Fidelity Expands Emerging Market Offerings
By John Bonnanzio

Fidelity has launched two new international funds. The first is called Total Emerging Markets and, frankly, it’s the less exciting (though practical!) of the just-launched pair.

Essentially a "growth and income" fund, its lead manager is John Carlson. He’s the longtime head of New Markets Income -- an emerging markets debt fund -- and more recently Global High Income. John’s latest charge will be the 40% or so slice of the fund that’s dedicated to bonds. (A floor of 20% is in place.) Although we don’t know this with certainty, we suspect that the fixed-income exposure of Total Emerging Markets will closely resemble that of New Markets Income.

The remaining 60% portion of "Total" is more interesting in that it’s run by a five-person team of stock investors. Team-managed funds are a growing trend at Fidelity, and this approach is already used at International Small Cap. There, three managers’ roles are divided along geographic lines. In the case of Total, stockpickers are divided among 10 industry sectors. (This is more commonly seen at Fidelity’s US stock funds.)

We believe this balanced emerging markets fund is a good and convenient way for investors to gain access to the stocks and bonds of many of the world’s fastest growing economies. We rate it OK to Buy.

The second new offering, Emerging Markets Discovery, fills a hole in Fidelity’s international fund lineup. As its moniker "Discovery" hints at, its stock universe consists of small- and mid-size companies in the developing (emerging) markets of Asia, Latin America, Africa and Eastern Europe.

In terms of its market cap, it differs from the larger companies already found in Fidelity’s Emerging Markets fund. It also differs from it in a more subtle way: there will be a decided bias for a range of consumer-oriented stocks. This reflects Fidelity’s view that as wealth grows in these populous and expanding economies, consumer spending will rapidly rise on everything from food to electronics to health care -- and we agree!

Identifying and buying these smaller, promising companies falls to Manager Ashish Swarup. He already runs a similar (though larger-cap) sleeve of stocks inside the massive Diversified International fund. And while he’ll be drawing upon Fidelity’s global network of securities analysts, he’ll have complete say on this new fund.

Based less on our opinions of Ashish and more on our long-term view of his investment universe, for now, we rate Emerging Markets Discovery OK to Buy.

Note: We’ll have more to say about both funds in the December Fidelity Insight report.



October 26, 2011

Fidelity Shuffles Equity-Income Funds
By John Bonnanzio

The longtime manager of Equity-Income, Steve Petersen, has been replaced by a team that runs an annuity version of that fund called VIP Equity-Income. At the same time, Scott Offen of Value Discovery has taken the reins of Petersen’s other charge, Equity-Income II. Notably, Offen will continue to run the common stock sleeve of Strategic Dividend & Income, which is likely to serve as the template for the soon-to-be-refashioned Equity-Income II.

These changes as important for two mostly, unrelated reasons. The first has been Fidelity’s and investors’ dissatisfaction with Petersen’s fund performance. (We sold his fund in two models several months ago.) One of Fidelity’s most experienced managers, Petersen has struggled navigating through an especially turbulent market for stocks generally, and financials in particular.

At the same time, Fidelity has been focusing like a laser beam on ways to address and exploit today’s low interest-rate environment. Indeed, millions of its customers – and a growing number of retiring baby-boomers – need more income. In recent years, bond yields have dwindled, though they have provided great returns. However, that story will eventually end. And so a huge dowry of corporate cash and a greater willingness by companies to return that cash to their shareholders in the form of dividends, are developments that Fidelity hopes to tap. In other words, look for both funds to increase their yields and, therefore, alter the ways in which they invest.

Between now and publication of the November report (it will be available here late Tuesday afternoon, on Nov. 1), we are planning to have more detailed conversations with Fidelity’s investment managers. While our initial reaction to these manager changes is very positive, we encourage you to review next month’s report for a discussion of these changes and how they affect the funds, our ratings, and possibly our model portfolios.



September 13, 2011

Magellan Gets Another Chance
By John Bonnanzio

Jeff Feingold is the new manager of the long-suffering Magellan fund. He replaces Harry Lange who, through almost five years of unprecedented market turmoil, ultimately disappointed his shareholders and his Fidelity bosses. Of course, knowing Harry the way we do, certainly this bright, hard-working and high-achieving stock picker -- qualities that landed him the Magellan job in the first place – has certainly disappointed himself as well.

If past if prologue, we expect Harry to take some time off and return to Fidelity in another capacity -- perhaps mentoring young analysts.

As for Jeff, he remains the manager of several portfolios including Trend, Large Cap Growth and VIP Growth Stock. (We hope to see him get some assistance on these funds as Jeff’s plate is already plenty full!) With performances at these funds that have surpassed their common benchmark (the Russell 1000 Growth index), and have also surpassed Harry’s Magellan and its S&P 500 benchmark, Jeff certainly has the track record to resurrect Magellan’s tattered reputation.

He also has the resume.

A former co-director of Fidelity’s research group and its managing director from 2004 through 2006, Jeff has worked his way up the ranks. Fresh out of the Harvard Business School, he joined Fidelity in 1997 as a research analyst and soon became a Select fund manager at Defense and Aerospace (1998 - 2001) and later Air Transportation (2000 to 2001). He’s also managed equity portions of Global Balanced (2004-2007) and Worldwide (2006-2007).

Earlier in his Fidelity career, Jeff ran Home Finance (now called Consumer Finance) and Financial Services. In fact, he served as the financial services lead researcher from 2001 to 2004. That experience may serve him even better today at Magellan than it already has at his other charges. That’s because financials are a comparatively smaller percentage of Trend’s and Large Cap Growth’s benchmark relative to Magellan’s (about 4% versus 15%). Moreover, with so many of the world’s banks and other financials in trouble, this expertise is a plus.

It will also be interesting to see Magellan’s forthcoming portfolio changes, especially whether Jeff decides to redeploy the fund’s 22% stake (about $3 billion) in foreign stocks. By comparison, Jeff’s funds have less than half as much invested overseas, and only a fraction of Magellan’s roughly $15 billion in assets.

While we’ll have more to say about this important change in the October Fidelity Insight report, we see today’s development as a positive for Magellan’s many shareholders. Notably, Magellan has been rated OK to Sell (under Harry), while we rate Jeff’s various funds Buy. (VIP Growth Stock is OK to Buy given the other options in Fidelity’s annuity line-up, but that is also under review.) As such, and until we’ve had a chance to see how Magellan is positioned relative to its peers, we’re stepping up its rating to Hold.



