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Can Fidelity Build a Better Value Shop?

Better known for a sprawling suite of growth funds, Fidelity finally adds muscle to its value lineup. 

Christopher Davis, 05/29/2012

It's hard to become a jack of all trades, but that doesn't stop big asset managers such as Fidelity from trying. Like big competitors such as Vanguard and T. Rowe Price, it houses practically every asset class and investment style under the same roof.

Fidelity's record in mastering different investment disciplines has been mixed. There surely are big bright spots. Its Merrimack, N.H.-based fixed-income operation is top rate, for example, and there are pockets of excellence scattered about the Boston-based equity side of the house.

Success in the value realm has been more elusive, though, especially among large caps. Indeed, as of March 2012, eight of nine Fidelity large-value funds landed in the category's bottom half for the trailing five-year period, while all four with 10-year records lagged their typical rivals. The shop's three mid-cap value funds' five-year records also placed in the bottom half of the pack, with two of three  lagging over the 10-year period as well.

What's Gone Wrong?
While portfolio managers deserve plenty of time to prove their worth, Fidelity left value skippers such as Stephen Petersen and Bruce Dirks at the helm for too long. Petersen delivered relatively consistent results for nearly two decades at Fidelity Equity-Income FEQIX, though overall returns during his tenure, which ended last October, were only middling. Dirks turned in uninspiring returns for roughly six years before Fidelity left him with oversight responsibilities for just one fund--Fidelity Stock Selector Large Cap Value FSLVX (formerly Fidelity Large Cap Value)--in August 2011.

With nondescript strategies, it's not surprising Petersen and Dirks never stood out. Both managers hewed closely to their benchmark, limiting their ability to distinguish themselves from their competitors. And despite his dividend-oriented mandate, Petersen didn't set Equity-Income apart in terms of yield or company quality, so it failed to provide the kind of downside protection you'd expect from a fund of its type.

Fidelity is hardly a stranger to value investing--Equity-Income launched in 1966, after all--but its growth roots run much deeper. Most Fidelity managers focus primarily on companies that can beat earnings expectations, not on those that look cheap. Moreover, a far larger slice of the firm's assets resides in growth strategies: Fidelity's 34 diversified, domestic growth funds account for $240 billion in assets, versus $29 billion for the 12 diversified, domestic value funds. The firm's analyst research reflects this growth bias; Fidelity Stock Selector All-Cap FDSSX, which encompasses the analysts' top picks across major market sectors, lands in the large-growth camp. Although the value managers draw from the same vast analyst pool as their growth counterparts, it may well be that they've had a tougher time putting such research to good use.

How Fidelity Can Get It Right
It may be tough to master both value and growth investing, but it's not impossible. Other big firms, such as T. Rowe Price, have been successful in both realms. Like Fidelity, T. Rowe Price managers rely on the same central analyst team. And its broad lineup, which first included value funds in the 1980s, grew from growth roots. Indeed, the firm's founder, Thomas Rowe Price, pioneered growth investing in the 1950s. It's helped that despite the differences in style, both value and growth investors share moderate, valuation-conscious strategies. Both camps avoid the extremes, neither deep value nor aggressive growth. Fidelity tolerates a wider range of approaches, though, which requires its analyst group to serve a wider spectrum of constituencies. And at least some portfolio managers will have to customize the analysts' research to suit their strategies.

Other rivals have taken different paths. American Century, for example, is perhaps best known for momentum investing, but value offerings such as American Century Equity Income TWEAX are arguably its strongest suit. Unlike Fidelity and T. Rowe, American Century's analyst structure is decentralized, with a compact group of portfolio managers and analysts working in smaller, tight-knit teams. This model isn't inherently superior, but rather than serving different types of masters, analysts and managers are viewing stocks through the same lens.

While T. Rowe and American Century built value lineups from scratch, some have done so by bringing in expertise from the outside. Janus rose on the back of its go-go growth funds in the 1990s, but in the early 2000s it acquired Perkins Investment Management, a highly regarded value shop. Funds such as Perkins Mid Cap Value JDPAX have continued to enjoy success because Janus has let Chicago-based Perkins function autonomously.

Fidelity, however, doesn't need to look as far afield for success stories. Consider Fidelity Low Priced Stock's FLPSX Joel Tillinghast, who looks for companies trading at significant discounts to his fair value estimates--an uncommon line of attack at Fidelity. Tillinghast, who's been at the helm since 1989, has one of the fund industry's best records. Chuck Meyers, a Tillinghast protege, isn't as seasoned, but he's built strong long-term records both at Fidelity Small Cap Value FCPVX and Small Cap Discovery FSCRX. Tillinghast not only has been adept in adapting Fidelity's research to suit his unique style, but to a remarkable degree he does much of the legwork himself. Meanwhile, Meyers has relied not on Fidelity's central analyst pool but a dedicated small-cap team. This team serves as a small group of portfolio managers, so it's easier for them to serve up picks that square with his approach.

Old Funds, New Guises
Fidelity recently has taken steps to right its value ship. It ditched longtime underperformers such as Stephen Petersen of Equity-Income. The successors have been more willing to deviate from their benchmarks, improving their chances of outperformance. And while Fidelity has hardly abandoned its central research model--in fact, its analyst team is larger than ever--it established a group of experienced sector specialists who cover stocks with a value-oriented perspective. This six-member group helms Fidelity Stock Selector Large Cap Value, but other managers can draw upon their research, countering the shop's growth-leaning bias.

Fidelity hasn't gone as far as Janus to purchase talent to supplement its lineup, but it poached an experienced value investor, Michael Chren from PNC, to head up Fidelity Blue Chip Value FBCVX, giving him considerable autonomy from the parent organization.

On the whole, these changes argue for cautious optimism. Chren's solid record running PNC Large Cap Value PALVX from 2004 to 2008 is encouraging. It could be helpful that he operates from an office in Florida with his own three-person analyst team who all share a deep-value discipline--a style in short supply at Fidelity. New Fidelity-Equity Income skipper Jim Morrow is more willing to diverge from his benchmark than his predecessor and has beefed up its yield, which could better set the fund apart. Stock Selector Large Cap Value's team is experienced, and while its multimanager approach is new to Fidelity, it's within the firm's longstanding tradition of company-by-company research. Even so, it's tough to pound the table for any of these funds just yet--Chren has gotten off to a poor start, Morrow's record at his previous funds is merely decent, and the Stock Selector team is unproven.

The best bet looks like Fidelity Dividend Income FEQTX, until recently named Fidelity Equity-Income II. New manager Scott Offen aims to produce a pre-expense yield at least 1.5 times the S&P 500's--a departure from his predecessor's secondary income focus. He's a 10-year veteran of Fidelity Value Discovery FVDFX, where he delivered consistently good results. (He stepped down from that fund to head this one.) Offen could invest without market-cap, sector, or yield constraints at Value Discovery, but he won't have that flexibility here. It's not clear he'll fare as well using a more-restrained approach, but for now, this is likely Fidelity's best large-value offering.

Christopher Davis is a senior fund analyst with Morningstar and editor of Morningstar's Fidelity Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. He welcomes e-mail but cannot give investment advice. Click here for a free issue of the Fidelity Fund Family Report.
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