Are Fidelity Managers Active Enough?

It's tough to beat the market by emulating it, but that doesn't stop money managers at Fidelity and elsewhere from trying. Over at least the past couple decades, fund portfolios have come to look increasingly like the benchmarks they aim to defeat. They know that may make it harder for their funds to stand out, but it also limits the risk of dramatic underperformance. The latter, even over short stretches of times, can cost managers their jobs, especially if shareholders head for the exits as a result.

What's good for fund managers' job security, though, isn't necessarily good for investors. That's one takeaway from a 2009 study by Yale academics Martijn Cremers and Antti Petajisto. The duo developed a simple metric called active share to describe how similar a fund's holdings are to an index's. (A fund with 60% overlap with an index would have 40% active share, for example.) Examining data between 1990 and 2002, the Yale professors found that funds with higher active share--that is, funds that take more risk versus the index--had better long-term returns. Morningstar director of fund research Russell Kinnel came to a similar conclusion focusing on data between 2004 and 2009.

Still, I'm not entirely convinced higher active share itself leads to better performance. A highly active but talentless manager would be an awful combination, after all. More freedom to succeed necessarily means more freedom to fail, so it's all the more important to invest alongside managers who can put it to good use.

On the whole, Fidelity managers don't give themselves a lot of leeway to invest differently from the indexes, at least next to their competitors. Sure, the firm is less restrained than in the late 1990s and early 2000s, when its then-bloated flagship,  Fidelity Magellan (FMAGX), had been taking few risks versus its S&P 500 benchmark. Today's Magellan, though, suggests Fidelity has recaptured some of its old nerve. Under manager Harry Lange, who took charge of Magellan in 2005, active share has nearly always been above 70%, at least double what it was under his predecessor. The eclectic, hard-to-pin-down  Fidelity Capital Appreciation (FDCAX) and the concentrated Fidelity Focused Stock (FTQGX) and  Fidelity Fifty  also scored highly relative to their category peers. These funds, though, were exceptions to the rule: Just 22 of 73, or 30%, domestic, actively managed diversified funds had higher active shares than their category rivals. Only nine landed in the top quartile.

That's the case partly due to size. The most-active Fidelity funds aren't its largest, with Magellan being an obvious exception. Big funds often cope with size by holding hundreds of stocks, resulting in more portfolio overlap with indexes. That's the case with  Fidelity Contrafund (FCNTX), whose assets ballooned in the mid-2000s. Contrafund's active share relative to the S&P 500 Growth Index slipped from 81% in early 2005 to 65% by the beginning of 2008. (It stands at 66% today, which is about average by large-growth fund standards.)

You can't blame size for everything, however. Fidelity as a whole consciously has adopted increasingly index-oriented approaches in recent years. Its multimanager, sector-neutral strategies, adopted at funds like  Fidelity Stock Selector All Cap (FDSSX) and  Fidelity Balanced  (FBALX), are cases in point. It's possible to have indexlike sector weightings and high active share if a fund has a relatively compact portfolio, but that's far from the case here. (Stock Selector, managed by a group of Select fund managers, has 883 holdings.) Those funds' active shares score near the bottom of their categories.

This play-it-safe approach is rarely disastrous. In fact, as you'll see, index-huggers are more likely to post middling, rather than awful, returns. You'll also notice that at Fidelity, at least, taking a less-constrained approach to the index is no guarantee of success.

Who Is Most Active?
 Fidelity Capital Appreciation (FDCAX): You can't put manager Fergus Shiel in a box. He invests in stocks of all market caps and across the value-growth spectrum. His portfolio looks like no index. Its 84% active share is among the highest in the large-growth category. Shiel's willingness to go his own way doesn't always pay off. A big bet on airline stocks hurt in 2008, for example, but it helped drive the fund to big gains in the 2009 rally. Most investors will find it too volatile for a core holding, but it's a great supplement to one.

 Fidelity Magellan (FMAGX): Here's proof that big funds don't have to be bland. At $21 billion, Magellan is smaller than it once was but it's no small fry. Manager Harry Lange has distinguished his portfolio by investing heavily overseas, avoiding big S&P 500 constituents, and by making large sector bets. (His portfolio is currently heavy on industrials.) The fund excelled in 2009's rally and posted strong results in growth-dominated 2007, but Lange's five-year tenure has disappointed. In a sustained growth rally, I'd expect the fund to look better. If it doesn't, I'd cut bait.

Fidelity Independence : Highly active managers require more confidence than usual. It's difficult to have great conviction in the abilities of this fund's skipper, Bob Bertelson. His fast-trading, sector-betting style has been successful in up markets but has been disastrous on the way down, with Bertelson often overstaying his welcome in hot-performing areas. With a poor record at this fund and elsewhere at Fidelity, I'd take a pass.

 Fidelity Fifty : Fidelity isn't a firm where you'll find many concentrated funds, but this one is an exception. Manager Peter Saperstone invests in just 50 to 60 stocks, making his portfolio quite different from broad market indexes. That has cut both ways, with the fund usually performing badly in down markets and faring well in up ones. Saperstone's record was marred by an ugly 2008, but his longer tenure at  Fidelity Advisor Mid Cap (FMCAX) has been more impressive. That's reason to be hopeful about his abilities, though his fund requires a strong stomach to handle the bumps.

The Index-Huggers
 Fidelity (FFIDX): Manager John Avery, this fund's manager since 2002, has varied in his willingness to deviate from his S&P 500 benchmark. After hewing closely to it in the early years of his tenure, he began making bigger bets in the mid-2000s, leading to index-topping results in years like 2007. But after a poor 2008, Avery has reverted to a more sector-neutral strategy. Not surprisingly, returns have been in line with the index's. There's an argument for taking different levels of active risk at different times, but Avery hasn't made a great case for it: His long-term record is middling and returns have been inconsistent, with the fund beating the index about 40% of the time in more than 80 trailing one-year periods since Avery's start.

 Fidelity New Millennium (FMILX): Talk about a turnabout. This fund was once the most distinctive around under former manager Neil Miller, but relatively speaking, its active share under current skipper John Roth is one of the lowest of any at Fidelity. That's not necessarily an indictment of the fund. Roth has delivered respectable results since taking over in mid-2006, eking out little victories in his small bets. I'm not expecting blow-out returns from this fund, but he could end up quietly building a nice long-term record.

 Fidelity Equity-Income (FEQIX): This fund is about as much of a standard-issue value fund as they come. Its top holdings, such as  ExxonMobil (XOM) and  J.P. Morgan (JPM), are old hat by large-value fund standards. No wonder its 55% active share is among the lowest in the category. Veteran manager Steve Petersen has been able to deliver consistent results--the fund has landed in the top or bottom quartile of his group just twice since his 1993 start--but he hasn't distinguished the fund long term. Indeed, the fund's 10-year return trails two thirds of its peers.

 Fidelity Growth & Income (FGRIX): It's back to the future for this offering. Historically, it's been one of the least-active funds in Fidelity's lineup--from 2000-05, it barely rose over 40%. But under Tim Cohen, the fund's manager between 2006 and 2008, it pushed 80%, thanks to his contrarian, sector-betting style. After a disastrous foray into financials in 2008, Fidelity gave Cohen the boot and installed James Catudal, who's brought the fund back to its bland roots. Thanks to Catudal's S&P 500-centric style, the fund's active share, at 49%, ranks in the large-blend category's bottom quartile. With his middling record employing the same benchmark-oriented strategy at prior charges like Fidelity Stock Selector, I find it hard to get behind this fund.