Fidelity ZERO Funds

Lately I’ve been thinking about the Fidelity ZERO series of funds. These are broad stock index funds, which is good, and they have zero fees, which is better. The downside, if it even is one, is that they track Fidelity proprietary indexes rather than industry standard ones. Fidelity also has outstanding standard index funds that track the industry standard broad indexes for low fees. My question to myself, and to anyone who cares to opine: is the difference worth any fee at all when I can pay zero?

Note that I’m not considering other companies’ mutual fund offerings here, nor am I considering exchange-traded funds. I’m sure someone is going to say that ETFs are better, or that Vanguard has lower fees in general, or that the zero-fee funds are to lure investors in to sell them other services. That’s fine, but the choice I’m evaluating is between Fidelity’s newish zero-fee funds and their closest Fidelity standard index fund. For the purposes of this discussion, there are no other options.

Here are the funds in question, with their expense ratio, yield, turnover, and trailing one-year and five-year returns. (All information cited in the post is from Morningstar.)

The figures for the U.S. total market funds and S&P 500 funds are very close. Likewise, if I delve into their holdings, looking at measures such as how their holdings are distributed according to the Morningstar style box, and what percentage of their holdings are companies with economic moats, they’re again almost identical. So, do I care that Fidelity is using a proprietary index for these rather than an industry standard total market index or the S&P 500 index? I see no reason why I should. I suppose the proprietary index could change without me knowing, but this doesn’t strike me as something to worry about and would not stop me from holding the zero-fee funds. By the way, both the low-fee and zero-fee funds get Gold ratings from Morningstar.

The U.S. extended market funds are a different story. The differences in yield and on trailing one-year and five-year returns are significant. Looking at their holdings tells us why. The standard low-fee fund tracks the Dow Jones US Completion Total Stock Market Index, which covers the mid-cap and small-cap stocks that are outside of the S&P 500, weighted by market cap (which is what I’d expect from a fund called  “extended market index”). The zero fee fund, on the other hand, is significantly tilted toward small caps, and toward value. So, it’s a very different fund. Both get Bronze ratings from Morningstar.

The zero-fee international fund isn’t as close to the standard index fund as the U.S. total market and large cap funds are, but it’s closer than the extended market fund. The standard low-fee international fund tracks the MSCI ACWI ex-USA Investable Market Index, which includes stocks of all market capitalizations from around the world, including from emerging markets. The proprietary index used by the zero-fee fund doesn’t include small caps. Perhaps because of this, the zero-fee fund holds more companies with economic moats (48 percent) than its low-fee counterpart (43 percent). There’s still not much of a difference in their trailing returns, but to the extent there is one, the zero-fee fund has done a little better. The low-fee fund gets a Gold rating from Morningstar; the zero-fee fund gets a Silver rating.

If I were building a portfolio now, and again assuming I only wanted Fidelity mutual funds, I would feel fine opting for the zero-fee total U.S. market or S&P 500 funds over the standard low-fee funds. I would probably also do this for the international fund. I don’t feel I’d be missing much by not having international small caps. (Indeed, I might prefer a developed markets index fund, but that’s not an option in this comparison.)

The extended market fund is a more complicated story, and I think it depends on the intended purpose of the fund. If the purpose is to complement a S&P 500 index fund, the standard low-fee fund does that, but the zero-fee fund largely misses mid-caps, so I’d pay the low fee. If the purpose is to give a small value tilt to a portfolio that otherwise largely mirrors the market, then the zero-fee fund seems fine.