Tough Times for Fidelity

Think you've had a bad year in the market? Be glad you're not Fidelity. Only five of the Boston behemoth's 60 or so diversified U.S. stock funds topped Standard & Poor's 500-stock index for the 12 months that ended January 31, according to Morningstar. The average such fund trailed the S&P 500 by a whopping five percentage points. And not one of the firm's diversified foreign funds topped the most popular foreign benchmark.

True, it has been a tough year for most actively managed U.S. funds. But Morningstar compared Fidelity's diversified domestic funds against their peers at other firms and found that, on average, Fidelity's ranked in the 52nd percentile -- in other words, slightly below par. The average broad-based Fidelity foreign fund performed horrendously, trailing the MSCI Europe, Australasia and Far East (EAFE) index by eight percentage points and finishing in the bottom 13% of peers.

I don't think the wheels are falling off at Fidelity. But plainly some mid-course corrections are in order for the huge revamping of the stockpicking operation that Fidelity launched 18 months ago. Someone high up at Fidelity may -- or may not -- agree. Stephen Jonas, who headed that restructuring, retired at the end of January. Bob Reynolds, Fidelity's chief operating officer, says Jonas, 53, wanted to spend more time with his family and that he and Jonas "came to a mutual agreement that this was a good jumping off point. Performance had nothing to do with it." Maybe so.

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Longer-term performance at Fidelity hasn't been awful, but those of us old enough to remember when Peter Lynch turned Fidelity Magellan into the most famous fund in the land do long for the good old days. Over the past three, five and ten years, Fidelity's average U.S. diversified fund ranks above average -- in the 40th to 42nd percentile over each period. The trend at Fidelity's foreign funds has been disturbing. Over the past ten years, they're in the top 32% of diversified overseas funds. Over the past five years, they're in the top 40%. But over the past three years, they rank in the 73rd percentile (or the bottom 27%).

Perhaps the best that can be said of the current situation is that Fidelity's chairman, Ned Johnson, who's in his 70s, also pines for the old days. He can't abide Fidelity continuing to fall behind its rivals. Not counting money-market funds, which are swollen by Fidelity's discount-brokerage business, the firm now ranks third, behind the American funds and Vanguard, in mutual fund assets. Johnson hates that to his core. So much so that he replaced his own daughter, Abby Johnson, as head of Fidelity's money-management division. Working under Reynolds, Jonas took over much of her responsibilities. She became president of employer services.

Fidelity announced other major changes around the same time. It more than doubled the number of its Boston-based stock fund analysts, from 94 to 180. (Worldwide, the firm employs 369 stock analysts.) It ended a practice, dating to the firm's inception 60 years ago, of recruiting almost all its analysts from university campuses, teaching them the Fidelity way and gradually promoting those who succeeded. Fidelity now also hires veteran analysts to research stocks and run the company's sector funds. The company also created an analyst career track.

And Fidelity acknowledged the problems of asset bloat by splitting off its $100-billion institutional business into a separate unit called Pyramis.

Just a month ago, Fidelity opened a refurbished building designed to increase face-to-face contacts among its fund analysts and portfolio managers. Walter Donovan, who heads the firm's stock fund division, boasts that all the analysts, managers and traders are now housed on just two sprawling floors -- each more than 60,000 square feet. "The level of communication has gone up," he says.

Reynolds sees more opportunity nowadays for analysts to add value in stock picking. Part of that, ironically, stems from the SEC's regulation FD, which forbids companies from sharing information with favored analysts. "Everybody was getting same thing," Reynolds says. He reasons that top-flight fund analysts can ferret out what's not being said publicly. What's more, brokerage research departments have scaled back -- an unintended consequence of government-mandated reforms following the collapse of tech stocks early this decade. "The value of in-house research is going to be even greater going forward than it has been in the past," Reynolds says.

Reynolds' words and Fidelity's actions all sound right on the money to me. But it's an open question whether anyone can make an elephant the size of Fidelity -- with total assets of $1.3 trillion -- fly. And, if so, how long will it take? "We knew it would be a two-, three- or four-year process for the full effect of these additional resources to be 100% productive," Reynolds says. How long until performance rebounds? "I wish I knew," he says.

But that's Reynolds' problem. For you, the investor, there's simply no reason to rush into Fidelity funds just now. If the restructuring works, they'll be plenty of time to climb aboard.

Meantime, Fidelity does offer a few pearls. John Bonnanzio, group editor of Fidelity Insight, an independent newsletter that tracks Fidelity funds, recommends these large- and mid-cap funds: Blue Chip Growth (symbol FBGRX), Equity-Income (FEQIX), Value (FDVLX), Value Discovery (FVDFX) and Value Strategies (FSLSX). (Kiplinger's has a different opinion about Blue Chip Growth, however.)

I think the firm's bond and index funds are a hair better than Vanguard's. Fees on Fidelity's bond funds are low, though not as low as Vanguard's, but lately Fidelity has done better at managing its fixed-income products. And Fidelity's index fund fees are lower than Vanguard's.

Steven T. Goldberg is an investment adviser and freelance writer.