traded funds. But until now, one big player in the brokerage industry has largely stayed out of the ETF fray, choosing instead to bring in a third-party player to support its customers. Now, though, that player seems to be changing its mind -- and the result could be a new battle in the broker wars.

Fidelity changes gears
Earlier this month, Fidelity filed with the SEC for permission to expand its lineup of ETFs. Among the possible offerings would be ETFs focusing on international and domestic equities and bonds, as well as so-called long-short funds that combine both purchases and short-sales in a single portfolio.

The move shocked some, given that Fidelity has largely stayed quiet on the ETF front for years. Currently, Fidelity has just one ETF, the Fidelity Nasdaq Composite Index Tracking ETF (NAS: ONEQ) . But analysts speculate that the move may target Vanguard's ETFs, which are structured in such a way as to build off existing index mutual fund portfolios.

Offering ETFs tied to its mutual funds makes sense for Fidelity to try to avoid losing its mutual-fund assets to rival ETF providers. But it also has implications for the broker wars overall.

Adding new commission-free funds
For investors, the big question isn't so much whether Fidelity's ETFs will break new ground. Based on the filing, the answer to that question looks like it'll probably be no. The filing makes numerous references and comparisons to other ETF providers, using them as precedents in support of its argument that the SEC allow Fidelity to go forward, so I wouldn't expect truly innovative funds from Fidelity.

The more interesting question, though, is how this will affect the cutthroat competition for brokerage customers. With TD AMERITRADE (NAS: AMTD) , E*TRADE (NAS: ETFC) , and Interactive Brokers (NAS: IBKR) among the brokers that also chose not to offer their own ETFs in favor of engaging outside providers for their commission-free lists, many players in the brokerage industry believe they don't need to have an in-house ETF presence.

But then again, Fidelity has its huge mutual fund business, something those other brokers lack. And with Fidelity likely looking at the relative success of Schwab's (NYS: SCHW) proprietary ETFs, such as the $760 million Schwab U.S. Broad Market ETF (NYS: SCHB) -- developed largely without a mutual fund base -- it probably feels that it could make a good go at its own ETF lineup, reaching critical mass purely from its current customers.

Heading for divorce?
The other important consideration is what will happen with Fidelity's current agreement with BlackRock's (NYS: BLK) iShares. Right now, Fidelity offers its customers commission-free access to 30 iShares ETFs. But if Fidelity becomes a bigger competitor to iShares, will BlackRock want to continue whatever agreement it has with Fidelity? With the liquidity and dominance of iShares ETFs over all but its largest competitors, Fidelity customers would probably not be too happy if Fidelity ditches those ETFs in favor of its own lineup of small, niche-oriented funds.

What seems more likely is that Fidelity will maintain a relatively low profile, building up a modest ETF business as an adjunct to its own mutual fund structure but seeking to hang on to its relationship with iShares. By doing so, Fidelity not only gives its customers more choice but also blocks other potential rivals from claiming the competitive advantage of an exclusive partnership with iShares.

Get the right broker for you
With all the activity among brokers and ETFs, it's hard to keep your eye on what really matters: getting the broker that fits best with your investing strategy. Although commission-free ETF offerings may play an important role in that decision, it's not the only factor. If you make a decision based solely on ETFs, then you may find yourself getting whipsawed from company to company as the broker wars continue. Fidelity's new ETFs won't automatically make it the best broker, but it may make the company look better to you.

That said, finding the right ETF can make a huge difference to your portfolio. Learn more from the Motley Fool's latest free special report on ETFs, which reveals three ETFs with huge growth potential. Read it now before it's gone!

In the market for a new brokerage account? Check out theFool's Broker Centerand get the skinny on the best in the business.

At the time this article was published Fool contributor Dan Caplinger hasn't had any broker complaints since he dumped the full-service broker more than 20 years ago. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Interactive Brokers. Motley Fool newsletter services have recommended buying shares of Interactive Brokers, Schwab, and BlackRock. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you its best.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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