- The Washington Times - Monday, January 16, 2006

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.

In response, Fidelity is revamping core operations, shuffling key money managers and hiring more investment analysts.

Fidelity thinks it is 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.

Outsiders agree that Fidelity is succeeding in becoming a diversified financial services company and seeing 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 seen 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 because of investors’ disappointment in its performance. In October, Robert Stansky was replaced as the Magellan Fund’s manager by Harry Lange, who is adopting a more aggressive investing style that emphasizes growth stocks.

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 past 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 that does not include bank account-style money market funds, a category in which 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 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.

“Their largest and most prominent funds have not been attractive to investors, so the assets have not flowed their way,” said John Bonnanzio, group editor of Fidelity Insight, anewsletter that tracks Fidelity.

Fidelity’s Mr. 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 former Beatle Paul McCartney.

As it tries to improve its overall performance, Fidelity has shuffled key managers. In May, Abigail Johnson, the daughter of company chairman and CEO Edward C. Johnson III, moved from a position overseeing Fidelity’s mutual fund business to a lower-profile unit managing retirement benefits.

Many observers had considered Abigail Johnson likely to replace her father, who is 75 but has not indicated publicly when he will retire. Morningstar’s Mr. Traulsen and other outsiders say Abigail Johnson’s move may signal she isn’t in line to take over.

“I think that has been thrown into doubt by her failure to innovate in asset management,” Mr. Traulsen said.

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