WILL CONTRA BE CLONED LIKE DOLLY THE SHEEP?: FIDELITY LEARNING SMALL IS BEAUTIFUL

Plagued by poor performance and massive redemptions from some of its most established mutual funds, Fidelity Investments may be conceding something that’s been common knowledge in money management circles for a long time: Bigger isn’t necessarily better.

Last week, Fidelity sharply reduced the mutual fund portfolio responsibilities of one of its top portfolio managers, George Vanderheiden. The mutual fund behemoth is also planning to launch four general equity funds this year, which may be used to capture cash being yanked from once-popular larger funds which have lagged their peers recently.

“It would make sense for them to close some of their big funds,” says Peter Di Teresa, an analyst at Morningstar Inc., a Chicago research group. “But Fidelity doesn’t like to close a fund until the assets become a real problem.”

Fidelity, the nation’s largest fund company with more than $600 billion in assets under management, says there are no immediate plans to close any funds. But Fidelity spokesman Scott Beyerl concedes, “We have a lot of large funds and managing them can be very challenging.”

Fidelity is not alone in that challenge. The company’s Boston-based rival, Putnam Investments, has closed three mutual funds in the past year and is seriously considering plans to close another. “There are liquidity difficulties with bigger positions,” says William N. Shiebler, president of Putnam’s retail mutual fund business. “You can also get overdiversified and have too many (securities) issues in a portfolio.”

The result can be a drag on performance. For example, the $31.4 billion Contrafund, one of Fidelity’s best long-term performers, gained only 23% last year, compared with 33.4% for the Standard & Poor’s 500 stock index – which Contrafund hasn’t outperformed since 1993. Contrafund suffered $523 million in net cash outflows in the first six weeks of 1998, according to Alpha Equity Research, a Portsmouth, N.H.-based consulting firm that tracks Fidelity fund
s.

Other Fidelity funds with lackluster one-year results that according to Alpha data show significant net outflows this year: Growth Company, with $412 million; Equity-Income II, with $263 million, and Value, with $255 million. The Investment Company Institute in Washington estimates that the industry’s 3,021 equity mutual funds took in $18.5 billion through Jan. 31, an average of approximately $6.1 million each.

Mr. Beyerl disputes Alpha’s numbers but says Fidelity won’t provide others, citing a policy of not talking about cash flows for individual funds.

closing funds may help

Analysts say the cash outflows from the funds may prompt Fidelity to close them. That’s because closing a fund has proven a good way to restore shareholder confidence and stanch the losses. $67 billion Magellan is a case in point. Before Fidelity announced plans to close its flagship to most new investors in August, the nation’s largest fund had suffered $2.9 billion in net outflows in the year to date. After the announcement, things turned around and the fund took in $382 million through December before shedding another $524 million so far this year, says Alpha.

While Magellan is again seeing more money go out than come in, the pace has slowed.

“If Fidelity learned anything from closing Magellan, it’s that closing a fund is a good way to stem outflows,” says Jack Bowers, editor of Fidelity Monitor, an independently published newsletter.

Closing funds isn’t Fidelity’s only option. It may also decide to “clone” an existing fund. An unnamed income and growth fund the firm plans to launch, for example, may share the same investment strategy, and even the same portfolio manager, as the existing Fidelity Growth & Income fund. Fidelity took the same tack in 1990 when it launched Equity-Income II after the original Equity-Income had been faltering for a year. The two have been competing ever since and have combined assets of $40 billion.

small and nimble

Next month, Fidelity will introduce the Small Cap St
ock Fund. In April, it will launch Strategic Income Fund, which will invest in high-yield securities and emerging market debt. The company also has plans for an as-yet-unnamed value fund designed to invest in beaten-down stocks.

The flurry of new offerings suggests the firm will emphasize smaller, more nimble investment vehicles. Fidelity is no doubt betting these siblings will enable it to boost overall investment returns. The main advantage of smaller funds is that they can move in – and more importantly, out – of hot stocks quickly.

“Fidelity is returning to its stock-picking roots,” says Eric Kobren, president of Insight Management Inc., an investment advisory firm in Wellesley, Mass. “Fidelity now recognizes that large funds can’t be managed as efficiently as small ones.”

But smaller funds within a giant fund complex face particular problems of their own. Besides having to compete for research with managers of hundreds of other Fidelity funds, small fund managers may see the price of a favorite stock move up or down dramatically once a colleague at a larger fund gets a whiff of it.

Nevertheless, the company announced last week it will scale back the amount of money run by Mr. Vanderheiden, a 27-year Fidelity veteran. He’s giving up management of Destiny II Fund and the stock portions of three Asset Manager funds. He will continue to manage Advisor Growth Opportunities Fund, Destiny I Fund and Variable Insurance Products Fund III: Growth Opportunities.

The changes, which will take place between April and June, will cut the assets under Mr. Vanderheiden’s management to $29 billion from $44 billion.

Mr. Vanderheiden says the lighter load will enable him to devote more time to research and stock picking. He was spending too much of his time on administrative and marketing duties, he says.

“It just comes down to wanting to do a better job for my shareholders,” he said in a telephone news conference last week. “I’m trying to free up some of the time I spent in non-
investment activities.”