Our Fidelity Wish List for 2006

I have mixed feelings about Fidelity. The firm does many things well, and I believe it tries to do right by its fundholders much of the time. Still, Fidelity is far from perfect, and it has some specific failings that it needs to address. I hardly expect CEO Ned Johnson to listen, but on the off chance that a board member or two has a spare minute to actually think in between reviewing data points on more than 300 funds, here's what I'd like to see.

1. Name an independent chair to the board of trustees that governs the funds.
This is a no-brainer, really. Mutual funds are independent corporations whose boards of trustees hire management firms to run them. It's up to the board to negotiate favorable terms with the management company (in this case, Fidelity), make sure the firm is doing its job in accordance with the terms of the contract, and look out for the best interests of fund owners. Given those responsibilities, it makes no sense whatsoever for the chair of the board to be a fund company insider--that's asking the fox to guard the henhouse.

The SEC agrees (as does the Mutual Fund Directors Forum, a national organization of independent fund directors) and has passed a rule that would have required all funds to have independent chairs by mid-January 2006. But a lawsuit by a group representing business interests has temporarily ground the process to at halt. Moreover, Fidelity CEO Ned Johnson--who is also chair of the board that oversees the Fidelity funds, vehemently opposes the rule.

Fidelity's fund board has repeatedly allowed Fidelity funds to grow too large to manage efficiently. Having an independent chair that is responsible only to fund-owners might help avoid some of these problems.

2. Split the board up so that trustees have a reasonable amount of work.
The board that oversees Fidelity funds is charged with protecting the interests of shareholders in each of the 322 funds run by the firm. They have formed committees to help them get through all the work as effectively as possible, but I think it's nearly impossible to undertake a detailed, independent analysis of every single fund when you're tasked with overseeing so many.

3. Undertake an independent study of capacity across the fund lineup, and close funds that are suffering from asset bloat.
I've criticized Fidelity many times in recent years for letting its mutual funds grow too large. Fidelity executives have consistently said they don't think asset size is an issue at any of the firm's open funds. (They may want to compare the performance of  Fidelity Contrafund (FCNTX) with a smaller fund run by Will Danoff:  Fidelity Advisor New Insights  (FNIAX).)

In any case, what Fidelity thinks is not the issue. The board members make the determination of whether to close a fund, and they're ultimately the ones who should be held responsible if a fund stumbles because its asset base grows too large to manage effectively. ( Fidelity Magellan (FMAGX), anyone?) As such, the board should commission an independent study of the firm's capacity, with a specific focus on the additional costs--including opportunity cost of foregone investments, market impact costs, etc.--imposed by fund size on investors, and close any funds that are in danger of having their performance eroded. (Contrafund and its various clones are the most obvious candidates, and  Fidelity Mid-Cap Stock (FMCSX) and  Fidelity Small Cap Stock (FSLCX) are worrisome.)

4. Stop treating public money as a training vehicle.
Currently, Fidelity trains promising analysts by assigning them to run a sector fund for a year or two, then rotating them to a different sector fund every one to two years until they've gotten experience running money across a broad swath of the market. At that point, the better managers are allowed to run diversified funds when a slot opens up. That's all fine and well from a training perspective, but it means the firm is treating investors in its sector funds like second-class citizens by assigning their assets to managers-in-training.

In my view, sector investors should be entitled to managers that are just as experienced as those at Fidelity's diversified funds. Fortunately, the new executive team at Fidelity appears ready to concede this--at least partially. They've indicated to me that some of the firm's larger sector offerings will have longer-tenured managers going forward. They should go further and put a stop to the practice at all the firm's sector funds, but it's a start.

5. Improve disclosure.
Fidelity deserves credit for making available on its Web site a wide array of information about its funds. At Fidelity.com, investors can now see anything from a Statement of Additional Information to a performance attribution summary.

However, the depth of the information is lacking. Manager biographies, for example, are so vague they are virtually meaningless, and shareholder letters tend to be terse affairs that give relatively little insight into a manager's process and investment philosophy. Fidelity has the ability to be an industry leader here, and should seize the opportunity.

A version of this article appeared in the December 2005 issue of the Fidelity Fund Family Report, our monthly newsletter dedicated to helping Fidelity investors find superior long-term return investment opportunities. To review a risk-free trial issue of the Fidelity Fund Family Report, click here. Fund Family Reports for Vanguard and American Funds are also available.