FIDELITY STRUGGLES TO SOAR AGAINMore cautious investing and a flock of new fund assignments are sparking a comeback
For Fidelity Investments, 1996 can't end soon enough. Amid one of the biggest bull markets in history, the nation's largest mutual-fund company has turned in a disappointing showing. While the Dow Jones industrial average has soared 26.5% this year through Nov. 22 and the Standard & Poor's 500-stock index is up 21.6%, Fidelity's U.S. diversified equity funds could only muster an average total return of 17.4% (appreciation plus reinvested dividends and capital gains). And where it really counts, this year's performance leaves Fidelity tied for seventh place among the 10 largest equity-fund companies (page 168). ''No question about it, it's been a difficult year for us,'' says William J. Hayes, who oversees Fidelity's equity funds.
Fortunately for Fidelity's 11 million customers, the company's prospects for 1997 are considerably brighter. After subpar performance in 1995 and early 1996, management implemented the most sweeping reorganization in the firm's 50-year history by reassigning managers of 34 funds. Some Fidelity managers came under heavy criticism for making large bets that went sour and for veering from their fund's intended investment strategy. In June, Fidelity's top manager, Jeffrey N. Vinik, resigned as head of the Fidelity Magellan Fund, following months of complaints about his big-bet investment style, especially his huge bet on bonds.
BIG DENT. For the most part, the changes are working, with improved returns in many of the leading funds (table). David O'Leary, a former Fidelity employee who tracks the firm at Alpha Equity Research in New Hampshire, is impressed with its progress. ''There's an excellent chance Fidelity will be back to their old ways next year,'' says O'Leary.
Fidelity had better hope so. The disappointing performance of the past year and the controversies over investment strategy put a significant dent in the company's torrid growth. Fidelity attracted more than 20% of all cash flowing into mutual funds in 1995, but the pace has slowed to a fraction of last year's rate. In fact, Vanguard Group, Fidelity's archrival, pulled ahead of Fidelity this year in the asset-gathering sweepstakes. Vanguard, a distant second in 1995, took in $27.8 billion in new cash (through Oct. 31) compared with Fidelity's $26.5 billion. Fidelity still remains far and away the largest fund company, with $437 billion in fund assets, up from $373.1 billion at the end of 1995.
One reason for that slippage is a sharp downturn in the growth rate of Fidelity's 401(k) business. So far this year, assets have climbed only 16%, vs. a 47% gain for all of 1995. Criticism from 401(k) executives about fund performance and lack of investment discipline was a key factor driving last spring's reorganization. Some 401(k) participants are avoiding the controversial Magellan fund, and analysts think Fidelity has been winning fewer exclusive deals with plan sponsors and having to share the business with other fund companies. But Fidelity remains the nation's largest 401(k) provider and continues to pick up big customers. Among this year's new clients: Intel, Toyota Motor, and United Technologies.
''10 REASONS.'' Fidelity isn't depending on portfolio managers alone to pull the company out of the slump. It has taken steps to improve its image by making public its beefed-up ethics code: Over the past few years, Fidelity has come under scrutiny about aggressive personal trading by some fund managers. The firm also overhauled its marketing organization, promoting institutional services chief Paul Hondros, a former Philadelphia cop, to head retail marketing. Changes have come rapid fire. A number of high-level staffers switched jobs or resigned. The company also launched an ad campaign offering ''10 reasons'' why investors should buy Fidelity funds--the 10 funds that are rated four or five stars, Morningstar Inc.'s highest ratings for risk-adjusted returns.
Noticeably absent from the ''10 reasons'' ad is Magellan. Long the engine powering Fidelity's market leadership, Magellan has been the focal point of the company's problems. Investors have withdrawn some $4 billion from the $53 billion fund this year. Now, however, the worst may be over.
New manager Robert Stansky has been steadily improving Magellan's performance. Since taking over on June 3, Stansky has halved Vinik's $12 billion investment in long-term bonds. That bond allocation was a bet made by Vinik in late 1995 that the economy was heading into a recession. When the economy strengthened instead, interest rates surged and bond prices plunged, dragging down Magellan. ''No doubt about it, that was a big mistake,'' admits Hayes.
