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Among the High-Yield Category's Most Aggressive

Silver-rated Fidelity Capital & Income is bold, holding lower-rated bonds and loans and shifting assets to equities.

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The following is our latest Fund Analyst Report for Fidelity Capital & Income (FAGIX). 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.

Manager Mark Notkin has demonstrated skill in security selection and managing Fidelity Capital & Income's (FAGIX) admittedly significant risks through a credit cycle, posting excellent returns. That record, low fees, and notable research resources support this fund's Morningstar Analyst Rating of Silver.

During Notkin's tenure, which includes a sharp rebound in high yield from the depths of the credit crisis, the fund's willingness to hold significant stakes in the lower-quality tiers of the junk-bond market, as well as strong security selection, have boosted returns. The fund has often held a large equity allocation of up to 20%, and while that caused some drag in 2016 as high yield was even hotter, the feature has been helpful during other periods. For the year through August 2017, for example, the fund's stock sleeve blew past the high-yield sector and the S&P 500, according to Notkin. The fund posted an 8.6% gain, placing near the very top of its (distinct) high-yield Morningstar Category peers.

Notkin's approach is not all offense. He built a 20% cash stake going into 2008, which provided dry powder coming out of the credit crisis. More recently, he has held an uncharacteristic underweighting to CCC rated bonds, including in 2015. That, along with a relatively small position in the struggling energy sector and strength in several equity names, held the fund to a 0.9% loss for that year, ahead of most peers. Notkin also pointed out in mid-2017 that he had been keeping the bond portfolio less aggressive based on valuations, which lent some risk balance to his stock allocation, then led by names such as Alphabet (GOOG), Facebook (FB), and Alibaba (BABA).

The fund's high returns come with a hefty dose of risk. Even with Notkin's move to raise cash ahead of the crisis, the fund lost 32% in 2008, trailing most peers; it also lost a near-category-worst 11% in 2011's rocky third quarter. Notkin has seen better value in equities lately, but with stocks running at the high end of the fund's historic range, it's vulnerable to a sharp sell-off in the stock markets. For those with an aggressive bent, though, it remains a great choice.

Process Pillar: Positive | Eric Jacobson 09/25/2017
This fund is among the high-yield category's most aggressive. At times, manager Mark Notkin has had significant allocations in bonds and loans rated CCC and below, exposing it to greater default risk than many peers. By 2007, for example, he had built big positions in several large leveraged-buyout deals done during the 2005-07 boom, just as others were sounding alarm bells. When Notkin thinks high-yield valuations look comparatively rich--as he did in mid-2017--he'll shift assets into equities. Those stakes have typically included companies with a lot of debt on their balance sheets, though Notkin has noted that 50% have been companies with investment-grade-level credit in recent years, and he has owned notable growth names, too.

Such boldness in the wrong hands can be disastrous. But Notkin has stayed nimble and has shown a keen sense of timing, which supports this fund's Positive Process rating. He uses cash as a buffer when the high-yield market sours, most notably when he packed 20% of the fund away there during 2008's painful second half; he quickly put that to work to take advantage of record-cheap prices in early 2009. He's also proved discerning in picking through the market's troubled names. Notkin has run the fund with a significant underweighting to energy during the past couple of years, for example, and has argued that valuations have not been compelling enough to offset the risk in many names.

Coming out of the credit crisis, manager Mark Notkin astutely concluded that there were better deals in bonds and loans than stocks. So he added to some of the fund's aggressive leveraged buyouts, which proved to be survivors, such as real estate brokerage firm Realogy RLGY. He also successfully dabbled in distressed debt, including the senior loans of General Motors GM. The fund's stake in bonds and loans rated CCC or below topped out at close to a third of the portfolio in 2009.

By 2010, junk bonds had rebounded, and Notkin started to rein in the fund's exposure to the riskiest bonds and loans, citing relatively meager absolute and relative yields. He significantly reduced the fund's stake in CCC rated bonds and loans, and while off its lows, that 12% exposure as of June 2017 remained at a below-market weighting, as had the fund's allocation to the troubled energy sector.

As Notkin dialed down the fund's credit risk, he increasingly found opportunities in equities, which he continues to view as cheap relative to high yield. As such he has kept the fund's equity stake in the 20% range, which has included aggressive names such as Alphabet, Facebook, and Alibaba, the last of which was a big contributor in 2017, along with Skyworks Solutions (SWKS) and United Rentals (URI). That has stood out notably in a category where many funds have held little or no exposure to common stock.

Performance Pillar: Positive | Eric Jacobson 09/25/2017
Given this fund's bold predilections, there's rarely any question about which side of a bull or bear market it will land on. After being punished in 2008 with a 32% loss, which lagged 114 of its 128 distinct peers in the high-yield bond category, the fund rocketed back with a near category best 72% gain in 2009. Unsurprisingly, the fund struggled in 2011's third quarter but flourished in the credit- and equity-friendly markets of 2012 and 2013.

The fund's performance in recent markets has reflected the fortunes of its relatively hefty equity stake. In 2014, for example, its 6.1% gain outpaced all of its peers' in a rocky market for high yield, thanks in part to strong performance in equity names, including chip supplier Skyworks, which climbed 155% that year. And while 2017 has provided a healthier climate for both high yield and equities, Notkin's stock picks--including big help from names such as Alibaba, Skyworks, United Rentals and Air Canada (ACDVF)--helped that sleeve beat the S&P 500, and the fund to pace most of the category.

There's no denying that it's been a wild ride here: The fund's 10-year standard deviation is one of the highest in the category. However, those who have stuck with this fund have been well rewarded, and the fund earns a Positive Performance rating. Its 9% annualized return during Mark Notkin's tenure through August 2017 is among the best in the category.

People Pillar: Positive | Eric Jacobson 09/25/2017
Manager Mark Notkin started out as a credit analyst in Fidelity's high-yield group in 1994 and began managing portfolios a couple of years later. He's run the high-yield segment of the multisector-bond fund Fidelity Strategic Income (FSICX) since 1999, and he took over this fund in 2003. He is one of Fidelity’s "opportunistic" managers, but there's no question his style can be aggressive. His demonstrated skill and the resources backing him earn the fund a Positive People Pillar rating.

That said, while Fidelity's analyst ranks generally defy much criticism given the quality and number the firm is typically able to hire, there has been reason for scrutiny. The firm's analyst team has a reputation as a stepping stone for those seeking management roles, rather than as a destination for careers. While the firm recently added four to its high-income team, more than a third its 21 analysts (not including associates and bank-loan and quant specialists) had a year or less of experience working at Fidelity as of September 2016 (the firm hadn't updated this data at the time of publication) while their median experience at the firm was only two years. The group's median analyst by industry tenure, meanwhile, wasn't even in the business during the financial crisis. That's not an indictment, but it's meaningful given how crucial experience and fundamental research are in the high-yield sector.

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 | Eric Jacobson 09/25/2017
The fund's expense ratio has bounced around within a few basis points during the past few years, most recently clocking in at 0.73%, up from 0.71% in 2014. At this stage, that figure places as below average relative to other no-load high-yield bond funds, earning a Positive Price Pillar rating, but it is worth keeping an eye on.

Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.