April 18, 2011

S&P Downgrades Outlook for U.S. Debt
By John Bonnanzio

Standard & Poor’s has downgraded its outlook for U.S. sovereign debt (i.e. Treasuries) from "stable" to "negative," (but not yet its rating, which remains AAA). While that move clearly surprised the markets on the deadline day for federal tax filings, arguably, this move shouldn’t have surprised anyone. After all, $14 trillion in debt didn’t happen over night.

We’re going to sidestep the argument about blame, and merely remind everyone that all this red ink accumulated over several decades, under many presidents, and while both political parties have controlled the government’s financial levers. The blame game, as they say, is water under the bridge. So the question we want to address now is this: what should you do?

Under normal circumstances (which no longer seem to apply to anything!), downgrading anyone’s debt (be it a corporation or sovereign entity) would result in an immediate decline in its value. But Treasuries actually rallied today! (Their yields declined and their prices rose.)

The reason may seem counterintuitive, but it makes perfect sense: whenever there’s a major unwelcome surprise with potentially far-reaching consequences, investors the world-over flee for safety.

Well, for as long as any of us have been alive, the safest place for your money has been Uncle Sam. That’s been the case through a civil war, two world wars, depressions, and the list goes on. In fact, Treasuries are still safe, but safety is not an absolute. Safety, as it turns out, is actually relative.

For example, even with all our problems, name another country where you would park all your money for 30 or just 10 years without thinking twice about it? China? We don’t think so. Germany? Maybe. But if it must keep bailing out Portugal and some of their other economic partners to the south (such as Italy, Greece and Spain), what will their finances look like in a few years?

In our view, S&P’s assessment of America’s overburdened balance sheet was long overdue and welcome. Granted, the stock market didn’t like it today, and Treasury investors may decide that they don’t like it tomorrow. But we like the fact that the government immediately responded to it today, and if there’s anyone on Capitol Hill who wasn’t particularly worried about the problem yesterday, there are presumably fewer of those folks today. In fact, S&P pointed to the fact that Congress has been unable to agree on a plan for reducing our deficit going forward as a reason for their action.

With respect to stocks, the more immediate concern for investors is first-quarter earnings. There are a lot of bellwether names reporting this week, so don’t be surprised if tech, industrials and financials, in particular, are rattled in the days ahead. The earliest companies that have disclosed their profit picture have not exactly thrilled investors, so even mediocre news this week is likely to get a chilly reception.

Hang in there.

As for Treasuries, today’s development was bad, but not disastrous. Had U.S. debt been downgraded, frankly, we could have been dealing with a severe market correction. Instead, our government got a warning shot sent over its bow. Hopefully, this puts additional pressure on the President and Congress to correct the government’s profligate spending habits. Indeed, if the threatened "closing" of the federal government was a trial run for just how serious Washington is about deficit reduction, it’s not just Treasuries that are in trouble, it’s our American way of life.

So we are optimistic that, with fits and starts, the deficit reduction brigade will win the day on Capitol Hill because it simply must. It will likely take longer than most would like to see, but the sheer economics of the situation will dictate its resolution, not any political debate.

In the final analysis, the bigger threat to Treasuries may not be the size of the deficit, but rather inflation expectations and the Federal Reserve keeping interest rates artificially low to spur economic growth. While the immediate road may be rocky, stocks still offer investors the best long-term growth prospects.



April 1, 2011

How To "Play" Energy Using Fidelity Funds
By Jack Bowers, President & Publisher

With unrest in the Middle East proving difficult to contain, and Japan’s tsunami-induced nuclear disaster casting a pall over the near-term future of atomic power, it would seem that the U.S. is once again vulnerable to the whims of OPEC. But looking beyond the grim reality of today’s $4/gallon gasoline, the present situation may not be nearly as threatening to your portfolio as energy crises of the past. What follows is a discussion about the important fossil fuel shift that has taken place over the last decade, along with even bigger changes that are yet to come.

HIGH-TECH LAND-BASED DRILLING
Just six years ago, domestic production of natural gas was in decline and it was expected to accelerate. The groundwork was being laid for a string of coastal import terminals so that Liquefied Natural Gas (LNG) could be brought in on super-tankers to meet growing domestic demand.

But that plan stalled early on. Domestic natural gas production suddenly surged, prompting LNG super-tankers to head for Asia, where they could get a better price for their fuel. Then, in early 2008, the price of natural gas crashed several months ahead of the financial crisis. Today, pricing remains low and reserves have surged. Even more surprising, drilling activity continues, and by some estimates we now have a supply of 100 years.

What’s going on? According to a Wall Street Journal story that ran back in April 2009, Texas oilman George Mitchell pioneered the use of shale fracturing over a decade ago in the Barnett formation near Fort Worth. He pumped large quantities of water down vertical wells at high pressure, cracking open enough shale to generate effective flow rates in places that would normally result in a dry hole. Devon Energy bought Mitchell’s company in 2002, and combined his methods with horizontal drilling, which tripled the output. Suddenly, shale production was competitive with traditional gas wells. Devon had an early lead, but it didn’t take long for competitors to jump in.

The financial risk of fracturing the Barnett formation plunged because the odds of drilling a dry hole became very low. Within six years, the region was producing four billion cubic feet of gas a day – almost single-handedly reversing the decline of U.S. natural gas production. By 2005, Devon’s competitor, Chesapeake Energy, was sending teams of geologists across the country in search of other shale gas fields like Barnett. In short order, more than a dozen were discovered. The grand-daddy, Marcellus, extends through much of the Appalachian Basin. At roughly 20-times the size of Barnett, it’s ideally located for serving the population centers on the East Coast.

With large-scale development has come a new set of environmental concerns, most of which center around the potential contamination of drinking water supplies. The media has sensationalized the threat, but actual problems have been few and far between. Shale gas drilling has the potential to be far less environmentally damaging than either coal mining or deep-water oil drilling. As the industry embraces non-toxic fracture fluids and improves its wastewater testing and disposal methods, most concerns are likely be put to rest with time and experience.

SELF-SUFFICIENCY IS ON THE HORIZON
For decades, energy independence for the U.S. has been little more than a pipe dream. Politicians have long scored points by making empty promises or by subsidizing alternative sources that come up short on the laws of physics, but real-world progress has been both incremental and costly. But finally, we have a game changer in the form of shale fracturing. It has already reshaped the domestic natural gas market, and is likely to thrust shale oil into the mainstream in the not-too-distant future. Throw in automotive efficiency gains and rising coal exports, and the U.S. could be a net energy exporter in 10-15 years!

