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Fidelity Working to Up Its Game

The firm has strong spots, but it needs more consistency.  

Katie Rushkewicz Reichart, CFA, 10/31/2013

Morningstar recently issued a new Stewardship Grade for Fidelity. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is a B. What follows is Morningstar's analysis of the firm's corporate culture, for which Fidelity receives a C. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

Fidelity's impressive size has worked for and against it. As one of the fund industry's biggest companies with roughly $1.5 trillion in assets under management as of mid-2013, the privately held firm has never had a problem pouring resources into areas that benefit the end investor. The scale of its research, compliance, and trading operations are hard to match. However, its size hasn't translated into industry-leading offerings across the board.  

Playing Catch Up
The firm has recently invested heavily in endeavors where it has ceded significant market share to competitors. For instance, in 2013, Fidelity launched Select Co., a Denver-based entity that houses its nascent exchange-traded fund efforts and existing lineup of sector-based "Select" mutual funds, hiring Tony Rochte from State Street and Greg Friedman from iShares and Russell.

While many argue Fidelity was late to the party, the firm has gone about its foray into the ETF market smartly. It partnered with BlackRock BLK (parent of ETF leader iShares) instead of building a passive outfit from the ground up, and in time, Fidelity will look to leverage its long history of sector-based research through actively managed ETFs and custom solutions. (So far Fidelity has only filed for a few actively managed fixed-income funds.) That Select Co. is based outside of Fidelity's Boston headquarters (and has a separate board of directors) could mean the firm thinks this venture needs space to develop its own culture; how that will affect staffing long term, including the mostly Boston-based Select managers (who also feed research to the diversified portfolio managers), remains to be seen.

Elsewhere, the firm has invested heavily in areas where its once-formidable competitive advantages have eroded. A pioneer of target-date funds in the 1990s, Fidelity Freedom Funds long had a stronghold on that market's assets, thanks to the firm's dominance in the 401(k) record-keeping business. However, Fidelity lost significant market share (it dipped from 62.1% in 2005 to 32.4% by the end of 2012) as the funds' performance languished, more innovative competitors sprang up, and investor appetite turned more toward index-based fare. In response, Fidelity shored up its global asset-allocation group, which grew from 36 people in 2011 to 67 by 2013, including hires from the IMF and Barra. As part of the group's reorganization, Bruce Herring was named CIO, leaving his post as equity CIO, where he made inroads in improving risk management and portfolio construction following the equity funds' generally dismal performance during the 2007-09 financial crisis.

With more manpower, the team refueled its research, using revised capital-market assumptions and participant data to justify upping the Freedom Funds' equity exposure to levels similar to Fidelity's biggest competitors, T. Rowe Price TROWand Vanguard. The team also addressed criticism about the bland underlying funds featured in the series by adding investments run by star managers Will Danoff of Fidelity Contrafund FCNTX and Joel Tillinghast of Fidelity Low-Priced Stock FLPSX. While Fidelity could have improved its middling series sooner, it's encouraging that the firm has taken action.

Pockets of Strength and Weakness
Other parts of the company have long been more stable and successful. Fidelity's fixed-income team, which ran about 21% of the firm's mutual fund assets (excluding money markets) as of September 2013, is among the best in the industry. With operations based in Merrimack, N.H., the taxable investment-grade and municipal-bond groups have developed their own tight-knit culture. Managers and analysts work collaboratively, supported by Fidelity's significant investment in proprietary tools, and share a risk-conscious approach. Meanwhile, the high-yield group, based in Boston, boasts an extensive analyst staff and supports a number of well-respected funds. The overall team has enjoyed stability in its ranks, save for the occasional departure, such as Fidelity Floating Rate High Income's FFRHX Christine McConnell, who retired in March 2013 after 26 years at the firm. Thanks to a team-oriented approach, succession planning at individual funds has largely gone seamlessly. Long-term performance has been strong, too: For the 10-year period through September, the median category rank for Fidelity's fixed-income funds was 24. As of September, all but one fund with Morningstar Analyst Ratings were medalists (the lone exception was rated Neutral).

Fidelity hasn't been as consistent on the equity side: Of the 60 equity funds rated by Morningstar analysts as of September, 43% were Neutral.

Katie Rushkewicz Reichart is a senior mutual fund analyst with Morningstar.

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