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An Upgrade for Fidelity Equity-Income

Robby Greengold

The following is our latest Fund Analyst Report for Fidelity Equity-Income (FEQIX) (). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Fidelity Equity-Income's capable leadership and below-average expenses tip the odds of success in its favor. The fund's Morningstar Analyst Rating has been upgraded to Bronze from Neutral.

At the start of 2018, Ramona Persaud officially replaced Jim Morrow, who ran the fund for six years and has since left the firm. Her tenure is brief, but her income-oriented investment expertise is deep. Since 2012, she has guided Fidelity Global Equity Income (FGILX) to stellar results on both an absolute and risk-adjusted basis while packing more than 40% of its assets in domestic equities. On that mandate, she seeks rich-yielding stocks and applies a conservative approach to capital appreciation--her paramount objective is downside protection, but she also wants respectable upside. She's adeptly met that goal by losing much less than the MSCI ACWI High Dividend Index during market pullbacks.

Here she has a new benchmark (the Russell 3000 Value Index) and a 20% cap on international stocks but uses an otherwise identical approach. While international equities won't play a big role here, Morningstar attribution at Fidelity Global Equity Income shows strong stock selection in the U.S., which lends credence to Persaud's ability to outperform in a domestic context as well as global.

Persaud also ran  Fidelity Dividend Growth (FDGFX) (2014-18), which lagged its S&P 500 benchmark during her tenure. That isn't entirely surprising: The large-blend fund was more valuation-sensitive than the index, and her tenure coincided with a period that favored growth.

This fund plays to Persaud's strengths given its value orientation. At the stock level, Persaud prefers unloved businesses from which investors don't expect much. Her interest is piqued when low expectations are applied to firms with relatively high and stable profits, strong free-cash flow generation, and competitive moats. In her view, a portfolio of inexpensive, high-quality dividend-payers should outperform on a risk-adjusted basis over time.

Process Pillar: Neutral | Robby Greengold 03/06/2018
Manager Ramona Persaud intends to assemble a portfolio with lower volatility and higher yield than the Russell 3000 Value Index.

Persaud focuses on valuations, quality, and capital allocation and wants the fund's returns to be driven by stock selection rather than style or sector biases. She uses a quantitative screening model to sift through a universe of 2,500 U.S. stocks and a few hundred foreign ones. Stocks are ranked on valuation (price/cash flow is an element here), quality (ROE, ROIC, balance sheet analysis) and sentiment (earnings momentum, short interest, mean reversion), in addition to other factors.

With the investable universe pared down, Persaud digs deeply into the fundamentals of the surviving stocks. She likes firms possessing competitive moats because they tend to offer stable ROICs; she thinks highly cyclical or volatile revenues and profitability tend to signal a low-quality business. Healthy free-cash flow generation is important, so she'll mostly steer clear of heavily capital-intensive firms. The ideal portfolio company offers stable and predictable cash flows, which means there won't be many cyclicals in this fund.

The approach has shown promise at Persaud's global strategy, but she's taking on a much larger asset base here, more than $15 billion. The approach needs to prove itself at a U.S.-centric mandate of this size, and so the fund receives a Neutral Process rating.

The portfolio reflects Ramona Persaud's investment philosophy and process. Her attention to quality reveals itself through the portfolio's aggregate profitability ratios and preference for competitive moats. As of January 2018, the fund's 19.4% returns on equity soared above the Russell 300 Value bogy's 11.5%, and the fund had 89% of its assets in firms with wide or narrow Morningstar Economic Moat Ratings versus the index's 80%.

Persaud intends to maintain a portfolio of 150-200 stocks with 40%-70% annual turnover. As of January 2018, large- and giant-cap companies together soaked up 87% of the fund's assets, while small- and micro-caps were allocated less than 2%. Persaud departs from the domestically oriented Russell 3000 Value Index by investing in attractively valued dividend-payers overseas. She can invest up to 20% of the fund's assets in foreign stocks, which in January included mostly multinationals paying stout dividends such as British American Tobacco PLC (BATS).

Beyond investing in dividend-paying common stocks, the fund can invest up to 5% into a sleeve composed of high-yield bonds, convertible bonds, and preferred stocks. Fidelity veteran Adam Kramer is responsible for conjuring and vetting those ideas, as he has on this fund since 2011. Finding few attractive nonequity opportunities, those holdings altogether amounted to less than 50 basis points of the portfolio in January.