Let’s consider the dynamics that are in play for all of the major sources of energy:

• Natural gas. With enormous quantities of cheap shale gas on tap, odds are that almost all new power plants will be built around this resource. Unlike the cheap "peaker" plants that some utilities use, modern 3-stage gas plants can achieve 60% conversion efficiency. By expanding pipeline and storage infrastructure, natural gas power plants can become the heavy lifters of the power grid, displacing coal and possibly nuclear.
• Oil. There has been substantial early success with the Bakken formation in and around North Dakota. Now shale oil projects are sprouting up all over, with the expectation that the U.S. can expand oil production by perhaps a million barrels a day over the next decade (on par with what currently comes out of the Gulf of Mexico). At the same time, we’re entering a period where the domestic consumption of oil will begin to shrink at a faster rate. In autos, hybrid technology is going mainstream, and conventional vehicles are eliminating drive belt loads by electrifying power steering and air conditioning.

  In air transportation, jet engine efficiency is climbing even faster than passenger cars. In houses, natural gas is displacing home heating oil because of its economic advantages. The combination of rising domestic oil production and declining consumption suggests that U.S. oil imports will continue to fall.

• Coal. As natural gas becomes the dominant choice for new U.S. power plants, coal will become more of an export industry. The U.S. is already a major global player, with exports of about 75 million tons a year and growing. The combination of shrinking oil imports and rising coal exports should improve our energy trade balance at a healthy clip.
• Nuclear. Japan’s disaster is likely to slow the growth of atomic power, and it may lead to plant closures in places where seismic activity is a major concern or where the will of voters is especially strong. Countries that remain committed to nuclear power are likely to require plants to upgrade or replace older reactors to make them less susceptible to natural disasters. Decades from now, advanced concepts similar to TerraPower’s traveling wave reactor (which requires no cooling pumps and is designed to run on reprocessed nuclear waste) may be compelling enough to overcome public resistance at some point. Meanwhile, natural gas is likely to pick up most of the slack. Gas plants can be built quickly, LNG can be shipping globally, and it’s the greenest hydrocarbon.

Renewables. With the exception of hydro, most renewable sources require subsidies to be competitive at the wholesale level. But that’s likely to change over the next decade as advancing technology leads to lower costs and better ways to store energy. Still, even with fast growth it could take decades for renewable sources to eclipse fossil fuels on the grid. Case in point: a major transmission line connecting San Diego with thermal solar plants in the Mojave Desert has become a 10-year project.

IMPLICATIONS
Because the U.S. relies heavily on oil imports for transportation, our domestic economy is vulnerable to energy shocks. However, in the current crunch there are two notable situations that suggest a future that is less dependent on OPEC.

First, the price of domestic natural gas barely budged even as the global price of oil jumped 20% on unrest in the Middle East. In the past, natural gas prices would have risen in tandem.

Second, the domestic price of oil in Cushing is running a full $10 below the price of global Brent crude. There’s so much crude coming out of Canada’s tar sands and North Dakota’s shale fields that very little needs to flow North from the Gulf region. Pipeline operators are looking at reversing the direction of flow between certain locations so that more North American oil can get to Texas refineries. Currently these refineries are paying for higher-priced imported crude. So even though U.S. consumers are bearing the full brunt of the global price increase at the pump, industrial firms (which run largely on natural gas) are seeing far less impact from rising energy costs. As time goes on, domestic refineries will be linked up with expanding supplies of North American crude -- allowing the price of gasoline to behave more like natural gas and less like global oil markets.

More importantly, manufacturing competitiveness is in the process of being redefined. Up until now, countries with low wage rates have had a huge advantage. But with global wages fast equalizing, the future will belong to factories that have the edge with energy, transportation, and inventory costs. U.S. manufacturers have a huge advantage in this area.

RECOMMENDATIONS
From a global standpoint, it may seem that we, as investors, are muddling through a cascade of economic disruptions. And given the stock market’s behavior over the past decade, it may feel like the best plan of action is to sit on the sidelines. But the reality is the U.S. market has already taken its lumps. Most corporations that had marginal business models have been sold or liquidated. The population that remains is, for the most part, a robust group. Some investors are concerned that the loss of Libya’s oil and a stall in nuclear power construction will constrain our economic growth. But chances are it won’t.

As the U.S. edges towards energy self-sufficiency, good things will be happening. Our rate of inflation will remain lower than the rest of the world. We’ll be depending less on the rest of the world to fill our gas tanks. And our exports of coal, LNG, chemicals and agricultural products will be growing at a healthy clip, closing our trade deficit. While opportunities in the energy group are looking up, it’s certainly not the only good place to invest. Sectors such as materials, industrials and technology are also poised to benefit from export growth, and others like health care, finance, and telecommunications offer good value. Energy stocks deserve a role in your portfolio, but it does not necessarily have to be a big role.

Following is a review of Fidelity’s energy-heavy funds, which are listed in increasing order of exposure to the sector. Unless you are targeting a specific energy weighting, consider sticking with a diversified fund that holds an overweighted energy position instead of making a dedicated sector bet. That way, the fund manager can consider the merits of energy stocks against those in other sectors, making portfolio adjustments as necessary.

Note: For our latest ratings on the funds below, please see our online Scorecard.

Focused Stock has the highest energy weighting (16.5%) among Fidelity’s diversified stock funds. Manager Stephen DuFour has been on a roll over the last year, outperforming the S&P 500 by a wide margin while maintaining similar risk.

Convertible Securities has a 23% energy weighting, and is managed by Thomas Soviero (who also runs Leveraged Company and Value Strategies). The fund holds bonds that carry the option to be converted into common stock, making it more risky than Capital & Income but less volatile than Leveraged Company Stock. Many of the firms that issue convertibles are benefiting from receptive debt markets.

Canada currently carries a 23% energy weighting. The Canadian economy is largely driven by natural resources, meaning that swings in the Canadian dollar can amplify the fund’s volatility. We’re also concerned with its significant precious metals position, which amounts to 14% of assets.

Emerging EMEA invests mainly in South Africa (45%) and Russia (32%), carrying an energy weighting of 25%. While there may be many growth opportunities in this region, it’s not so clear that the firms operating here are world-class competitors from a technology-utilization standpoint.

