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The Honolulu Advertiser
Posted on: Saturday, January 14, 2006

60-year-old Fidelity struggles to revamp profile

By Mark Jewell
Associated Press

BOSTON — Fidelity Investments is turning 60 this year, but the more important milestone may be the changes the nation's largest mutual fund company is making to restore investor confidence in some of its big-name funds after lagging returns and a stormy 2005.

Mediocre performances by Fidelity's once-stellar Magellan Fund and others have enabled rivals to surpass the company in attracting new investors. Fidelity also found itself the subject of an influence-peddling investigation involving its traders.

Responding to these challenges, Fidelity is revamping core operations, shuffling key money managers and hiring more investment analysts.

Fidelity says it's heading in the right direction, citing third-quarter earnings that rose 26 percent from the previous year's comparable quarter and broke a company record. It also points to growth in businesses outside its core mutual fund operations, including individual retirement planning and employee benefit management services Fidelity provides to large corporate customers.

"It's been a very, very good year," Chief Operating Officer Robert Reynolds said in a recent interview at Fidelity's Boston headquarters.

PROBLEMS LINGER

Outsiders agree Fidelity is succeeding in becoming a diversified financial services company and enjoying strong returns from certain mutual funds, but say the company is still dealing with the aftermath of problems at Magellan and some other high-profile funds.

"You can't use that to mask the real potential weakness in what used to be — or arguably still is — their core business," said Jim Lowell, a former Fidelity employee who runs an independent advisory newsletter called Fidelity Investor. "There's no question they've been moving against the tide with Magellan's woeful performance. And investors tend to think that as the flagship fund goes, so goes the rest of the fleet."

Observers credit Fidelity for recent moves to replace managers of poorly performing funds and bring in more experienced analysts from outside the company.

"I think they're on the right track with the changes they're making, but only time will tell if the execution will work out," said Christopher Traulsen, lead Fidelity analyst at Morningstar Inc.

Fidelity, which manages $1.2 trillion in assets, started out in 1946 with just $13 million. The company helped pioneer mutual funds and such investment products as tax-exempt money market funds before its consistently market-beating Magellan Fund fueled explosive growth in the 1980s and '90s.

Fidelity weathered the 2001 recession better than most of its rivals, and emerged unblemished from the industry's trading abuses scandal in 2003-04. It has recently enjoyed strong performances from its bond and international funds and impressive returns from its largest fund, Fidelity Contrafund.

While Magellan, Fidelity's second-biggest fund, posted a better return than all but 39 percent of its investment class peers last year, 71 percent of its rivals did better than Magellan over the past three years, according to Morningstar data.

Magellan's assets, which peaked at $102 billion in 2000, have dwindled to $51 billion, largely due to investors' disappointment in its performance.

COMPETITION RISES

Other Fidelity domestic equity funds weighted toward large company stocks had disappointing returns over the past year. Fidelity's fourth-biggest fund, Growth & Income, outperformed just 15 percent of its peers over the last 12 months and 8 percent over three years.

Meanwhile, Fidelity faces growing competition amid rising popularity of low-cost index and exchange-traded funds that are not actively managed.

The Vanguard Group, known for its index funds, leaped ahead of Fidelity in early 2004 as the No. 1 manager of stock and bond funds — a ranking which does not include bank account-style money market funds, a category Fidelity leads. Capital Research's American Funds took over the No. 2 stock-and-bond slot from Fidelity last June.

Just $4 billion in new investor money had flowed into Fidelity's stock and bond funds through from January through November, compared with $72 billion for American Funds and nearly $42 billion for Vanguard, according to the consulting firm Financial Research Corp. This measurement also excludes flows into money market funds.

Fidelity's Reynolds blames lagging results in part on heavy reliance on large-company stocks that generally fell short of smaller companies' returns in 2005 — a trend he considers cyclical.

The disappointing returns come as Fidelity and its rivals jockey for the money management opportunities from baby boomers set to retire and roll over 401(k) savings into new investments. Fidelity is trying to woo that market with commercials featuring singer Paul McCartney.

Meanwhile, federal regulators and a grand jury are investigating possible influence-peddling that could result in civil penalties and criminal charges. At issue is whether some of Fidelity's traders sent company business to brokerage firms that offered gifts and gratuities rather than to firms offering the best deals on trades. More than a dozen Fidelity employees have been disciplined in connection with the investigation, and at least five traders have left the firm.