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Will Fidelity Magellan Take a Nine-Figure Pay Cut?

Big dollars are riding on the fund's near-term returns.

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Fidelity Magellan's (FMAGX) expense ratio may be on the verge of declining. That's good news for shareholders, and not-so-good news for Fidelity.

Why the potential fee cut at Magellan? One word: performance. Many of Fidelity's retail funds, Magellan among them, sport performance-based adjustments to their expense ratios. Put simply, the better their returns versus a benchmark index over the trailing three years, the more Fidelity gets paid, up to 20 basis points (or 0.20%) over the base expense ratio. Similarly, if a fund's performance trails the index over that period, as many as 20 basis points could be lopped off the base expense ratio. Twenty basis points may not sound like much, but at a huge fund like Magellan, they add up to a hefty sum.

To understand Magellan's current situation, one must look back a few years. When the Asian economic crisis hit in 1998's third quarter, technology stocks got pummeled. Sensing a buying opportunity, many of Fidelity's diversified-fund managers, including Magellan's Bob Stansky, loaded up on the sector's shares. Among Stansky's picks were some huge winners such as AOL, which is now part of AOL Time Warner (AOL). Magellan delivered an exceptional gain in the ensuing months, returning 36.6% during the half year ended March 1999. Meanwhile, the S&P 500, which serves as the benchmark index for the fund, gained "just" 27.3%.

Scott Cooley does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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