Global Commodity Stock is a diversified play on the major commodity groups, including energy, basic materials, and agricultural. Energy accounts for a 35% weighting. The materials and agriculture side is well-diversified with precious metals accounting for less than 10% of overall holdings.

Natural Gas is now our favorite dedicated sector in the energy group, in part because it is less exposed to a pullback in global oil prices, but also because it could benefit more from a slowdown in nuclear construction. 78% of holdings are considered in the energy group; the rest are deemed utility holdings. Stock prices here are cheaper than those in other segments of the energy group, and over the last 18 months they’ve become less volatile because of stable natural gas prices.

Natural Resources also has a 78% energy weighting, but unlike Natural Gas its minor position is invested in the materials group -- with almost half in gold stocks. Diversification usually reduces risk, but not in this case.

Energy Services has a risk score of 1.9, making it the most volatile fund in this lineup. It focuses on the drilling companies, whose earnings tend to magnify the underlying swings in the price of oil. Rated hold. Energy has a 95% weighting in energy stocks and covers the entire range of the sector. Its risk score of 1.6 is typical for a dedicated energy play. If you want to make a long-term bet on the sector, this is the best way to do it.



March 17, 2011

Our Strategy For Japanese And U.S. Stocks
By John Boyd & John Bonnanzio

It goes without saying that our prayers go out to the Japanese people as they struggle through these unfathomable disasters that have shaken and now gripped their country. We obviously don’t know what will happen to their nuclear plants over the short-term. However, we know the Japanese to be industrious and smart. They also have an indomitable spirit to change and move forward with their lives. For these reasons, coupled with their democratic and free-market principles, they are one of America’s closest allies. Taken together, we find it difficult -- even in these very darkest of days -- to sell Japan’s future "short."

So here’s our strategy.

For starters, our more "significant" exposures to Japanese stocks are found in our Growth & Income Model via Pacific Basin, and in the Income & Preservation Model through Total International Equity. Importantly, these international funds comprised only about 7% of both models’ assets heading into this catastrophe, and remain at that level. In turn, their Japan exposures are roughly 36% and 12% of fund assets, respectively.

Drilling down one more layer, our Growth & Income Model holds a mere 6% in Japanese stocks while the Income & Preservation Model measures just 5%.

Even with these modest exposures, we’re cognizant of the fact that these now-volatile exposures are held in our two most conservative models. But with Pac Basin already down 10% this month and Total Int’l Equity off 7.5% (through Wednesday’s close), now is not the time to sell.

Couple that fact with another: At about the time we purchased these funds, valuations on Japanese equities were already about half of what they were when the Kobe earthquake of 1995 struck the island-nation. And, since then, they have become even more attractively valued. According to Fidelity, the price-to-book (P/B) value of Japanese stocks was 2.1 back then. In February 2011, their P/B was only 1.2.

Both Total Int’l Equity and (especially) Pacific Basin have the flexibility to adjust their Japan weightings to either take advantage of new attractive opportunities, or to shed exposure in areas that may look less attractive in light of recent events. In fact, we know that in recent days some Fidelity managers have been net buyers of Japan.

Frankly, our optimism for Japan’s future (economic and otherwise) was reinforced yesterday by looking at an entirely different asset class than stocks: bonds.

On Wednesday, Japan issued its first sovereign debt since the 9.0-magnituide earthquake struck. (By the way, Japan is one of the most indebted countries in the world, although unlike the U.S., 95% of its government debt is owned internally.) The Ministry of Finance successfully sold the equivalent of $12.5 billion of sovereign 20-year bonds. The sale was successful in two important ways: 1. Demand was very strong, and; 2. Their average yield of 2.13% is a post-quake premium of only 20 basis points (0.2%). Given the fact that Japan will need to issue much more long-term debt to finance its rebuilding, the positive reception for its bond issuance was very encouraging.

In the short-term, larger-cap Japanese companies could be hurt by the rise in the yen since the crisis began. That’s because their exports will be crimped. However, it is hard to see how this event would ultimately be conducive to a higher yen. And we expect the yen to gradually come back down.

While Japan’s Asian trading partners may also slow a bit, in the broader picture, Japan’s woes should not have a significant impact on the ongoing global recovery. Even before these tragic events, Japan’s economy was not expected to contribute that much to global growth.

Fortunately, Japan’s most important ports were undamaged this time around, so getting their products from their industrial centers to their ultimate markets should not be a significant problem. At the same time, Japan’s economy should get a short-term bump from the vast construction projects that must be undertaken.

While we plan to say much more about this in the April Fidelity Insight report, we’re obviously concerned about the growing list of market risks. Oil prices are a concern we addressed in last month’s report, and so was the Mideast. But with civil unrest itching to spread further in Libya, Bahrain and perhaps even Saudi Arabia, we’re a bit more nervous. Indeed, higher oil prices remain a threat to global GDP growth.

Even with a modest downward revision to U.S. GDP growth, we believe that the U.S. economy is still on a solid footing for recovery. Yes, we’re still not replacing jobs at an acceptable pace. And, yes, the housing market remains a serious drag on the economy. Overall, however, job growth is on the right track and, most importantly, it appears that corporate profit growth is also gathering steam, though we expect to see hiccups along the way. (For Fidelity’s part, its revenues rose 6.7% to $12.3 billion last year, while operating income soared 17.0% to $2.9 billion.)

Bottom line: we are comfortable holding on to our modest Japan positions, and letting the managers of those funds decide when the time is right to add to those exposures. (We think they are better equipped to make that choice than we are.)

Conservative Income Offers More Yield

With money market funds yielding nothing, Fidelity has responded to investors’ desire for more yield by introducing Conservative Income Bond [ticker: FCONX].

Essentially, the fund holds many of the securities that the SEC prohibits or limits from being in money market funds, which the government has been trying to make "safer."

The new offering holds a mix of investment-grade (high quality) short-term debt, including Treasuries, corporate bonds and money markets. However, a small allocation of up to 5% may be in high-yield bonds, plus an allocation of up to 20% in long-term floating-rate notes. Such debt has higher credit risk than Treasuries. Couple that with the fund’s average maturity of 270 days versus about 30 for a money market fund, and Conservative Income should produce a yield that’s roughly 30 basis points (0.30%) higher than a money market fund. Notably, it will try to maintain a steady NAV of $10 per share, but this is not given nearly the same priority as a money market fund’s constant $1.00 NAV.

