Fidelity's Stock-Picking Culture Is Alive and Well
The fund company has diversified into new businesses, but it is not abandoning its stock-picking roots.
Every April, the investment team at Fidelity holds an internal stock-picking contest. On the appointed day, after the market closes, the team gathers on the 14th floor of the firm’s Summer Street offices in Boston, and 40-odd portfolio managers each pitch one stock (some via prerecorded videos or teleconference from Hong Kong, London or Tokyo) to some 120 research analysts—a departure from the usual protocol. Each manager gets just 60 seconds to present, and then the analysts, traders and fund managers vote on the best pitch. “It gets fiercely competitive,” says Brian Hogan, head of the stock and high-yield-debt divisions at Fidelity and emcee of the annual event.
The stakes aren’t high, although there’s some gentle heckling from peers. The most persuasive pitch wins dinner for four on the company’s dime. So does the best-performing stock after one year. But there is a penalty for losing. The pickers of the four worst-performing stocks over the 12-month stretch must each donate $500 to the winner’s favorite charity. That keeps the picks within the realm of the reasonable. “In these contests, if there’s no risk, the managers will go for the highfliers,” says Tim Cohen, who leads the firm’s global research team.
The stock-picking challenge offers a telling glimpse into Fidelity’s mutual fund business. For starters, it’s collegial and spirited. “It’s fun, even though we give each other a hard time,” says Jed Weiss, manager of the International Growth fund. It’s also a teaching opportunity, and Fidelity is big on those. Many managers and analysts take notes during the pitches. New hires—analysts scheduled to start the following August—sit in on the contest as an initiation of sorts. “It’s a room full of really smart people, and they’re all trying really hard,” Weiss says. Most important, it’s all about individual stocks. For even as index funds win all the attention these days, these guys and gals are, at heart, stock pickers. They’re passionate about it. Many have been playing the market since they were kids.
Fidelity is, after all, home to one of the best stock pickers of all time: Peter Lynch. The minute-long pitch is a bit of an homage to him. As Fidelity Magellan’s manager in the 1980s, Lynch would listen to anyone with an idea, says Joel Tillinghast, manager of Fidelity Low-Priced Stock. But “you were dead after 60 seconds” if he decided your idea was a dud.
Lynch stepped down ages ago, but others have stepped up. Will Danoff, at Fidelity Contrafund, and Tillinghast, to name two, have enabled many parents to cover college tuition bills and retire afterward with the earnings from successful funds. But fund managers aren’t the rock stars they used to be, and even in a bull market, fund investing hardly captivates the masses.
Indeed, over the 10 years that Fidelity has run these contests, much has changed in the fund industry. First came the financial crisis, ushering in a deep-seated trepidation about the stock market. Then came the rising popularity of indexing and low-cost exchange-traded funds. These trends have been a drain on assets in actively managed funds. The next bear market looms, which will crimp business as spooked investors pull out of the market. Fidelity, still the big kahuna in actively managed funds, is coping with this change by branching further into other financial services. But when it comes to the fund business, it stands by its stock-picking roots. Can it win over investors to active funds again?
A Family Business
Fidelity’s long history hangs in the balance. The firm started with just one fund. The late Edward C. Johnson II (Mr. Johnson, to most employees) founded the advisory business in 1946 after taking over the flagship Fidelity fund in 1943. Today the company has 479 mutual funds, 23 exchange-traded funds and, including money market funds, $2.4 trillion in assets under management. It has grown into a financial-services behemoth that aims to meet every imaginable customer need. From its brokerage to its advisory services, which range from robo advice to white-glove amenities, the firm serves individual investors as well as institutional ones—the latter with thriving custodial and trading businesses and workplace retirement savings plans, among other things.
Despite a sprawling footprint, Fidelity is still a privately held family business. Abigail Johnson, a granddaughter of the founder, took over as chief executive from her father, Ned Johnson, in 2014. The family still controls 49% of the firm; Fidelity employees hold the remaining 51%.
Now the mutual fund business that put Fidelity on the map faces the challenge of a lifetime. Since the financial crisis, investors have pulled money out of actively managed funds and poured it into index funds (see The Perils of Investing in Index Funds). Ten years ago, Fidelity, which has offices all over the world, was the biggest fund firm in the land, as measured by mutual fund assets. Now Vanguard holds the top spot, thanks to its many popular index funds, and Fidelity ranks number two.
