WORLD CORPORATE Fidelity holds secret weapon to take on Robinhood and Vanguard Justin Baer / Bloomberg February 10, 2021 21:54 pm +08 -A+A Geode has helped Fidelity gain back ground lost to passive-investing giants Vanguard and BlackRock Inc. (Feb 10): Blocks from Fidelity's headquarters, a team of quants toil in relative anonymity. They're also a key weapon in the investment firm's fight to take on all rivals, from Vanguard Group to Robinhood Markets Inc. Geode Capital Management Inc was spun out of the Boston-based firm nearly two decades ago. At the time, Fidelity Investments Inc was content to be undercut by rivals in the low-cost index business and didn't want to overshadow its powerful and famous stock pickers. Today, Geode is the key plank in the firm's effort to lower the costs of investing across all of its businesses. It has helped Fidelity gain back ground lost to passive-investing giants Vanguard and BlackRock Inc. It has also drawn new clients to the firm in the era of no-commission trades. The investments Geode manages helped Fidelity lift assets under administration — or what investors held in brokerage and retirement accounts and in its funds — to US$8.8 trillion in September from US$8.32 trillion at the end of 2019.. Geode now manages some US$720 billion, up from less than US$100 billion a decade ago and more than household names such as Blackstone Group Inc, Eaton Vance Corp and Putnam Investments. "It's one of the best-kept secrets in asset management," said Ben Johnson, director of global exchange-traded fund research at Morningstar. Geode has about 140 employees and no marketing budget. Most of the staff are quants — engineers trained in mathematics or computer science. Its investment-research team has just a dozen members. The firm's surge underlines the emergence of index investing as a dominant force in the markets, and also reflects Fidelity's own evolution from stock picker to tech-savvy financial conglomerate. Index funds are now top sellers at brokerages, and serve as building blocks in other popular investment products, like the target-date funds sold through 401(k)s and other retirement accounts. Money managers don't make much money off these passive funds, which are priced low enough to attract new customers to the firms' platforms. But Fidelity is betting enough of those clients will eventually turn to it for higher-end services, like financial advice. Of course, nearly every one of Fidelity's rivals — from Charles Schwab Corp and Morgan Stanley to Vanguard and Robinhood — are after the same thing. Fidelity overcame a late start to become one of the industry's biggest indexers. The firm's top-selling index fund, Fidelity 500, manages US$287 billion -- nearly tripling its assets in five years. That fund, along with several others, is a no-fee product. Geode advises on all of Fidelity's no-fee Zero funds and dozens of others. A decadelong market rally proved the ideal conditions for passive investors like Geode, whose funds tracked stock benchmarks that rose steadily — often outperforming more-expensive stock-picking funds. Those indexes produced big gains in 2020, too, but the volatile year would go down as Geode's toughest test. In March the markets stood at a precipice. Stocks were cratering. Many debt securities essentially stopped trading. The freeze ended almost as quickly as it began, thanks to aggressive actions by the Federal Reserve. The rally was back on. Index investors like Geode are charged with keeping pace with those benchmarks. The task grows more challenging when stock prices are moving rapidly and the pace of client money moving in and out of funds quickens. Vincent Gubitosi ran Geode for 13 years before retiring as president and chief investment officer in December. He reckons the benchmark S&P 500 covered more ground in 2020, as measured by the distance between the low and the high points, than it had in any year since Geode's founding. "What impacts us as index managers is how big the daily move is, and what the flows are like," Mr. Gubitosi said. "There was no time to come up for air." Geode's emergence as one of the biggest beneficiaries of the index-investing boom would have been difficult to foresee, even inside Fidelity, when it first opened its doors in 2001. The firm began as one of a handful of boutique managers created to invest a slice of the fortune of the founding Johnson family, along with those accumulated by a coterie of current and former Fidelity executives. Fidelity committed US$229 million to the computer-driven investor and installed as its head Jacque Perold, a Fidelity executive who later served as the investment firm's president. Fidelity's nascent index funds were originally subadvised by Bankers Trust Corp. After a series of transactions moved that business around, Edward "Ned" Johnson 3d, then Fidelity's chairman, had seen enough. "Ned said, `This is crazy to pay anyone to do an index fund,'" one former senior Fidelity executive said. In August 2003, Fidelity spun out Geode. That same month, regulatory filings revealed that Geode had begun to manage six Fidelity index-fund portfolios, including what would become Fidelity 500. Though at the time many of the firm's index funds had already been around for decades, Fidelity didn't market them or price them competitively until recently. The firm also largely stood pat as some of its competitors seized on demand for exchange-traded funds, a popular vehicle for passive strategies. When BlackRock paid US$13.5 billion to acquire Barclays PLC's ETF business in 2009, a deal that would reshape the money-management industry for the decade to come, some Fidelity executives groaned. "We were pretty late to the game on that front," Abigail Johnson, Ned Johnson's daughter and successor as Fidelity chief executive, said of Fidelity's foray into ETFs. "I don't want to be late to the game on other things," she said in an interview. At the time of the Barclays deal, many of Fidelity's index funds charged higher fees than those offered by rivals such as Vanguard and Charles Schwab. Until recently, Fidelity's index funds weren't even branded "Fidelity." They were called "Spartan." Under Ms. Johnson's direction, Fidelity has since repeatedly slashed the fees on index funds and, in 2016, dumped the "Spartan" name. That these index funds are managed just outside the Fidelity banner, from a nondescript office building two blocks away, also speaks to the way the Johnson family still views the 73-year-old investment firm, executives said. There is no chance Geode would be folded back into Fidelity, Ms Johnson said, describing index investing as "completely unrelated" to its active-management business. "It's a different kind of culture," she said. "It's just a completely different approach to running money." "Being a passive-index manager is not something that's woven into the Fidelity DNA," said Matt Nevins, Geode's general counsel and one of a handful of employees who had worked at Fidelity. After the market mayhem of early 2020, Geode's Mr Gubitosi decided it was time to bow out. He told the board last summer he was interested in stepping down as president to focus on his entrepreneurial interests. "Running US$700 billion, you don't get a chance to focus much on that," he said. The board considered both in-house and external candidates before landing on Bob Minicus, a longtime Fidelity executive who had run the firm's sprawling equity-trading desk until 2018. In his most recent role, he led the asset-management division's compliance, risk and business operations organization. Geode may be a separate company, pursuing a different investment strategy from its own office space. But as Mr. Minicus's appointment underlined, the operation is still family — and under the Johnsons' control.