That the fund is benchmarked against Barclays Capital 3-6 Month US Treasury Bills Index is a bit problematic for us because it holds riskier securities. Indeed, Fidelity has given itself plenty of wiggle room for the fund to beat its more conservative benchmark. Regardless, Conservative Income is an innovative option for income-oriented investors.

So where would this hybrid money market/bond fund fit in an investor’s portfolio?

While we’re loath to call it a money market alternative (because the fund is definitely riskier in terms of credit and interest-rate risk), it’s also a safer alternative (on both counts) to Ultra-Short Bond’s 1-year average maturity and its more "adventuresome" holdings. Certainly, this new fund will have an easier time attracting assets than Ultra, given that fund’s poor record.

Notably, the fund is managed by James "Kim" Miller who joined Fidelity in 1991 as a muni bond analyst. In 2001, he moved to muni money market funds and has since run taxable funds, too.

Conservative Income has an expected expense ratio of 0.40% (which is in line with Fidelity’s other taxable bond funds) while it requires a minimum initial investment of $2,500. Dividends are paid monthly.

We rate it Buy for conservative, income-oriented investors who are looking for a higher-yielding alternative to money markets, and less overall risk to Ultra-Short Bond.



March 10, 2011

Fidelity Launches New Bond Fund
By John Bonnanzio Editor, Fidelity Insight

Responding to investors’ desire for funds that can potentially increase their income in today’s low interest-rate environment, Fidelity has launched Conservative Income Bond. It’s the company’s second new bond fund in less than a year. (Corporate Bond was introduced in May 2010.)

Conservative Income [ticker: FCONX] holds a variety of high-quality (investment-grade) short-term debt. Its weighted average maturity is targeted to be no more that 0.75 years (about 9 months). Its holdings include Treasuries, corporate bonds and money markets. However, a small allocation of up to 5% may be in high-yield notes, plus floating-rate bonds. Both types of debt securities carry credit risk that’s significantly greater than Treasuries, and will undoubtedly be used by the fund to help boost its yield.

That the fund is benchmarked against Barclays Capital 3-6 Month US Treasury Bills Index is a bit problematic for us. Why? Because it appears that the fund’s interest-rate risk may be greater, while its overall credit risk will certainly exceed Treasury Bills. All things being equal, Fidelity has given itself plenty of wiggle room for the fund to beat its more conservative benchmark.

Regardless, we welcome Conservative Income as potentially useful ammunition in its already hefty arsenal of fixed-income funds.

Although there is no holding information for us to analyze, the fund’s interest-rate risk will likely fall between a money market fund’s very short average maturity of about 60 days and Ultra-Short Bond’s 1-year maturity. As for credit risk, that’s tougher to discern at this time, but we’re assuming that the fund is a higher-quality alternative to Ultra-Short.

As for Conservative Income yield, given the newness of the fund, there is none yet reported.

The fund is being managed by James "Kim" Miller who joined Fidelity in 1991 as a municipal bond credit analyst, and became a trader in that area in 1998. In 2001, he transitioned to muni money market funds and has since run taxable funds, too.

Conservative Income has an expected expense ratio of about 0.40% (which is in line with Fidelity’s other taxable bond funds) while it requires a minimum initial investment of $2,500. Dividends are paid monthly.

You needn’t run out and buy the fund today, but we rate it a Buy for conservative, income-oriented investors who are looking for a higher-yielding alternative to money markets, and less overall risk to its close cousin Ultra-Short Bond.



November 30, 2010

Fidelity Renames Southeast Asia Fund
By John Bonnanzio Editor, Fidelity Insight

Fidelity has renamed its Southeast Asia fund, Emerging Asia. Along with its new name comes a new benchmark, which now includes India. You will find this name change reflected in our online scorecard and guide, later this evening. The printed scorecard in the December issue of Fidelity Insight (available on the web on Wednesday night) will still reflect the old Southeast Asia name (so members can find it!), but we will switch to the new name in the January issue.




May 11, 2010

Fidelity Cleaves Key Business Units; Abigail Johnson’s Role Expands
By John Bonnanzio Editor, Fidelity Insight

Fidelity has announced a reorganization of its key business units.

In broad terms, its operations are being divided into two separate pieces: asset management and distribution. In the process, we believe this move is a step towards positioning Abigail Johnson, daughter of Chairman Edward C. (Ned) Johnson 3d, as the eventual head of the family-run company. More immediately, she now runs the distribution business and reports directly to her father.

On the asset management side, Fidelity has hired Ronald O’Hanley of BNY Mellon Asset Management. He, too, reports directly to Mr. Johnson.

As significant as these changes may become, we do not believe that they will have any immediate impact on the way any Fidelity funds are currently managed.

For the past five years, Ms. Johnson has been heading the Personal and Workplace Investing group. In her new role, which starts immediately, her responsibilities have grown to include all of Fidelity’s customer and client-focused businesses, including Fidelity Institutional Services. The latter business includes its relationships with banks, brokerdealers, insurers, registered investment advisors, and other financial professionals.

Apart from these roles, Ms. Johnson is vice chairman and director of FMR LLC, the holding company for the businesses of Fidelity Investments. She is also a member of the powerful Executive Committee. And, in drawing upon her experience as a fund manager, she is chairman of the Fixed-Income/Asset Allocation Board of Trustees.

Ms. Johnson’s first job at Fidelity was an analyst covering the industrial equipment industry, and later managed a Select fund in that area. Shortly thereafter, she ran Dividend Growth, OTC, and Trend. Because she only met with modest success in these money management roles, her skills and qualifications for the inevitable managerial roles she would eventually assume are often second-guessed by critics. That said, during her roughly three-year tenure as head of Fidelity’s investment group, the company’s expanded lineup of funds grew by about $100 billion.

As for Mr. O’Hanley’s responsibilities, they encompass the newly established Asset Management and Corporate Services businesses. Fidelity says that "Ron O’Hanley will bring valuable asset management and executive experience to our investing and corporate functions as well as a strong leadership track record. We are looking forward to having him join our firm." This will occur mid-summer.

