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Fidelity's Experience Proves Bigger Doesn't Mean Better

It's not for lack of effort that the Boston behemoth's culture is just average.

Christopher Davis, 05/04/2011

If only the strength of Fidelity's investment culture matched its size.

It's not for lack of effort that the Boston-based behemoth hasn't become the best. No doubt, Fidelity usually has confronted challenges with gusto. It did so in the mid-2000s, for example, after it had become clear that the firm's edge in equity research had diminished. The early 2000s' passage of Regulation FD, which barred public companies from selectively sharing data that could materially affect stock prices, meant it could no longer rely on its access to top executives to obtain information on companies before everyone else. Fidelity spent lavishly in an attempt to retain a research edge, more than doubling its number of equity analysts to nearly 400 worldwide. By the numbers, at least, its analyst army became bigger than just about any competitor.

Fidelity also introduced significant organizational changes, breaking with tradition by hiring experienced analysts and, for the first time, opening a career track for those who didn't want to become portfolio managers. It grouped portfolio managers and analysts into small teams, helping counteract the bureaucratic effects of a large centralized research pool. And it pledged to give its portfolio managers longer tours of duty--a big change of pace for a firm that rightly had been known for high manager turnover.

Bold measures like these had borne fruit before. After poorly timed interest-rate bets and ill-conceived forays into Mexican debt badly hurt many bond funds in the mid-1990s, Fidelity endowed its Merrimack, N.H.-based bond shop with tremendous human and technological resources, creating one of the best fixed-income operations in the business.

The equity-research push has been less successful. Only now, after more than five years since beginning its analyst-hiring binge, is there is hope that its promised benefits have begun to materialize. Early on, the effort was beset by culture clashes, and with a deluge of new faces, portfolio managers didn't know who to trust. With time, the managers became better acquainted with the analysts' investment styles and capabilities. However, challenges remain. Analysts still must communicate their research to literally hundreds of different managers--a daunting task. To cope, analysts frequently give the most face time to managers of the biggest funds because that's where they have the most impact. But this system puts managers--not to mention shareholders--of smaller funds at a disadvantage.

Finding Portfolio Managers--and Keeping Them in Place
Much to its credit, Fidelity has stemmed manager turnover in recent years. Many of its sector-focused Select funds, which had been notorious for their managerial musical chairs, now benefit from experienced, skilled skippers who have been at the helm for a while, at least by Fidelity standards. But measured against the biggest fund families, Fidelity still falls woefully short in this area. Its average manager tenure, at 3.2 years, ranks 24th out of the 25 largest firms.

Such short stints contribute to one of the most maddening aspects of investing at Fidelity: Changes in management frequently lead to sweeping changes in funds' strategies, leaving shareholders with something different from what they signed up for. In 2008, for instance, Fidelity replaced manager Larry Rakers with a group of sector specialists at Fidelity Balanced FBALX, giving its once-eclectic, all-cap stock portfolio a relatively bland, S&P 500-like complexion in the process.

While average tenure speaks to the length Fidelity keeps managers at its funds, it doesn't say anything about its ability to retain talent. Unfortunately, the firm has hardly excelled in the latter regard, either. In the past five years, its annualized average manager-retention rate clocked in at 85%, placing 19th among the 25 largest fund families. It's true that few managers have left for greener pastures and most are dismissed for performance reasons. There's nothing wrong with dismissing perpetual laggards, of course, but that so many portfolio managers have been subpar to begin with calls into question Fidelity's ability to either hire the right people or develop them when they arrive.

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