Here's what the credit crisis tells us about Fidelity.
Christopher Davis is editor of Morningstar's Fidelity Fund Family Report, a monthly newsletter that offers independent guidance on the fund family and helps investors find the best Fidelity funds.
"Adversity reveals genius, prosperity conceals it," said the ancient Roman poet Horace.
Something tells me he probably wasn't talking about investing--that is, unless the Roman Forum had a stock exchange I don't know about. But he easily could have been. In bull markets, nearly anyone can make money, obscuring who's really talented and who's merely lucky. Downturns, however, put investors' skills to test.
This year has been some test. The U.S. financial system has more or less teetered on the brink thanks to tanking housing prices and the resultant credit crisis. Icons of American finance, ranging from Bear Stearns to Merrill Lynch, have either disappeared altogether or into much-larger organizations. And firms too big to fail--Fannie Mae
In this article, I'll look at how well Fidelity funds have navigated the credit crisis and explore what their recent performance says about Fidelity's research capabilities.
Fidelity and Financials: The 360-Degree View
Financials are prime stomping grounds for value funds, so the credit crisis has hit them especially hard. Fidelity's growth-leaning lineup, however, has helped insulate it from financials' fall. Fidelity managers generally look for earnings growth, and you won't find much of that among financials these days. Not surprisingly, most Fidelity funds (though not an overwhelming majority) have less exposure to financials than the competition. Indeed, 59 of 109--or 54%--of diversified domestic and foreign equity funds had below-average financials weightings versus their category peers as of August 2008.
To be sure, Fidelity was shedding its holdings in many troubled financials stocks in the spring and summer. According to Fidelity's most-recent SEC filing of its firmwide holdings, the firm had pared back in its exposure to Lehman Brothers by 20% in 2008's second quarter. (By July, only nine Fidelity funds had more than 0.5% of assets invested in the stock.) It also deserves credit for scaling back on Morgan Stanley
Even as Fidelity was pulling away from some distressed financials, it was moving toward others. Goldman Sachs
Bank stocks with stronger financial positions, such as J.P. Morgan Chase
Try to Catch a Falling Knife and You Might Get Cut
If your research centers around spotting companies with improving earnings, you might not be quite as good at analyzing depressed firms. I'd be painting Fidelity with too broad a brush to say it hasn't or couldn't be successful investing in deep-value fare. But lately, it has run into trouble. Take Fidelity Magellan
As poor a year as it has been for Magellan, Fidelity Growth & Income
Fidelity's focus on earnings growth proved helpful in other instances, especially at Fidelity Contrafund
Is Fidelity's Financials Research Up to Snuff?
Managers that dodged the bullet may have done so in spite of Fidelity's financials research, not because of it. One big reason to doubt the firm's capabilities is the bruising 55% loss Fidelity Select Financial Services
If they are, I can't say I blame them. In the April 2008 Fidelity Fund Family Report, I explained my own doubts, with my chief concern being that Manuel may be too confident in his ability to assess tough-to-buttonhole risks. In Morningstar's 2007 visit to Fidelity, Manuel told a couple of my colleagues that he and former comanager Brian Younger were convinced they could precisely calculate Citigroup's exposure to subprime mortgages--a feat that Citigroup itself couldn't pull off. Since then, he hasn't exactly bolstered my confidence. Even as Fidelity as a whole was paring its exposure to the likes of Lehman Brothers and Morgan Stanley during the summer, Manuel was adding to his positions. In August, he also ramped up his stakes in Fannie Mae and Wachovia--right before the former fell into government conservatorship and the latter plunged and agreed to sell itself at a fire-sale price. Manuel tried to more defensively position his portfolio by tilting it in favor of insurers, but with AIG as his top insurance pick, that move backfired as well.
Fidelity only recently added Hesse, also manager of Fidelity Select Brokerage & Investment
I'm pretty sure how managers play financials now and in the near future will have a big impact on returns for years to come. And if Fidelity managers are apprehensive about their firm's research, I'm concerned they won't be in as strong a position to take advantage of the downturn as they should be. Having the chance to speak with Manuel, Hesse, and the other financials-focused Select fund managers might help boost my confidence, but Fidelity wouldn't make any of them available for an interview when we asked in September.
What Should You Do?
In confronting just about any crisis, you face only two choices--fight or flight. The flight response in this instance would involve moving your portfolio into cash. If you flee, you're locking in your losses at a moment when stocks are more likely to be closer to the bottom than the top. Moreover, you'll have to the none-too-easy task of deciding when to get back into the market. None of us will know when the next bull market has begun until it's well under way. Often the biggest returns come at the beginning of a rebound, and if you're out of the market, you'll miss out.
Staying in stocks will require a strong stomach. But as the great investor Shelby Davis (no relation) once put it, "You make most of your money in a bear market. You just don't realize it at the time." What he meant was that bear markets afford you the opportunity to buy great investments at bargain prices. As I noted earlier, buying beaten-down stocks isn't necessarily Fidelity's strong suit. But that doesn't mean Fidelity investors need to be left in the cold. Fidelity's no-transaction-fee FundsNetwork offers access to some terrific bargain-hunters. FPA Crescent
I still think we're in the early innings of this credit crunch. Its implications, and those of Washington's much-discussed $700 billion Wall Street rescue, are yet to be fully known. In the coming months, I'll be discussing more what it means for Fidelity and your portfolio in the Fidelity Fund Family Report. In the meantime, I'd hang on tight and take your Pepto-Bismol. You'll need it.
Christopher Davis is a fund analyst with Morningstar.
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