In his new role, Mr. O’Hanley will oversee all of Fidelity’s Asset Management organizations, including Fidelity Management & Research Company (FMRCo) whose employees make the investment management decisions for most funds. (This extremely important unit stays under the control of Jacques Perold.) In addition, Mr. O’Hanlon oversees Pyramis Global Advisors (which is the subadvisor to index and so-called enhanced index funds), and its Asset Allocation Division, comprising Strategic Advisers and Global Asset Allocation. All corporate functions such as communications, human resources, public policy, legal and the like are all under his purview.

Fidelity, of course, is one of the world's biggest financial services company. Assets under administration are $3.3 trillion, including managed assets of $1.5 trillion (an amount equal to Canada’s GDP in 2008). It provides investment services to over 20 million individuals and institutions.

April 9, 2010

Supreme Court Rules On Fund Fees
Fidelity's competitive fees may rebuff legal challenges, but fund expenses could rise elsewhere.

By John Bonnanzio, Editor

The road to hell is paved with good intentions.

On March 30, the U.S. Supreme Court weighed in on mutual fund fees. With its decision (there were actually two) prompting both sides claiming victory, it's less clear now than before if retail investors will eventually see their fund expenses reduced. For Fidelity investors, it's unlikely.

Let me explain.

At issue is a complaint by Oakmark fund shareholders against Harris Associates (managers of the funds). In a case that goes back to 2004 (Jones v. Harris), the plaintiff's argued that small, individual investors are charged much more than large, institutional investors.

Like most every fund family, Oakmark offers two different share classes of funds with two different fee structures, but the same managers and holdings. Needless-to-say, institutions (who may invest hundreds-of millions-of dollars in a single fund) use lower-fee shares. And so they wind up making commensurately more money on their investments relative to retail investors. So here's the rub: At the time of the suit, fund expenses for Oakmark's retail shares were almost twice as high as institutional accounts (0.88% versus 0.45%).

In the 7th US Circuit Court of Appeals, Harris Associates argued that smaller investors pay more because they require more day-to-day services. Relative to big investors, individuals require more bookkeeping, account statements, customer service, etc. Therefore, their fees are justifiably higher.

The Appeals Court actually agreed with Harris, and threw the case out, ruling that the Harris board hadn't breached its fiduciary responsibility. Why? Because its higher fees were clearly communicated to prospective investors and that no fraud was committed.

But this didn't settle the matter. The case was appealed to the Supreme Court because of a 1940 law that gives a fund company's board the fiduciary responsibility of negotiating fees on behalf of shareholders. Moreover, a 1982 Supreme Court ruling (Gartenberg v. Merrill Lynch) said that fees cannot be "so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's-length bargaining."

In Jones v. Harris, Justice Alito reaffirmed the so-called "Gartenberg standard." In writing the court's unanimous decision, Justice Samuel Alito indicated that, in fact, the Harris board did not meet its full fiduciary responsibility. Why? Because it did not amply demonstrate that it bargained at arm's-length with management on behalf of fund shareholders. In other words, it's not enough that the board merely negotiate fees; they must be able to justify those fees with empirical evidence or data.

A Raised Bar
Providing the plaintiffs can make a legitimate case for excessive fees, they are likely to win their case when it is returned to the Court of Appeals. At the very least, they've apparently opened the door to further board accountability (we wouldn't be surprised if this ultimately leads to more outside directors being assigned to boards), and perhaps more shareholder suits.

However, the story doesn't end here.

With the Supreme Court strengthening the Gartenberg standard, the fund industry now avers that it has even more clarity, and that it's business as usual.

An industry trade group (the ICI) said this: "The Supreme Court's unanimous decision brings stability and certainty for mutual funds, their directors, and almost 90 million investors, by endorsing the Gartenberg standard under which courts have long considered claims of excessive fund advisory fees."

So, to the ICI's way of thinking, if a fund company provides accurate and full disclosure, and if a board can demonstrate that a different fee structure is the direct result of higher overhead, then existing multi-tiered fee structures can and will remain in place.

As the Supreme Court has had the opportunity on at least two occasions to address advisor fees and has largely left matters vague, it's understandable why the ICI is claiming victory. The Supreme Court has never directly ruled that market forces (competition) are or aren't a fair arbiter of fee schedules. But it has said that courts are ill-equipped to decide such matters. To wit, the ICI makes a very reasonable point that fund fees have fallen by half in the last 20 years. No court made that happen -- competition did.

But let's say that when the Court of Appeals revisits Jones v. Harris it decides that shareholders in the Oakmark funds do not deserve to pay twice as much in fees as institutions. Then what?

It's highly unlikely that Harris will dramatically increase fees for their institutional clients -- they simply won't pay it. That suggests that Harris may be forced to dramatically lower fees for retail accounts. While I could imagine some narrowing between the two fee structures, that delta (almost a half percentage point!) cannot be narrowed by much. Economies of scale in the fund business are very real. So what Harris and other fund companies could do is to raise fund minimums -- perhaps dramatically -- to keep smaller investors from buying their funds, while also increasing redemption fees and lengthening holding periods to keep them from leaving. (Such fees are paid to existing shareholders.)

In keeping with the law of unintended consequences, the Supreme Court's decision is so murky and riddled with grey matter that it's likely that more shareholder suits will emerge. In defending themselves, funds' expenses could rise.

As for how all this might affect your Fidelity funds, I suspect that they're in a better place relative to smaller-sized competitors, such as the Oakmark fund family. The reason for that is Fidelity's extremely competitive fee structure.

For example, for all its ups and downs, Magellan's expense ratio is 0.71% versus 1.31% for its industry-wide peers. With assets of almost $22 billion (down from over $100 billion a decade ago!) and more than a million shareholders, it has economies of scale that few other large-cap growth funds enjoy. But even Fidelity's six considerably smaller (asset-wise), small-cap funds have expense ratios that range from just 0.67% to a high of 1.35%. They average just 1.07% versus 1.51% for their industry peers.

With a product line consisting of hundreds of funds in multiple share classes, Fidelity is most assuredly weighing its own fee structures in light of the recent High Court ruling. However, with one of the few companies with performance adjustments to their fees, and as the average expense ratio of Fidelity's domestic retail fund is only 0.81% -- almost half that of the industry -- it's their competitors who should be the most concerned.




March 12, 2010
Fidelity's Annual An Eye-Opener

Fidelity's recently released annual report for fiscal year 2009 is a treasure trove of information.

Though the report always falls far short of the detail that publicly traded companies must provide shareholders and others, we always find it a useful tool for peering deeper into the inner sanctum of this private, family-owned business.