As he slowly unloaded bonds, Stansky bought $5.3 billion in tech stocks and divvied up the remaining portfolio into a well-diversified array of about 540 stocks. His biggest sector bet (through Sept. 30) was a relatively tame $7 billion stake in energy stocks, far smaller than the $20 billion investment Vinik once had in technology. The result: Stansky trails the S&P by 3.02 percentage points through Nov. 22, but he's still beating 65% of the nation's 772 growth funds, according to Morningstar.
An improvement, to be sure. But for the year, mighty Magellan is just an average-performing mutual fund. And at yearend, Magellan will have underperformed the S&P in four out of the past five years. Says Eric M. Kobren, publisher of Fidelity Insight, a newsletter that tracks Fidelity funds: ''Given what [Stansky] inherited, he's done a great job bringing it back to where it's supposed to be.''
Many of Fidelity's other funds, which are under new managers as well, are also picking up steam without making the big bets that got Fidelity into trouble earlier. That's because in the sweeping management changes, Fidelity executives reined in some types of risk-taking, such as investing in emerging markets. Still, executives say fund managers have wide latitude to make big industry or company bets or buy bonds. But so far, managers have been playing cautiously and investing in line with their fund charters.
A QUESTION OF STYLE. The $11 billion Fidelity Asset Manager Fund has made one of the sharpest comebacks. The supposedly conservative fund, once heavily marketed to retirement investors, lost a bundle from a big stake in emerging-market debt back in 1994. But since Apr. 1, a three-man management team headed by Dick Habermann has halved the fund's 19% stake in foreign investments and fled to the safety of big U.S. stocks. Through Nov. 22, Asset Manager ranks 23rd of 77 multi-asset global funds tracked by Morningstar.
Improvement is also evident in the $9 billion Fidelity Blue Chip Growth Fund, which came under fire for investing in midcap stocks instead of the large caps its name implies. New manager John McDowell has gone back to basics, with holdings such as General Electric, IBM, and Philip Morris, and has outperformed 60% of all growth funds since Apr. 1.
It's a similar story with Fidelity Capital Appreciation Fund. The $1.6 billion fund had been in the bottom quartile in its category for the latest 12 months, loaded down with clunky commodity and cyclical stocks. But under the direction of high-tech ace Harry Lange, the fund has been recast and has outperformed 67% of its peers.
Still, a number of funds that got new managers on June 3 are trailing the S&P's 12.89% return for the period. The $3 billion Fidelity OTC Portfolio is up just 7.57% under Charles Mangum, about average for its peers. The $9 billion Fidelity Growth Company Fund, where Lawrence Greenberg replaced Stansky, is up just 6.62%. The $4 billion Fidelity Retirement Growth Fund was in the dumps when Fergus Shiel took over, and so far he hasn't made it much better. The fund is up just 2.27% during his tenure.
Hayes says he's optimistic Fidelity's results will improve next year. The problem in 1996, he argues, is stylistic. The market is rising on the strength of large-cap stocks, while Fidelity's investment style and expertise are the small and midcap companies, which are lagging. But Hayes refuses to chase the popular big stocks. ''We think large stocks are overvalued,'' he says.
OVERWEIGHT? The problem is exacerbated by the growing popularity of index funds. As index funds attract new cash, they invest in the same large stocks, usually those in the S&P, which improves the returns of the index and attracts even more money. ''We're not saying when, but we think the cycle'' is going to change, says Hayes, as it has always done in the past. And he says Fidelity's funds are well positioned for that shift.
Of course, repositioning Fidelity is a long-term process because of its huge asset base. ''Fidelity has made its living being flexible, but their assets are weighing them down,'' says John Rekenthaler, publisher of Morningstar Mutual Funds. Hayes argues that size is not an issue. ''Bonds would have slowed down any fund no matter what the size,'' says Hayes. Yet Fidelity in the past has been nimble enough to minimize the impact of its mistakes.
It's no coincidence, analysts say, that the relatively small $370 million Fidelity Export Fund has been a top performer, with a 37% return through Nov. 22. Manager Arieh Coll concentrated about a third of his assets in his top 10 holdings, mainly small and midsize technology and gaming stocks. Magellan would have great difficulty jamming 33% of its assets, $17.7 billion, into those 10 stocks.
It remains true that stock-picking is the key to Fidelity's success. If Hayes is right and small stocks come back in favor next year, Fidelity will surely do better in 1997 than in 1996. The fund giant can hardly afford to do worse.
By Geoffrey Smith in Boston
Updated June 14, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.