Fund Spy

A Distinctive Approach to Real Estate Investing

David Kathman, CFA, Ph.D.
The following is our latest Fund Analyst Report for Fidelity Real Estate Income (FRIFX). 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. 

Fidelity Real Estate Income's manager has continued to do a fine job of executing its distinctive strategy, helping the fund maintain its Morningstar Analyst Rating of Bronze.

This can be a tough fund to evaluate in many ways. Its historical returns appear to be all over the place at first glance; each year from 2007 through 2016, it ranked in either the bottom quartile or top quartile of the real estate Morningstar Category, including four years in the top decile and two years in the bottom decile. However, those numbers are misleading, because the fund's distinctive approach means that less than half of the portfolio is typically in real estate common stocks, so the real estate category isn't a very good basis for comparison.

Manager Mark Snyderman, who has been in charge since the fund's 2003 inception, aims for a higher yield than real estate stock funds and investment-grade bond funds, but with less volatility and interest-rate sensitivity. To do this, he draws from the entire capital structure of real estate companies, so that in addition to common stocks (which currently make up less than a third of the portfolio), there are big chunks of real estate preferred securities, commercial mortgage-backed securities, and real estate corporate bonds. Those tend to have higher yields but lower total returns than REIT common stocks, with better downside protection in most markets.

Compared against a custom benchmark consisting of 20% real estate common stocks, 40% REIT corporate bonds, and 40% REIT preferred securities, this fund looks pretty good. Its annualized returns have handily beaten that custom benchmark from inception through Sept. 30, 2018, and its standard deviation (a common measure of volatility) has been much lower. In addition, as of Sept. 30, 2018, the fund's 12-month yield of 4.11% was more than twice the category median of 1.96%. Invesco Global Real Estate Income (ASRAX), a global REIT fund with a similarly broad mandate, has higher total returns than this fund over the past 15 years, but with much more volatility, a slightly lower yield, and a significantly higher price tag.

Process Pillar: Neutral | David Kathman, CFA, Ph.D. 10/25/2018
This fund has a distinctive, income-oriented approach that's dependent on manager Mark Snyderman, earning it a Process Pillar rating of Neutral. It aims to achieve a better yield than pure real estate equity funds and most bond funds, but with less volatility and interest-rate sensitivity. To achieve this, Snyderman invests in a diverse mix of commercial real estate security types ranging across the capital structure: common stock, preferred stock, commercial MBS, and real estate corporate bonds. Historically, 30% or less of the portfolio has been in REIT common stocks, with roughly 10%-30% in preferred stock, 15%-30% in CMBS, 25% to 50% in corporate bonds, and 0%-10% in cash and other.

With the help of Fidelity’s research analysts and visits with company management, Snyderman keeps track of all the major real estate companies in the fund’s universe, thinking about their entire capital structures. His fundamental research focuses on such factors as balance-sheet strength, property quality, cash flows, quality of company management, growth rates, debt/property value, debt yield, and covenants. When he finds a fundamentally strong company, Snyderman determines which of its securities (common stock, preferred stock, bonds, and so on) is most attractive in terms of valuation, yield, or other fundamentals before deciding what to add to the portfolio.

As of June 30, 2018, this fund's portfolio consisted of 32% common stocks (primarily REITs), 19% preferred stock, 19% CMBS, and 23% corporate bonds. The common stock weighting, 89% of which is in the real estate sector, is about as high as it has been since the fund's 2003 inception and has stayed fairly steady since mid-2013. Manager Mark Snyderman thinks real estate stocks are currently cheap relative to real estate bonds and the value of the underlying securities, even though they're somewhat expensive relative to the broader stock market. Conversely, the fund's 23% weighting in corporate bonds is about as low as it has been since the fund's inception.

The portfolio's preferred stock weighting is higher than it was during the 2008 financial crisis, when it got down to about 10% of funds assets, but it's lower than it was from 2004 to 2006, when it hovered around 30%. Snyderman has focused on higher coupon paying preferred issues, while being cognizant of their interest-rate sensitivity.

The portfolio's 19% weighting in CMBS is similar to what it has been for most of the fund's history except from 2010 to 2012, when it swelled above 20%. Snyderman has focused on pockets of opportunity within this asset class, such as conservatively underwritten seasoned deals, and has avoided bonds containing mortgages dating from the pre-2007 bubble years.