For starters, Fidelity's assets under management (AUM) grew by a robust 21% in 2009, from $1.247 trillion to $1.502 trillion. As much as this growth is good news to everyone involved with the firm, AUM are still 6% below 2007's pre-correction level of $1.597 trillion.

At the same time, revenues fell almost 11% last year, from $12.9 billion to $11.5 billion. This is partly the result of investor anxiety. Following the 2008 bear market for stocks, many investors were reticent in 2009 to get back into the market. (This is still the case today, as asset flows into stock mutual funds remain anemic.) Instead (and in spite of their low yields), assets continued to flow into safer fixed-income funds. While Fidelity was undoubtedly grateful not to lose these assets to competitors (all of whom have wrestled with the same asset allocation shifts), the management fees on bond and money market funds are significantly lower relative to stock funds.

In anecdotal terms, Fidelity's largest stock fund, Contrafund, has a management fee of 0.80%, whereas its biggest bond fund, Investment Grade, is just 0.32%. (Their expense ratios are 0.90% and 0.46%, respectively.) With less "room" to squeeze out profits, Fidelity had to make adjustments to grow its earnings.

One important way it did that last year was to lay off 3,000 of its nearly 40,000 employees. This, coupled with many other belt-tightening measures (such as slashing $300 million in expenses from its IT operations and another $80 million in savings by reducing U.S. mail deliveries in favor of electronic deliveries), yielded the intended results: operating income rose 5.2% from $2.39 billion to $2.51 billion.

While many fund shareholders are, understandably, only marginally interested in how well Fidelity's own balance sheet is faring, we'd argue that it's quite important for the company that manages your money to be financially robust. And while its credit rating was modestly downgraded last year (concern over eroding market share was cited), its bonds remain at a strong investment-grade status, while its financials are very good and improving.

Still, the most important issue for all of us is how well have Fidelity's nearly 500 funds recently fared?

Some highlights from 2009:

• Fidelity funds beat 74% of their competitors last year, up from 56% in 2008 (all performance figures are presented on an asset-weighted basis; this better reflects actual shareholder experience);

• Stock funds improved dramatically. Sixty-six percent beat their peers in last year's bull market, up from 36% in 2008's bear market;
  
• High-income funds hit their stride last year beating 78% of their rival funds. This was up from 23% in 2008, when Capital & Income (Fidelity's biggest and most aggressive junk bond fund) performed particularly badly in absolute and relative terms (down 31.9%);
  
• Money market funds haven't been yielding very much at all in recent years, but perspective is important: their funds consistently outperform about 87% of their peers regardless of all market conditions;
  
• Investment-grade bonds were one of the few disappointing areas for Fidelity fund investors last year. Only 46% beat their peers, which was down sharply from the 62% level it achieved in 2008.

Some other tidbits:

• Fidelity's customer base consists of more than 20 million individuals and institutions, and more than $3 trillion in assets under administration. This makes it one of the world's largest financial services company. In the U.S., it remains the largest mutual fund company.
  
• Fidelity provides defined contribution, defined benefit, heath and welfare and stock plan services to over 20,000 employers with more than 22 million participants. With that, they provide "benefits solutions" to 46 of the Fortune 100 companies.
  
• Fidelity has 132 Investor Centers around the country. Its website handles an average of 2.7 million "visits" per day.

February 2, 2010
Fidelity Takes On Rivals

The competition for fund assets and brokerage customers has heated up, with Fidelity making two bold moves today to regain market share in the increasingly competitive financial services industry.

The first of Fidelity’s two-part news today was its decision to step up its participation in the ETF fund business. In short, this initiative is a marriage of convenience between Fidelity and BlackRock.

On the one hand, Fidelity will make 25 popular BlackRock iShares available on an exclusive commission-free basis to its brokerage clients. As for BlackRock (which bought the iShares business from Barclay’s in June 2009), it gets instant access to a huge distribution channel. On that score, Fidelity has about 12 million brokerage accounts. Moreover, we believe that at some point, iShares will be made available to Fidelity retirement investors in 401(k) and 403(b) plans – though that’s just speculation on our part.

In reality, Fidelity has long been an indirect player in ETFs through its brokerage business. In fact, their customers have had access to 800 or so Exchange Traded Funds through a variety of fund companies. The difference now, is that Fidelity is making the country’s most popular brand available (roughly half of all ETF assets -- about $500 billion! -- are in iShares) on a commission-free basis for “at least three years,” says Fidelity.

While we’re excited to see Fidelity expand its second-party product offerings, we’ll be interested to see how competitive iShares’ expenses are relative to Fidelity’s own index funds.

In related news, Fidelity took another shot at its brokerage competitors today by introducing flat-rate commissions. Online equity commissions will be priced at $7.95 effective February 3. This move eliminates Fidelity’s tiered pricing structure and, says Fidelity, "reduces some customers’ commissions by as much as 60 percent." That’s a reference to the fact that some customers pay as much as $19.95 per transaction, a figure that falls dramatically from that level depending upon assets and trading volume.

Make no mistake about it, all these moves by Fidelity today are shots fired right at brokerage rivals Schwab, Ameritrade and E*Trade. And, to a certain extent, in the competition for fund assets, Fidelity is also taking on Vanguard -- the industry’s main fund index provider.

January 28, 2010
Former China Region’s Manager Suspended

On January 19, Wilson Wong was replaced on China Region fund. Now we’ve learned that Fidelity has apparently suspended Wong and a colleague for having run afoul of Fidelity’s strict internal code of ethics. But in keeping with Fidelity’s past practice, the company is saying nothing more about the two Hong Kong-based managers, pending the outcome of its own internal investigation.

Replacing Wong is Joseph Tse.

With 40% of the fund’s assets invested in Mainland China, 35% in Hong Kong and most of the balance (22%) in Taiwan, fortunately, Tse is no stranger to investing in this arena. Nor is he unfamiliar with this fund (which we hold in two model portfolios), as he previously managed it from 1995 to 2003.

Tse joined Fidelity in 1990 as an analyst covering Hong Kong and Chinese equities. In 1993, he became an assistant portfolio manager of several regional equity funds.

While we’re obviously concerned about this development and look forward to learning about whatever transgressions may have been committed, we feel that China Region’s $2.4 billion in assets remain in good hands. As for our outlook on China itself, we continue to rate the fund a Buy, and plan to say more about this volatile area of the market in our February report.