Performance Pillar: Neutral | Robby Greengold 03/06/2018 
The fund receives a Neutral Performance rating as Ramona Persaud took over as sole manager in January 2018 and is not responsible for its long-term record.

Predecessor Jim Morrow ran the fund from late-October 2011 through 2017. Its 12.3% annualized gain during that time lagged its benchmark, the Russell 3000 Value Index, by 1.5 percentage points and landed in the large-value category's bottom third. It places similarly on a risk-adjusted basis. The fund also didn't keep up with dividend-focused benchmarks such as the WisdomTree Dividend and FTSE High Dividend Yield indexes, falling short of those bogies in nearly every rolling three-year period. Performance attribution during Morrow's tenure indicates little value added in any particular sector by stock selection.

Persaud has built an impressive track record at Fidelity Global Equity Income, the global analog to this fund. Since its May 2012 inception through February 2018, that fund's 10.4% annualized gain outpaced the MSCI ACWI High Dividend Yield by more than 2 percentage points. Those solid returns came with much lower volatility, translating into outstanding risk-adjusted returns. Her performance at Fidelity Dividend Growth underwhelmed, however. In her four years leading that charge, the fund's 10.6% annualized return trailed its S&P 500 benchmark by 2.5 percentage points.

People Pillar: Positive | Robby Greengold 03/06/2018  
On Jan. 1, 2018, Ramona Persaud took the reins from Jim Morrow, who left the firm. Persaud is well-prepared to lead the fund given her experience running other dividend-focused strategies, meriting an upgrade of this fund's People rating to Positive from Neutral.

Persaud is no stranger to this mandate. She had managed a small portion (around 5% of assets) since October 2011, where she focused on foreign dividend-paying stocks. She's now responsible for both foreign- and domestic-stock picks, and her success running Fidelity Global Equity Income suggests she's primed for the challenge. Roughly 43% of that fund has been devoted to U.S. stocks on average in her six years managing the fund, and Morningstar Attribution versus the MSCI ACWI High Dividend Index shows strong U.S. stock selection.

When she took over this fund, Persaud stepped away from Fidelity Dividend Growth, which she'd headed for four years. That fund generated relatively mediocre gains versus its S&P 500 benchmark on her watch, partly owing to her aversion to the sort of pricey and dividend-free fare that fueled the index's gains. Persaud joined the firm in 2003 and was soon put in charge of two sector funds--Fidelity Select Construction & Housing (FSHOX) and Fidelity Select Banking (FSRBX)--which she ran for two years apiece. She also served as an assistant manager at  Fidelity Diversified International (FDIVX) from 2008 to 2010.

Parent Pillar: Positive | 04/18/2017 
Long one of the industry's biggest asset managers, Fidelity has faced pressure as investors have pulled money from the active U.S. equity funds for which the firm is best known. While significant outflows could gravely impact some firms, Fidelity is shielded by its diverse mix across asset classes (including its own competitively priced index funds), success in other business lines, and private ownership that helps it escape quarterly earnings scrutiny.

The asset-management division remains well-staffed amid cost-cutting across the firm. Still, the firm could stand to rationalize its active-equity fund lineup: There are many redundant or mediocre funds alongside the standouts run by longtime star managers and up-and-comers. Retaining talent remains critical, particularly following the unexpected retirement announcement of a talented young small-cap manager. To its credit, Fidelity has handled equity manager transitions better than in the past. Meanwhile, Fidelity's fixed-income division remains among the industry's best, with a team-oriented approach assuaging key-person risk. Fidelity's target-date funds have improved, and the firm's technology and trading resources remain topnotch.

Even as it has raced to address competitive headwinds by unveiling a handful of factor-based exchange-traded funds, Fidelity remains capable on the actively managed side, earning a Positive Parent rating.

Price Pillar: Positive | Robby Greengold 03/06/2018 
Competitive fees earn the fund a Positive Price Pillar rating. The large-cap no-load shares charge a net expense ratio of 0.67%, which is 23 basis points lower than the median of similarly sold peers. The retirement K shares are also attractively priced, sporting a Below Average Morningstar Fee Level versus its comparable rivals.

Robby Greengold does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.