Do Fidelity Managers Eat Their Own Cooking?

I've taken the lead on Morningstar's Fidelity coverage at an important historical juncture. The one-time king of the U.S. fund industry is undergoing a massive reorganization designed to recapture the throne from upstart competitors such as Barclays Global Investors as well as stalwarts such as American Funds and Vanguard.

In this excerpt from the February 2006 issue of Morningstar's Fidelity Fund Family Report, our monthly newsletter dedicated to helping Fidelity investors find superior long-term investment opportunities, I explore whether Fidelity managers invest heavily in the funds they run. To review a risk-free trial issue of our Fund Family Report on Fidelity Funds, click here. Fund Family Reports on Vanguard and American Funds are also available.

Fidelity has always been a personality-driven shop. The concept of the star portfolio manager was practically born there, with such legendary figures as Gerry Tsai, Peter Lynch, and George Vanderheiden forerunning modern luminaries such as Will Danoff and Joel Tillinghast. The latitude that Fidelity gives individual managers to craft funds in their own image ("Two men can't play a violin," as Fidelity founder Edward C. Johnson II used to say) makes manager ownership a bigger issue at Fidelity than on Vanguard's index funds or on team-managed funds.

In my mind, nothing aligns portfolio managers' interests with those of long-term shareholders quite like "eating their own cooking." A big manager ownership stake is a vote of confidence in a fund's strategy and expenses; it also signals managers' confidence (or lack thereof) in their own abilities. It keeps their time horizons long. And it could make them more mindful of taxes, trading costs, and asset size.

How Much Is Enough?
The SEC requires only that managers report their ownership in broad ranges: less than $10,000; $10,000 to $500,000; $500,000 to $1 million; or $1 million and above.

Although I don't know what Fidelity pays its portfolio managers, I can surmise that it's a tidy sum. Fund directors at less prominent shops than Fidelity have told us that good portfolio managers make $1 million per year after their first or second year on the job. And the Boston Business Journal has reported that, as part of its current hiring spree, Fidelity is offering some experienced analysts salaries of $750,000 per year.

Based on that (admittedly anecdotal) information, I think it's fair to expect seasoned Fidelity managers running core funds to have more than $1 million invested. I certainly don't expect as much for managers of niche funds, and I understand that managers of single-state municipal-bond funds dedicated to a state they don't live in won't be invested. I also know that some countries make it very hard for their citizens to buy foreign-domiciled funds--a fact that Fidelity has made clear to me as well. But whenever possible, I'm looking for a significant commitment.

Naming Names
I'll start with the Fidelity managers who eat their own cooking and move on to those who don't eat enough.

I was most encouraged by the ownership levels of domestic-equity managers. Several have more than $1 million invested in their respective funds, including Will Danoff ( Contrafund (FCNTX)), Rich Fentin ( Value (FDVLX)), Charles Mangum ( Dividend Growth (FDGFX)), John McDowell ( Blue Chip Growth (FBGRX)), Joel Tillinghast ( Low-Priced Stock (FLPSX)), Stephen Petersen ( Equity-Income (FEQIX)), Larry Rakers ( Balanced (FBALX)), Thomas Soviero ( Leveraged Company Stock (FLVCX)), and Tim Cohen (whose ownership information pertained to former charge  Export & Multinational  but who now runs  Growth & Income (FGRIX)).

Beyond equities, I was satisfied with Fred Hoff's commitment of between $500,000 and $1 million in  High Income (SPHIX), given that it's a niche fund. The same goes for Steve Buller's commitment of between $500,000 and $1 million in  Real Estate Investment (FRESX).

Now I'll turn to the negative. On the bond side, I was disappointed to see that long-tenured Ford O'Neil invested only between $10,000 and $50,000 in the stellar  Intermediate Bond (FTHRX) and had nothing in equally fine  U.S. Bond Index  or  Total Bond (FTBFX). Jeffrey Moore didn't even have a token investment in  Investment Grade Bond (FBNDX), nor did Mark Notkin have a commitment to  Capital & Income (FAGIX). Similarly, I can understand that emerging-markets bond manager John Carlson wouldn't bet the ranch on  Fidelity New Markets Income (FNMIX), but I wish he was eating at least a morsel of his own cooking.

Moving on to domestic equity, I was disappointed with both Bob Haber's $50,000 to $100,000 investment in  Focused Stock (FTQGX) and John Avery's commitment of between $100,000 and $500,000 to  Fidelity Fund (FFIDX), given their tenures and their funds' core mandates. The same is true for Ramin Arani's $100,000 to $500,000 commitment to  Trend (FTRNX), Steven Snider's $500,000 to $1 million investment in  Disciplined Equity (FDEQX), and Brian Hogan's $500,000 to $1 million in  Blue Chip Value (FBCVX). Sonu Kalra was new to the  OTC Portfolio (FOCPX) as of its filing, but I still wish he had invested more than between $50,000 and $100,000.

As far as Fidelity's international lineup is concerned, I was disappointed across the board. Bill Bower had only between $100,000 and $500,000 in  Diversified International (FDIVX), which is not much given that he's overseen that fund since 2001 and has been at Fidelity for more than 10 years. In the same investment range is Boston-based Maxime Lemieux, who manages  Canada (FICDX), and Ian Hart, who recently completed a five-year stint on  Europe Capital Appreciation . I understand Lemieux's limited investment--Canada is a niche fund and this is his first management stint--but I wish Hart had invested more.

I found too many foreign managers with goose eggs after their names. I'll give the benefit of the doubt to some of the foreign managers who face restrictions. But that doesn't excuse Bill Kennedy, who didn't own any shares of  International Discovery (FIGRX).

I was probably most disappointed to see the ownership level of Rick Mace, who has been managing money at Fidelity for 16 years. Mace had nothing invested in  Overseas (FOSFX) or  Global Balanced  (both of which he had managed since 1996), nothing in  Worldwide (FWWFX) (since 2001), and between $10,000 and $50,000 in  Aggressive International (FIVFX), which he only took over in September 2005. (Mace is taking a leave of absence until this summer.)

How to Use Manager Ownership Information
I think manager ownership, while a crucial data point, is just one among many that should be considered when evaluating a fund. I didn't need to verify their membership in the Millionaire's Club to know that Joel Tillinghast (Low-Priced Stock) and Charlie Mangum (Dividend Growth) serve shareholders well. And I wasn't sold on John Avery's Fidelity Fund or Rick Mace's foreign funds even before learning of their low-level commitment to their charges.

On the flip side, would I avoid Diversified International because manager Bill Bower isn't eating more of his own cooking? No. It's still an excellent fund, and Bower has done an outstanding job for long-term shareholders. The same is true of Ford O'Neil's Intermediate Bond and Steve Wymer's  Growth Company (FDGRX).

Manager ownership data makes a bigger difference to me for funds in which I have less conviction. Seeing goose eggs after the names of Mark Notkin (Capital & Income) and Bill Kennedy (International Discovery) diminishes the appeal of their funds, as does the low investment amount for Bob Haber (Focused Stock). Conversely, I've gained even more conviction in funds like Blue Chip Growth and Balanced because the managers of those funds (McDowell and Rakers, respectively) are in the Millionaire's Club.

Because there's quite a bit of manager turnover at Fidelity, filings often can't keep up with changes. I'll be watching with interest to see how much new  Magellan (FMAGX) skipper Harry Lange has invested, what his successor on  Capital Appreciation (FDCAX), Fergus Sheil, has committed to that fund, and if Ian Hart is eating his own cooking on Overseas.