January 28, 2010
S&P 500 Index Funds Merge

Spartan 500 Index fund (Investor Class: FSMKX) fund has merged into Spartan US Equity Index fund. The combined fund then changed its name back to Spartan 500 Index, although its ticker is now, oddly enough, FUSEX.

Fidelity says that it made these moves because Spartan 500 Index "is more descriptive of the highly recognized" index. We agree with that, but we suspect that there’s another motive: cost containment. By merging the funds’ assets, Fidelity gains some economies of scale in managing a product whose expense ratio is kept at a razor-thin 0.10%. (Industry-wide expenses are closer to 0.60%.)

There are no other changes in terms of how the “new” fund is being managed, nor are there any tax implications.

January 20, 2010
Fidelity’s President To Step Down

At a meeting this morning with Fidelity Insight, Fidelity President Rodger Lawson told me that he plans to step down from his post “at the end of the quarter.”

Frankly, this "news" was not really news to us. After all, shortly after his arrival at the firm, he indicated to us that he only intended to stay for a few years. Indeed, Fidelity Chairman Ned Johnson 3d had altered Lawson’s plan to retire from his prior charge at Prudential.

Now, roughly three years into his tenure as president, he’s making good on his personal pledge. "Why now?" I asked Lawson. He grinned, and said that his short tenure at Fidelity had been made especially "challenging" by unprecedented market volatility.

Of course, this is no exaggeration on his part.

When Lawson came on board, it seemed that his greatest challenge was to shore up Fidelity’s slipping market share, as ETFs and other fund companies competed for the Boston-based company’s managed assets. And while he and his boss Mr. Johnson probably never overlooked that concern, it’s hard to imagine that there weren’t times when “organic growth” was the last thing on either executive’s mind.

Of course, 2008 challenged every aspect of Fidelity’s many businesses, especially its mutual funds. With the "collapse" of Lehman Brothers, followed immediately by a competitor’s money market fund (Reserve Primary) “breaking the buck,” Lawson had to deal with one crisis after another. A short list: the ensuing implosion of the credit market, the bear market for stocks and all other “risk assets,” bank failures, bankruptcies, home foreclosures, TARP funds, zero percent interest rates, etc. As such, we can certainly understand why retirement is looking good to him!

That said, the great performances that Fidelity funds booked last year bear the unmistakable "fingerprints" of Lawson’s handiwork. His predecessor Robert Reynolds (who now runs Putnam) and his team were responsible for bolstering and altering the company’s research prowess. But not content to sit still on prior changes, Lawson stepped-up the use of multi-managers on funds, and even undid some prior approaches such as creating smaller teams of analysts who are charged with more focused research tasks.

Because Fidelity’s businesses are much more than "just" managing mutual funds, the success of his tenure is more complicated than merely measuring fund performance. But, of course, that’s our primary interest. In that regard, his grades are high. In 2008’s bear market, Fidelity’s mutual funds (on an asset-weighted basis) beat 59% of their peers. Even better: in 2009’s bull market, 69% of their funds outperformed their peers.

As for what lay ahead for Fidelity without Lawson, Ned Johnson and his executive management team may continue without Lawson for a time (we expect him to eventually be replaced), though Lawson plans to remain working for Fidelity on an advisory basis. In the meantime, it’s really business as usual at Fidelity, which is actually a very good thing!

John Bonnanzio
Editor

March 31, 2009
Mega Cap Stock Manager Change

Matthew Fruhan now oversees Mega Cap Stock's investment team succeeding Rick Mace, who is retiring. Fruhan continues to manage Large Cap Stock which he's done since 2005. Although we prefer other large-cap growth funds to Fruhan's Large Cap Stock portfolio, our rating remains OK to Buy on Mega Cap as we prefer that particular area of the market.

March 25, 2009
Fidelity Plans to Merge Select Funds

As we noted on March 19, Fidelity is closing Select Networking & Infrastructure and Select Paper & Forest Products after the close of business on March 30. We speculated that they may be planning to merge them into other Select funds. I was reminded today by a colleague, that as we reported in our 2009 Independent Guide to Fidelity Funds Fidelity has already announced that they are planning (pending shareholder approval) to merge Networking into Select Communications Equipment and Paper & Forest into Select Materials this June. Mea Culpa.

March 24, 2009
Fidelity To Reopen Two Funds and Launch Another

Effective after the close of business on March 30, Fidelity is reopening Diversified International and Small Cap Stock to new investors. With these funds Fidelity has now reopened 6 funds since late last year as the bear market has led to significant fund redemptions making their management more difficult.

Small Cap Stocks assets have fallen from just under $5 billion when it was closed in 2006, to just under $2 billion today. While lower assets in themselves are not a problem (and, in fact, in the small-cap arena having less money to deploy is actually a positive) when money is steadily leaving a fund, it complicates the managers task. They are either forced to sell securities (that they may not want to sell from an investment point of view) to meet redemptions or hold more cash than they would otherwise. We welcome this move, but our rating remains OK to Sell, until we see a bit more from Manager Andrew Sassine who took over from long-time manager, Paul Antico in July of 2008. After a tough 2008, Andrew has done a good job over the first few months of 2009.

Assets in Diversified International, closed since late 2004, have fallen from a peak of around $57 billion in 2007 to $22 billion at the end of February. This is actually about the same level of assets as the fund held when it was closed, and the (still) large size of this offering is a mild concern. That said, Manager Bill Bower has done an excellent job on this fund since taking the reins nine years ago. Our rating remains OK to Buy.

Fidelity to Launch Global Commodity Stock Fund
On March 31, 2009, Fidelity will launch Global Commodity Stock Fund which will be managed by Joe Wickwire, who also manages Select Gold. Unlike Strategic Real Return which invests around 25% of its assets in commodities themselves, through notes linked to a commodity index, Global Commodity Stock will invest in the stocks of companies in the energy, metals and agriculture industries around the world (including the U.S.). We will rate this fund in the April Fidelity Insight Report.

March 19, 2009
Fidelity Closes Two Select Funds

Fidelity announced today that at the close of the market tonight, March 19, Select Paper & Forest Products and Select Networking & Infrastructure will be closed to new accounts. Given the low asset levels of these funds ($7.7 million and $38.5 million respectively) this may be a precursor to merging the funds into other Select Portfolios such as Natural Resources in the case of Paper & Forest and Technology in the case of Networking.