The firm has weathered bad stretches before. Between January 1973 and October 1974, when the stock market cratered 48%, Fidelity’s assets shrank by one-third. That’s when the firm decided to sell its funds directly to investors via a toll-free telephone number—the first fund company to do so—eschewing brokers and hefty sales fees. Today, Fidelity has a renewed focus on innovation. The personal investing side of the business is organized into agile squads, tasked with solving big-picture problems and given free rein to, for example, come up with a better active-trader platform or figure out the next iteration of Fidelity Go, the firm’s robo-advisory service.
The biggest thorn in Fidelity’s side has been the average active fund’s inability to beat its benchmark index consistently. Over the past 10 years through 2017, only nine of Fidelity’s 28 no-load, large-company stock funds outperformed Standard & Poor’s 500-stock index on an annualized basis. That’s on par with the rest of the industry. “I won’t sugarcoat it. Most managers don’t outperform their benchmarks,” says Sonu Kalra, manager of Fidelity Blue Chip Growth. “We need to do a better job.”
Some Fidelity managers have beaten the indexes over the long haul. Hogan calls them the “hall of famers.” Many have been at their posts for decades, including Tillinghast, Danoff and Steven Wymer, of Fidelity Growth Company. On the bond side there’s Ford O’Neil, at Fidelity Total Bond. There’s a new guard, too: Since taking over at Blue Chip Growth in mid 2009, Kalra has beaten the index by an average of 3.3 percentage points per year.
Like many of the fund managers at Fidelity, Kalra is a lifer. He joined Fidelity after business school in 1998 as an analyst and worked his way up. That’s the Fidelity way. The firm prefers to groom its managers, not transplant them from elsewhere, oftentimes breeding a fierce allegiance to the firm. “I’m living the dream,” says John Carlson, manager of Fidelity New Markets Income, an emerging-markets bond fund. Carlson isn’t a lifer—he’s a midlife hire—but he talks like one. He has run New Markets Income for 20 years. “I intend to be here a long time,” says the 67-year-old, who looks as if he stopped aging a decade ago.
New hires typically start as analysts. They learn by doing, getting to know companies in an industry or two and pitching their best ideas to fund managers. Good analysts move up to run sector funds. The next step is to take on a diversified stock fund. Ramona Persaud spent just six months as an analyst before taking over Fidelity Select Construction and Housing in 2004. Persaud is a rare woman among the manager ranks. She now has a hand in six diversified stock funds and focuses on dividend stocks.
Despite the sprawl of the Summer Street building, one of two that Fidelity owns in Boston, the U.S. stock team sits in close quarters along a stretch of the 11th floor, in a maze of cubicles and glass offices. It’s communal and collegial, as is the custom-designed space in Merrimack, N.H., where most of the firm’s bond fund managers and analysts work. Fidelity has 84 bond funds—a fraction of its 395 stock portfolios. Compared with the Boston headquarters, the culture in Merrimack is a touch more casual and outdoorsy. Bears, as in the actual furry animals, have been sighted on campus.
Skin in the Game
Just as with the stock-picking challenge, Fidelity’s fund managers earn bonuses (worth well more than a dinner out) if their funds outperform their benchmarks and similar funds. Many managers have invested their own money in the funds they run, so when the funds underperform, the managers feel it, too. Says John Roth, whose New Millennium fund has lagged the S&P 500 for most of the past four years: “It’s not very enjoyable. You feel a lot of pressure.”
Yet Fidelity fund managers are encouraged to take risks. “You can be wrong a lot and still outperform your benchmark,” says Hogan. “You can only lose 100% of a stock. It’s painful, and I’ve had it happen to me,” he adds. “But you can make two, three, four, seven, eight or even 12 times your money on a winner.”
Managers are free to develop their own investment philosophy and manage money the way they want to—as long as they stick to their methodology consistently (there is oversight from higher-ups). Tillinghast, for instance, likes small companies and appreciates a good value. Weiss, of International Growth, favors firms that can maintain demand for their product without slashing prices even during tough times. All of the managers are stock pickers who focus on fundamentals. They fill their portfolios one stock at a time by doing nitty-gritty research, company by company.
The philosophy dates back to Fidelity’s early days. In The Go-Go Years, a book about 1960s Wall Street, author John Brooks writes that Mr. Johnson would tell his fund managers, “Here’s your rope. Go ahead and hang yourself with it.” The quote illustrates how Fidelity to this day refuses to be defined by a single investment process. It’s not a growth-oriented shop or a value-seeking shop. It’s just after good stocks, whatever their stripe.
