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A Look at Fidelity’s Tax-Exempt Lineup

Fidelity’s municipal-bond funds are worthy of note.

Morningstar, 11/24/2015

Fidelity may be known for its equity effort, but it has quietly built an impressive lineup of fixed-income funds. We've previously highlighted the firm's taxable lineup, but its tax-exempt funds are similarly noteworthy, with six funds earning Morningstar Analyst Ratings of Gold and one earning a rating of Silver.

Fidelity's municipal-bond team is as concerned about meeting investors' expectations for safety as delivering competitive total returns. It avoids tools that can add volatility, such as leveraged inverse-floaters, and keeps each fund's duration close to that of its designated benchmark without using derivatives to hedge interest-rate exposure. And unlike more-yield-focused rivals, the team won't load up on lower-quality bonds or rockier sectors such as tobacco just to boost returns. Although these funds might not top their respective categories in healthier credit markets, Fidelity's approach has offered solid downside protection in rocky muni markets and has led to solid results over the longer haul.

At the core of this lineup's appeal is its experienced and well-resourced team.  Comanagers Jamie Pagliocco, Mark Sommer, and Kevin Ramundo took the helm of these funds when former lead manager Christine Thompson became the chief investment officer of Fidelity's bond group in 2010. All three bring complementary skills to the mix: Ramundo came from credit research as a longtime healthcare analyst, Pagliocco came from trading and now heads the muni portfolio management group, and Sommer came from quantitative research.

Strong collaboration among different team functions--trading, credit research, portfolio management, and quantitative research--also sets this group apart. Fluid communication links the team together. The portfolio managers, traders, and a quant analyst sit at the same desk and use analytical tools designed to disseminate information across the team. Proprietary systems allow the team to review hundreds of risk factors for each fund as well as dissect information regarding performance and volatility attribution on a sector and individual security basis. The group draws on a deep research bench of 10 research analysts and nine associates. The team saw some turnover among the analysts in the past 24 months yet has not seen any departures since then, and this remains a solid effort.

Finally, most of these funds rank among the cheapest available to no-load fund investors in the muni market, which complements this team's cautious style.

Fidelity Tax-Free Bond FTABX and Fidelity Municipal Income FHIGX 
Fidelity Tax-Free Bond and Fidelity Municipal Income are the team's largest entrants in the muni national long Morningstar Category. Both earn Morningstar Analyst ratings of Gold, having delivered solid long-term records with below-average volatility and super-low expenses over the longer term. The team also offers Fidelity Advisor Municipal IncomeFAMUX, which features fees that are mostly just average when compared with similarly distributed share classes; as a result, it earns a Morningstar Analyst Rating of Silver.

Kevin Ramundo recently took the lead at Fidelity Tax-Free Bond but still works very closely with its former lead Jamie Pagliocco, who heads up the effort on Fidelity Municipal Income. Beyond that, the most significant difference between the funds is their target investment universe. Fidelity Tax-Free Bond will normally not invest in municipal securities whose interest is subject to federal Alternative Minimum Tax. As of Sept. 30, 2015, nearly 5.0% of Fidelity Municipal Income's assets were subject to the AMT.

In addition, the funds feature slightly different initial minimum investments and expense ratios. For those who can meet the $25,000 initial minimum investment, Fidelity Tax-Free Bond's 0.25% expense ratio, which includes the effect of a long-standing fee waiver, ranks among the cheapest available to no-load fund investors. And those low fees really pack a punch: During the past decade, the fund's gross return lands below the category median, reflecting in part the fund's relatively low-risk approach. After fees are factored in, the fund's 4.9% annualized total return through October 2015 topped nearly 85% of the pack.

Although the 47-basis-point expense ratio of Fidelity Municipal Income is a bit higher, it still ranks low among no-load fund offerings. With that comes a lower initial minimum investment of $10,000. This fund's 4.7% average annual return over the 10 years ended Oct. 31, 2015, topped more than 75% of its category rivals.

Fidelity Intermediate Municipal Income FLTMX 
Fidelity Intermediate Municipal Income is one of only two Gold-rated funds in Morningstar's muni national intermediate category. Mark Sommer takes the lead manager role here, supported heavily by Pagliocco and Ramundo. The fund offers a familiar and attractive package that combines low volatility and solid returns over a market cycle.

The team's sizable analyst staff gives Sommer a head start in identifying mispriced pockets of the muni market. Recent favorites include hospital-revenue bonds, which the team favors as possible takeover candidates, and a handful of state general-obligation bonds, including those issued by California, which the team has picked up when they periodically cheapened considerably relative to the broader market. The team steers clear of leveraged structures and the market's rockiest sectors such as tobacco and troubled names such as Puerto Rico.

Over the longer haul, such moves have helped the fund to an appealing long-term record. Considering risk-adjusted returns, this fund's 10-year Sharpe ratio beats all but a few of its category peers, while its standard deviation remained among the lowest in the group during the same period.

Fidelity Limited Term Municipal Income FSTFX 
This Gold-rated fund shares many of its siblings' strengths. Mark Sommer takes the same straightforward and risk-conscious approach that has fared so well at the team's other charges. This careful approach is well-suited to the fund's niche at the short end of the muni-bond universe and helped it stay out of trouble in 2008.

This portfolio does generally carry more interest-rate risk compared with its category peers. Sommer keeps the fund's duration (2.7 years as of Oct. 31, 2015) close to that of its benchmark, the Barclays 1-6 Year Municipal Bond Index. That bogy's duration tends to run longer than the typical muni national short fund's and, as a result, this fund can be a touch more vulnerable than its peers to losses when muni yields spike. Despite that, the fund held up relatively well in 2013's tumultuous bond markets, aided by its focus on higher-credit-quality bonds. It continued its solid run in 2014 and 2015. During Sommer's tenure, which began in January 2003, the fund has topped over 60% of its category rivals.


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