With So Many to Consider, Can the ‘New’ Fidelity Keep ‘Em All Happy?

Poor, poor Fidelity Investments. Even when it tries to apologize for and explain the last year--by some measures arguably the worst 12-month period in its 50-year history--there is only more ridicule and scorn.

The mutual fund giant’s senior executives are now embarked on a roadshow, meeting with clients in six cities in an attempt to calm concerns about the company’s past and future.

Beset in 1996 by fund manager defections and subpar returns, the message Fidelity undoubtedly hopes to convey on the road is that its problems are temporary, that shareholders needn’t fret about the quality of the management behind their money.

Yet reports from the first few shows depict a Fidelity more on the defensive than on the offensive. Eric Kobren, editor of the Fidelity Insight newsletter in Wellesley, Mass., went to the New York meeting last week and wasn’t impressed. The basic explanation given for the loss of some star fund managers last year was the boilerplate that “change is inevitable,” Kobren said. “I wasn’t thrilled. I think they could have done a better job of empathizing with shareholders’ concerns.”

But therein lies Fidelity’s most vexing problem: What, exactly, do its shareholders expect from it now?

“Great performance--just like the old days,” many of those shareholders would probably reply.

In the “old days” of just a few years ago, however, Fidelity was a gunslinger among mutual fund companies. Its fund managers, many of them young, brilliant and aggressive, were allowed wide leeway in how they invested and what they invested in.

From 1991 through 1994, that freedom did indeed foster great performance: Each year, the average return of Fidelity’s diversified stock funds beat not only the return on the blue-chip Standard & Poor’s 500 index, but also the average return of U.S. diversified stock funds in general, according to fund tracker Morningstar Inc.

In 1995 Fidelity still beat the average stock fund, but it lagged the S&P; index--as did the vast majority of funds.

Last year, though, Fidelity’s underperformance was glaring. Its diversified stock funds posted a 17.2% average total return, far below the 23% of the S&P; index and--more important--below the 19.6% return of the average U.S. stock fund, Morningstar says.

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Did Fidelity’s gunslinger style finally backfire? Certainly in the case of its flagship fund, the $56-billion Magellan fund, that was the case. Manager Jeff Vinik took what was supposed to be a stock fund and used a significant chunk of assets to make a bet on bonds in 1996. But the bond market went south while the stock market surged, and by May of last year, Magellan’s performance had become so dismal that Vinik resigned.

By virtue of its high profile, Magellan created a public relations nightmare for Fidelity. Yet even before Vinik quit, Fidelity management had decided that the freewheeling investing style that had characterized the company for so long had become too risky.

Today’s Fidelity, with nearly $500 billion in assets (including trust accounts), is a much different company from the Fidelity of even five years ago. Nearly half the company’s assets are held in retirement accounts such as 401(k) plans. That has put Fidelity increasingly at the mercy of retirement plan consultants, who above all want the funds that they choose for clients (such as companies sponsoring 401(k) plans for employees) to be predictable.

By definition, a gunslinging style isn’t predictable. Hence, Fidelity management’s message to its troops early last year was “you guys are going to take less risk . . . you’re going to get in line,” said William Dougherty, head of Boston-based Kanon Bloch Carre, a retirement plan consultant.

Not surprisingly, that didn’t sit well with some of Fidelity’s managers. Nearly 20 fund managers and analysts have resigned over the last 12 months, including some major stars. Fidelity has reassigned managers at more than two dozen of its funds.

The extent to which those defections, and Fidelity’s tightening of the reins on its remaining managers, helped cause the subpar stock fund returns in 1996 is probably impossible to quantify. In Vinik’s case, of course, it would have been better to have halted his foray into bonds earlier rather than later. But for other Fidelity managers, how do we know that they wouldn’t have performed better if left entirely to their own instincts?

What is clear, in any case, is that the chances Fidelity stock fund managers regularly took with shareholders’ money between 1991 and 1994--with great success, as it turned out--won’t be taken in the near future.

“They used to load up on stuff that they’d never touch now,” says John Rekenthaler, editor of the Morningstar Mutual Funds newsletter. For example, the heavy emerging-markets stock bets that some of Fidelity’s U.S. stock funds made in the early 1990s aren’t likely to be repeated at the “new” Fidelity.

Is that what shareholders want--less opportunism on the part of Fidelity fund managers and a more religious adherence to category style (smaller stocks, blue-chip stocks, whatever)?

That is definitely what the gatekeepers of the retirement plan business want, says Dougherty. “I think shaking up the managers was a positive thing,” he says.

Yet there still are many Fidelity shareholders who came aboard years ago specifically because Fidelity produced above-average returns. And it’s probably safe to say that many of those investors didn’t care how Fidelity managers generated those numbers--at least they didn’t care as long as the numbers were good.

It is certainly possible for fund managers to excel without reaching outside their funds’ stated asset category, or taking undue risk. In 1997, Fidelity will have to demonstrate that it still knows how to do that--because the media focus on its performance will be relentless.

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Despite the company’s challenges, it’s worth noting that “poor Fidelity” isn’t quite as beleaguered as all the bad publicity might otherwise suggest.

The company still is the No. 1 mutual fund firm by far, with $431 billion in its funds as of Nov. 30, the latest date for which industry rankings are available from tracker Dalbar Inc. Vanguard Group is a distant No. 2, with $244 billion.

Fidelity’s assets grew by $76 billion last year, including new money invested and market appreciation of its portfolios. That was slower growth, in percentage terms, than many of its peers enjoyed. Even so, Fidelity’s market share slipped only slightly from 13.51% of fund industry assets at Dec. 31, 1995, to 13.36% by Nov. 30.

Morningstar’s Rekenthaler views Fidelity’s problems as “way overhyped right now.” Even so, he notes, the painful truth in almost any industry is that “it’s hard to stay No. 1.”

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Performance Begins to Lag

On average, Fidelity’s diversified stock funds beat both the typical U.S. diversified stock fund and the Standard & Poor’s 500 stock index from 1991 through 1994. But Fidelity lagged the S&P; in 1995, and in 1996 it lagged both the S&P; and the typical U.S. fund.

Average total returns: *--*

Group 1991 1992 1993 1994 1995 1996 Avg. Fidelity fund 39.0% 12.6% 18.8% 1.5% 33.8% 17.2% Avg. stock fund 37.2 9.6 13.1 -1.5 31.4 19.6 S&P; 500 index 30.5 7.6 10.1 1.3 37.5 23.0

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Note: Fidelity fund data is for its diversified stock funds; average stock fund data is for all diversified funds, excluding Fidelity funds.

Source: Morningstar Inc.

Still No. 1, But Losing Share

Fidelity still is by far the largest mutual fund company. But its market share slipped last year as a percentage of total fund industry assets. Fund companies ranked by net change in assets between Dec. 31, 1995 and Nov. 30, 1996:

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Nov. 30 assets and change vs. Market share Group end of ’95 (billions) End of ’95 Nov. 30 Fidelity Invest. $431 +$77 13.51% 13.36% Vanguard Group 244 +60 7.02 7.58 Capital Research 175 +37 5.28 5.44 Putnam Funds 112 +34 2.98 3.48 Franklin/Templeton 134 +21 4.35 4.17 AIM Group 60 +19 1.54 1.85 Merrill Lynch 160 +19 5.39 4.96 T. Rowe Price 68 +17 1.94 2.10 Janus Funds 37 +12 0.92 1.14 Oppenheimer Funds 54 +11 1.64 1.67 American Express 58 +10 1.84 1.82

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Source: Dalbar Inc.