Tracking the Big One

Fidelity Investments is the world’s largest mutual fund company. It sends customers and the media regular newsletters and other information about its managers and offerings, but it rarely allows its money managers to speak directly to the media.

As a result, there tends to be less independent information about Fidelity than about other fund companies. This can be particularly frustrating for the many investors who have only Fidelity fund choices in a employee retirement account or prefer the convenience of investing only within the Fidelity universe, whether in funds or through Fidelity’s brokerage operations.

Jack Bowers’ Fidelity Monitor newsletter is one of the small number of independent information sources on Fidelity. The publication tracks all 150 funds that Fidelity markets directly to investors, not the broker-sold Fidelity Advisor portfolios, and makes recommendations for investors.

It appears that Bowers, Fidelity or both have been making some wise investment choices, because his newsletter has the No. 1 ranking for risk-adjusted performance of the 61 newsletters tracked by Hulbert Financial Digest over the 10 years ended Nov. 30, 1997.

Over that span, Bowers’ four model portfolios returned 18.2% a year on average, eclipsing the 16.9% annual gain of the Wilshire 5,000 index, which covers most of the U.S. equity market.

Bowers suggests only a few choices for his model portfolios. He starts his research by determining which industry sectors’ stocks are selling at the most reasonable valuations, then adds in his market outlook.

Currently, he’s nervous about the stock market but optimistic about bond investments. Bowers, who works in Rocklin, Calif., near Sacramento, also helps manage Weber Asset Management of Lake Success, N.Y., and is the author of the book “Successful Investing with Fidelity Funds.” He spoke recently with Russ Wiles, a mutual fund columnist for The Times.

Times: Does it bother you that Fidelity’s funds frequently aren’t well defined--that they often don’t stick closely to an investment approach? Such as when Fidelity’s large-stock funds salt their portfolios with medium and small companies?

Bowers: No. . . . I’d prefer that they remain flexible. That said, Fidelity has been moving toward more rigid controls and restraints for some of its funds. This has been seen in the bond area and among some of the large stock funds, whose managers have been told to stay fully invested. But in general, Fidelity’s managers still have an opportunity to make their own decisions and live by them.

Times: Fidelity has built its reputation with domestic stocks. It hasn’t fared so well in the international arena. Why not?

Bowers: Fidelity’s domestic stock-picking machine is based on looking at individual companies. This approach also has worked reasonably well in Europe, but problems arose when they ignored some of the other countries.

Just before Mexico came unwound [in 1994], Patti Satterthwaite had something like a 40% Mexican position in Fidelity Latin America, which was was roughly double Mexico’s weighting in the Morgan Stanley Latin American index. She liked so many companies in Mexico. What she missed was that the peso was about to go over a cliff. Fidelity’s managers miss such things because they don’t worry about them--they just focus on companies.

The same thing happened this year with the Fidelity Emerging Markets Fund. Richard Hazlewood had 30% of the fund’s assets in Malaysia, based on a belief that Malaysian companies were incredible bargains. That’s because everyone else knew the currency was going to take a fall.

So if you look at the big blunders that Fidelity has made on the international front, it’s because they have focused on trying to pick good companies.

When you get into international markets, you also have to be savvy on currencies and other factors, and you have to make sure you’re not too heavily exposed to one place. That’s starting to hit home with Fidelity. You can see that in the management changes they have made this year. Fidelity is making sure they don’t heavily bet on one country or region, which should improve performance over the long run.

With what they know in stock research, if they also can manage risks in their international funds, Fidelity will become an international powerhouse, too.

Times: It seems that Fidelity lately has issued a press release every month or two announcing a portfolio manager change. Is so much turnover frustrating to you?

Bowers: Not really. Turnover in the Select funds happens all the time. These are research beds for Fidelity, and to some degree they are a way for Fidelity to check out their promising analysts to see who is large-fund manager material for the future. Fidelity moves people around to see how they fare with different industry groups and investment strategies.

The Selects as a group have the highest manager turnover in the industry, by far. But look at the 10-year returns of the combined Select funds against the Standard & Poor’s 500. You’ll find that about 60% of the portfolios beat the index. So here’s a good example of a group of funds where high manager turnover has had no negative impact on long-term returns.

Times: But Fidelity also has lost some big-name managers like Jeff Vinik and Brian Posner. Is there a talent drain going on?

Bowers: With the exception of Posner and David Ellison, almost all the other people who left did so under a cloud. In one way or another, they had made mistakes that limited their upside with Fidelity. They knew their careers were over and that they had to go somewhere else. There’s some drain, but I think the new talent Fidelity brings in through hiring and promotions more than offsets what it’s losing.

Times: How do you make selections for your newsletter portfolios?

Bowers: I have developed a valuation model for evaluating industry sectors.

Fidelity releases stock holdings for its sector funds twice a year. [Some fund holdings are released more often.] I go through these lists and put a price-to-book ratio on every stock holding, then aggregate a price-to-book ratio for each sector fund.

After that, I compare how those funds are valued relative to their history. Certain sectors always are highly valued. Certain sectors always are cheap.

But if you look at how the market values these funds now relative to the past, you get a feeling for what’s cheap and what’s expensive. I also have opinions on what might happen in the market. Right now, with large stocks heavily overvalued, I’m playing it conservatively, favoring small caps and bonds. So with sector valuations and market conditions in mind, I try to decide which Fidelity funds are poised to outperform. I also consider who the managers are.

Times: You assume in your portfolio advice that subscribers fall into one of four models?

Bowers: I try to offer recommendations over a broad spectrum of risk tolerance.

