A Newly Top-Rated Core Bond Fund

The following is our latest Fund Analyst Report for Fidelity U.S. Bond Index FXNAX

. 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 U.S. Bond Index FXNAX is a great core investment-grade bond fund. Under our new ratings framework, which places greater emphasis on fees, the fund warrants a Morningstar Analyst Rating upgrade to Gold from Silver.

The strategy tracks the Bloomberg Barclays U.S. Aggregate Bond Index, which includes investment-grade U.S.-dollar-denominated bonds with at least one year until maturity. The index is weighted by market value, tilting the portfolio toward the largest, most liquid issues, which are easy to obtain and cheap to trade. This approach also harnesses the market's collective wisdom about the relative value of each security. That said, bond-issuing activity influences the composition of this portfolio.

The U.S. government is the largest debt issuer in the United States, so the portfolio maintains a larger position in Treasuries relative to the intermediate core bond Morningstar Category average. The strategy invests nearly 70% of its assets in Treasuries and agency mortgaged-backed securities, which carry AAA ratings, while the corresponding category average is only about 45%. While this might limit the fund's return potential, its lower credit risk should offer better downside protection.

This portfolio has minimal credit risk, which can make it a low hurdle for active managers. That does not make this an unattractive proposition, as risk and return are highly correlated in the fixed-income market. Nearly 75% of the assets in this portfolio carry a AAA rating, making it one of the more conservative options in the category. After controlling for risk, this portfolio is tougher to beat. Like most investment-grade-rated portfolios, interest-rate risk is the biggest drivers of this fund's returns. Its average effective duration was about 5.5 years as of February 2020, generally in line with the category average.

While conservative, the fund's corporate-bond sleeve maintains a tilt toward BBB rated issues. As of February 2020, about 20% of the fund's assets were in corporate bonds, while just less than 10% of the fund's assets were rated BBB.

Process | Above Average This portfolio replicates the composition of the U.S.-dollar-denominated investment-grade bond market, effectively harnessing the market's collective wisdom about the relative value of each bond. This is a sound approach because it promotes low turnover, is cost-effective, and because the market does a decent job pricing these bonds. It earns an Above Average Process Pillar rating.

The strategy employs representative sampling to track the performance of the Aggregate Index, which includes investment-grade U.S.-dollar-denominated bonds with at least one year until maturity. Qualifying bonds must have at least $300 million in outstanding face value. The index weights its holdings by their market value and is rebalanced monthly. This yields a conservative portfolio, which limits its return potential but also cuts downside risk.

The composition of the portfolio is conservative, reflecting the size and quality of the U.S. investment-grade bond market. The amount of debt issued by the U.S. Treasury Department grew sharply since the global financial crisis, and the portfolio maintains a larger percentage of its assets in Treasury bonds as a result.

As of February 2020, approximately 45% of the fund's assets were in Treasury bonds, versus the category average of slightly less than 25%. The bulk of the fund's remaining balance is composed of agency MBS and corporate debt, which represent about 25% and 22% of the portfolio's assets, respectively. While this limits the fund's potential for returns, it also limits potential losses.

Although it represents only about one fifth of the portfolio, the fund's corporate-bond sleeve contains most of the fund's credit risk. In addition to the growth of the Treasury bonds, the U.S. corporate-bond market also grew in response to the global financial crisis, as companies issued debt to capitalize on low interest rates. As a result, BBB corporate bonds grew rapidly and now represent about half of the market value of all investment-grade corporate bonds. Accordingly, nearly 10% of the strategy's assets are rated BBB.

The strategy's interest-rate risk is line with category peers. As of February 2020, its average effective duration was 5.5 years.

People | Above Average Fidelity maintains a relatively small portfolio management team, but the team enjoys strong support from Fidelity's broader fixed-income portfolio management department. As a result, it enjoys the benefits of a large and experienced team supported by a centralized trading desk, which mitigates key-person risk. This team earns an Above Average People rating.

Brandon Bettencourt and Jay Small have managed this fund since 2014 and 2015, respectively. Prior to serving as portfolio managers, Bettencourt was a portfolio analyst, while Small was a corporate-bond trader. Two quantitative research analysts assist the named managers.

The portfolio managers are primarily responsible for managing the daily operations of the fund. The quant analysts act as an extension of the portfolio managers, applying input from Fidelity's research team to help mitigate index-tracking error. The portfolio managers benefit from the technical expertise of the quant analysts when identifying baskets of securities for creations or redemptions.

Independent oversight of the fund is provided by the chief investment officer, who leads a team that independently reviews the index portfolios and index-tracking performance. Fidelity links manager compensation to index-tracking performance, aligning managers' interest with investors'.

Parent | Above Average Fidelity earns an Above Average Parent rating because of its ability to stay ahead of its competition.

The firm's successful stock-picking mutual funds fueled its rise to prominence, and it has adapted well to investor preferences that have shifted markedly over the past two decades. Index funds and exchange-traded funds have garnered most of the industry's flows as money has gushed from actively managed products--Fidelity's included. Yet overall, the asset-management division has continued to achieve positive organic growth by introducing or maintaining aggressive pricing on its own suite of passively managed funds and expanding its menu of client-demanded investment structures, such as managed accounts and collective investment trusts. These moves are made possible by the firm's strong distribution network, scale, established brand, and willingness to tolerate losses on some products in pursuit of broader strategic objectives.

Fidelity continues to invest heavily in its active managers' analytical and technological resources. It is home to a handful of the industry's most talented equity managers and boasts a topnotch fixed-income division. Across asset-class teams, elevated levels of turnover within its leadership ranks bear watching. Overall, though, the firm has served fundholders well through its competitive capabilities and costs.

Performance The fund's performance from its inception in May 2011 through March 2020 was solid. It beat the category average by 30 basis points annually, ranking in the category's top third, largely thanks to its cost advantage.

The fund's category-relative performance is largely related to credit spreads, given its Treasury-heavy tilt. The fund has tended to outperform category peers during periods of widening credit spreads, and it has tended to lag during periods of tightening credit spreads. For example, the strategy outperformed its average category peer by 1.13% during 2011, as the ICE Bank of America BBB Option-Adjusted Spread, or OAS, widened by 1.04%. Conversely, the fund lagged the category average by 1.41% during 2012, as the OAS tightened by 1.07%.

The fund's conservative credit risk should help it weather periods of market turmoil better than most of its category peers. For instance, the strategy did not decline by nearly as much as its average peer during the onset of the novel coronavirus economic crisis between Feb. 20, 2020, and March 22, 2020. During that time, the fund fell by 2.01%, while the category average fell by 3.75%.

Over the trailing five years through March 2020, the strategy's returns matched its index.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar Category's cheapest quintile. Based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Analyst Rating of Gold.