Performance Pillar: Positive | David Kathman, CFA, Ph.D. 10/25/2018
This fund earns a Performance rating of Positive, thanks to returns that look solid once its unique exposures are considered. Through Sept. 30, 2018, its total returns ranked in the real estate category's bottom decile over the trailing five and 15 years, and since the fund's 2003 inception; however, it ranked in the top decile over the trailing 10 years. These feast-or-famine results are also reflected in the fund's annual returns, which ranked in either the category's top or bottom quartile each year from 2007 through 2016, including four years in the top 10% and two years in the bottom 10%.

However, the real estate category isn't a particularly good basis for comparison, given this fund's substantial holdings in preferred securities and fixed-income securities, which often perform very differently from real estate common stocks. Fidelity compares this fund's returns to those of the Fidelity Real Estate Income Composite Index, a custom benchmark consisting of 20% real estate common stocks, 40% real estate corporate bonds, and 40% REIT preferred securities. The fund has beaten that custom benchmark over the trailing three, five, and 10 years, and since inception.

The fund has been far less volatile than the average real estate fund. Its risk-adjusted returns have beaten the category's over all these trailing periods, as have its Sharpe and Sortino ratios, which account for both returns and volatility.

People Pillar: Positive | David Kathman, CFA, Ph.D. 10/25/2018|
This fund earns a People rating of Positive, thanks to an experienced manager backed by deep resources. Mark Snyderman has been the sole listed manager since the fund's February 2003 inception. He has also managed Fidelity Strategic Real Return (FSRRX) and its Fidelity Advisor version since that fund’s September 2005 inception, and Fidelity Series Real Estate Income (FSREX) since its October 2011 inception. Prior to taking on this fund, Snyderman managed Fidelity Real Estate High-Income, an institutional open-end fund, from 1995 to 2000, as well as institutional CMBS accounts from 1995 to 1999 and institutional REIT accounts from 1999 to 2002. He has been with Fidelity since 1994, managing real estate portfolios that whole time. He's been in the industry since 1988.

Snyderman works most closely with Fidelity’s high-yield real estate debt team, which he has headed up since this fund’s launch in 2003. It includes seven investment professionals, including Snyderman, who analyze high-yield CMBS. He also makes use of Fidelity’s high-yield, investment-grade debt, and investment-grade CMBS analysts when necessary. Snyderman also uses Fidelity’s eight-person U.S. real estate securities research team led by Steve Buller, manager of   Fidelity Real Estate Investment (FRESX), as well as the firm's 180 U.S. & international equity research analysts, to provide research on key tenants and industries.

Parent Pillar: Positive | 07/06/2018
Fidelity isn’t without challenges but remains well positioned enough to compete in a changing industry. It earns a Positive Parent rating. The firm’s diversified asset mix has shielded it from steady outflows from its active U.S. equity funds, with its taxable bond, international equity, and low-priced index offerings attracting assets. Its revamped target-date offerings have improved, and in 2018 the firm plans to launch an additional series combining active and passive funds to better compete in an area where investor interest has grown.

Attracting and retaining talented investment professionals is more important than ever. The equity division came under fire in 2017 amid reports of sexual harassment and a hostile work environment, leading to portfolio manager dismissals and a change in leadership. While Fidelity addressed the personnel issues and is working to improve collaboration through weekly team meetings, more-open floor plans, and improved feedback systems, it remains to be seen how the division may incorporate team-based elements into the legacy star-manager system. Meanwhile, the fixed-income division remains in steady hands following the retirement of a longtime CIO. While the bond analyst and manager ranks have seen more change than usual lately, the team-oriented structure of its investment-grade and municipal offerings helps minimize the impact of departures.

Price Pillar: Positive | David Kathman, CFA, Ph.D. 10/25/2018
This fund's 0.77% expense ratio ranks in the cheapest quintile of the specialty no-load fee comparison group, earning it a Price Pillar rating of Positive. That expense ratio has come down from 0.81% in 2016 and 0.84% in 2013.

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David Kathman, CFA, Ph.D. does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.

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