For conservative folks who might need the money within the next three years, I invest mainly in bond funds.

For people with a horizon from three to eight years, I suggest the growth-and-income portfolio. For long-term investors looking beyond eight years, there are two options. The more conservative approach is a growth model. There’s also a model for Fidelity’s Select portfolios, for aggressive people who want to trade sector funds in their IRAs.

Times: Why do you use eight years as a cutoff?

Bowers: If you look at historical returns for the S&P; 500 index, which is the benchmark for my growth model, you would see that if you held the index for eight years or more, your downside risk was minimal while your upside potential was attractive. But shorter than that, there were periods when you really could have been burned.

Times: What’s your current market outlook?

Bowers: I’m heavily favoring bond funds right now, especially since the federal government is switching from having a budget deficit to a surplus. At the same time, corporations are aggressively paying down debt, while individuals are saving more. So we have a situation where there’s not much demand for money, especially if the economy slows. And with low inflation, bonds are real attractive. Both short- and long-term yields are several percentage points above the rate of inflation.

Times: Isn’t Fidelity known more as a stock-fund powerhouse, not a bond-fund specialist?

Bowers: Fidelity’s bond funds have done surprisingly well this year. My favorite is Fidelity Government Securities because it’s a long-duration fund that obviously invests in bonds with top-notch credit quality. If we do see declining interest rates, that fund’s share price will realize a large benefit. Another perk is that the income from government securities is tax- free at the state level. I also like Fidelity Short-Term Bond. I think the [Federal Reserve Board’s] next move could be one to cut interest rates, although it might not come for a year. Short-term bond funds would benefit directly from that. They are particularly good choices for people with income needs within the next few years who don’t want to risk losing much money.

Times: You also mentioned small-stock funds.

Bowers: Yes. They have not seen the big run-up that the large caps have, and they are not so highly valued--except for technology issues. Also, a lot of the cost-cutting efforts that large companies have made will ripple down to small and medium companies, allowing them to really improve earnings. I think small stocks are set to shine for at least five years or so. In my growth and Select models, I place a heavy emphasis on funds owning value stocks and small stocks.

Times: The Hulbert Financial Digest ranks you No. 1 in risk-adjusted return over the last 10 years. What do you think you’re doing right?

Bowers: One thing that has helped is that I focus on Fidelity’s better risk-adjusted performers. Also, each of my models stays relatively true to its strategy. The growth model, for example, has maintained a fully invested stance. I don’t do market timing, which destroys the performance of a lot of newsletters. Since I maintain exposure to bonds and stocks at all times through the various model portfolios, together they provide good diversification. This reflects what a lot of subscribers do.

Times: What’s an example of a Fidelity fund that has been a good risk-adjusted performer?

Bowers: Fidelity Low-Priced Stock, one of my favorites. It exhibits about half as much volatility as most other stock funds. Another example is Fidelity Spartan High-Income. Fidelity does an extremely good job of analyzing junk bonds as a result of its stock research. Fidelity is second to none in the high-yield category.

[Also] Fidelity Asset Manager Growth. It offers a way to get George Vanderheiden’s stock picks without paying a load. It has a small bond position, which stood at about 19% at the end of October. For a growth fund, it thus has enough bonds that if the stock market gets into more trouble over the Asian situation, this fund will hold up well. I also like Fidelity Asset Manager Income, which anchors my growth-and-income model portfolio. It combines Vanderheiden’s stock picks, at about 20% of the fund, with a heavy bond position. It’s a way to be in a bond fund without being totally in a bond fund.

Times: Any Fidelity funds that you recommend people avoid?

Bowers: Fidelity Select Computers and Fidelity Select Electronics. I’m leery of anything with extensive technology exposure, due to the Asian situation. . . . These companies are looking at earning the same profit margins or less on revenues that are declining. Yet tech stock valuations already are at a premium. I’m also leery of more broadly diversified funds that have a heavy tech exposure, such as Fidelity OTC, which has half its holdings in tech stocks.

Times: Why do you prefer not to interview managers?

Bowers: I’ve found that fund managers frequently are mistakenly bullish or bearish about their own funds or sectors. For example, Satterthwaite, who runs Fidelity Latin America, was extremely bullish just before that fund went over a cliff [in late 1994].

Conversely, Karen Firestone, former manager of Fidelity Biotechnology and Fidelity Health Care, had been very bearish and thus invested very conservatively where she really analyzed companies. Her funds ended up doing extremely well during a period she was bearish. All of these Fidelity managers are working hard and are set up with good research. I don’t need their opinions. What I need are data on the funds. I like to analyze the risk-adjusted returns, see what the stock-bond-cash positions are, find out which industry sectors they’re holding and determine the price-book ratio of the funds.

Times: Some observers seem to think that Fidelity’s hot-handed managers have lost their touch. Do you agree?

Bowers: Not really. Fidelity’s performance has not been up to snuff lately, so the natural conclusion is that Fidelity has done something wrong. But you have to realize that mid- and small-cap stocks have been under-performing relative to the S&P; 500.

Fidelity’s research machine is geared toward getting good leads on stocks that aren’t widely followed by analysts--mainly medium and small companies. . . . I think the company’s research machine is good. I even think they have sharpened it over the past three years. But they’ve been battling a head wind in the market.

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Profile

Editor: Jack Bowers

Newsletter: Fidelity Monitor, founded 1986. Tracks and offers recommendations on Fidelity mutual funds. Newsletter rankings are based on several model portfolios reflecting various investment objectives and risk profiles.

Phone: (800) 397-3094

Subscription: $96 a year for 12 issues; one free sample copy available on request