Good ideas can find an ear at Fidelity. In the late 1980s, Tillinghast was an analyst covering tobacco and personal-care-products firms when Fidelity asked for pitches for new funds. He came up with Low-Priced Stock. The idea was to find good values in small companies and out-of-favor larger firms. “I’d seen Peter [Lynch] make a lot of money on big companies trading at small-market-cap prices,” says Tillinghast. Since Low-Priced Stock launched in 1989, it has returned 14.1% annualized, which beat the S&P 500 by an average of four percentage points per year.
Tillinghast learned from Lynch. Now he mentors others. “We say to everyone here, ‘You have to teach and you have to learn,’ ” says Hogan. Those who teach but don’t learn may decide Fidelity isn’t the place to be and leave. If someone learns but never teaches, the company may say, “We’re not sure how long we want you here.”
A slew of high-profile departures have taken place recently. Wunderkind Chuck Myers, of Small Cap Discovery, retired in December. So did Jim Morrow, manager of Equity-Income. It was widely reported that Gavin Baker, of OTC fund, was fired for sexual harassment. A spokesman for Baker denies the allegations, and the official line from Fidelity is that he left to pursue other opportunities. But change is endemic to Fidelity. Although many will spend whole careers at the firm, people move around a lot and always have—Abby Johnson worked in nearly every division before she succeeded her father.
Amid changes within the firm and in the industry, Fidelity’s stock team tries to stay focused. Hogan says Fidelity is “a good house in a bad neighborhood.” But, he adds, “the neighborhood is getting better.” Indeed, things look brighter for actively managed funds. At Fidelity, more money poured into fund coffers in 2017 than was pulled out for the first time since 2014. And most of Fidelity’s large-company stock funds trounced the S&P 500 in 2017. Growth Company beat the index by nearly 15 percentage points, Blue Chip Growth by 14 points and Contrafund by 10 percentage points.
Success looks easy in a powerful bull market. Fidelity’s managers will also have to prove their mettle in the next market correction or even a bear market. Blue Chip Growth manager Kalra welcomes the challenge. “When there is fear in the market,” he says, “it’s usually a good time to be picking stocks.”
What Fidelity Likes Now
Fidelity’s army of analysts and fund managers scour every market sector and corner of the globe for good ideas. After a strong 2017, international stocks will continue to outpace the U.S. market, says Brian Hogan, who leads Fidelity’s stock team. “Our sense is this will be a four- or five-year phenomenon,” he says. Jed Weiss, who runs Fidelity International Growth (symbol FIGFX), focuses on firms that have long-term-growth prospects and solid standing in their industry. ASML Holding, a Dutch company, is a leader in photolithography tools, which are crucial to making smaller, faster, next-generation semiconductor chips. The stock is a top-10 holding in the fund. (Funds in boldface are members of the Kiplinger 25, the list of our favorite no-load funds.)
Weiss will travel to Japan soon to scout for bargains—a challenge, given the 26% rally in Japanese shares in 2017. He currently favors small and midsize companies there. Some of the stocks Weiss finds may wind up in another fund he manages, Fidelity International Small Cap Opportunities (FSCOX), which has 35% of its assets invested in Japan. He is also looking for buys in markets where economies that were under pressure are now improving, and he says Brazilian banks are attractive now.
Fidelity New Markets Income (FNMIX) manager John Carlson is “cautiously optimistic” about emerging-markets debt. With interest rates in the U.S. still low, payments aren’t yet onerous (much of the debt is denominated in U.S. dollars), and higher oil prices bode well for commodity-producing economies. Carlson says the portfolio is well positioned to deliver current income of 5.5% to 6%. The fund returned 10.2% in 2017.
On the home front, Sonu Kalra, who runs Fidelity Blue Chip Growth (FBGRX), still sees value in big-name tech stocks, including Amazon.com and Apple. Kalra looks out three, five and sometimes even 10 years. He has increased the fund’s stakes in Broadcom and Qualcomm based on the promise of 5G, the upcoming wireless broadband technology.
John Roth, who manages Fidelity New Millennium (FMILX), is defensive. He favors regional banks, including PNC Financial Services and US Bancorp, which will benefit from tax reform and a more benign regulatory environment. He likes retailers that are less vulnerable to competition from Amazon.com, including Tiffany on the high end and Dollar General on the low end. Roth, a contrarian at times, shed shares of tech companies last year, but he sees opportunity in shares of insurer Chubb, which is under pressure after a devastating hurricane season.