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Closing funds teaches lessons about new ones

Chuck Jaffe

Publication: The Day

Published November 18. 2012 4:00AM

Fidelity Investments recently closed three funds to new investors, as the firm reportedly mulls merging or liquidating them into oblivion.

It's not big news; thousands of funds are killed off across the industry every year.

Closings, however, affect millions of investors and for anyone who would prefer to stay out of that group, which typically suffers from poor results, high hassle factors and potential tax consequences, there is something to be gleaned from Fidelity's actions.

The first inkling comes from simply seeing the names and objectives of the funds involved: Fidelity Tax-Managed Stock, Fidelity 130/30 Large Cap and Fidelity Fifty.

It might not be so patently obvious at a small firm with a lesser name, but any time you see a big firm like Fidelity, Vanguard, T. Rowe Price and others making changes to their line-ups, it's almost always fringe issues taking it on the neck.

It's not that you won't find a plain, vanilla growth fund on the chopping block, but that's much more common at smaller firms - the way Royce is liquidating Royce Mid-Cap Service this month - or with troubled firms that are shuffling their line-up, as has happened with Columbia having merged away more than 50 funds in an ongoing restructuring.

Mergers and liquidations aren't horrific events for shareholders - in some cases, it rouses investors from ongoing inertia - but typically mean that an investor fell for a sales pitch and wound up with a lousy fund that failed to attract investor interest and hold management's attention.

If you consider that potential any time you consider a new fund - especially one based on the latest issues and strategies - it will force you to consider if the new issue 1) can attract other investors, and 2) has a strategy that actually works.

For proof, consider the three Fidelity funds.

The 130/30 fund was one of Fidelity's attempts to join an industry trend after the financial crisis of 2008 that has resulted in almost universal mediocrity, using leverage and short positions, where managers are betting against stocks, to create a fund that purportedly will make money in all market conditions.

The problem is that the large-cap fund, positioned in what is recognized as the easiest place to have been making money over the last few years, had lousy performance (bottom 10 percent of its peer group over the last three years) and never found enough investors/suckers/victims to attract enough dough to keep Fido interested. The fund has less than $20 million in assets.

Fidelity Tax-Managed Stock, likewise, has a size problem ($70 million just isn't a big deal to Fidelity) and performance issues (bottom 10 percent over the last five years, bottom quartile in the last decade), but also has the distinction of being run in a way that Fidelity was slow to adopt and that goes against the grain of what the firm does best.

While other firms were hyping tax-efficient offerings, Fidelity executives maintained that the best way to minimize taxes was to lose money, and they wanted their stock-pickers to have free reign to do what they do best. They ultimately caved in to marketing pressure, but it should have been clear from the beginning that this was more about responding to the market than about an exciting new issue in the firm's sweet spot.

Fidelity Fifty is the most intriguing of the changes, with a long history, strong assets ($663 million) and some stretches of stellar performance. It carries a bronze analyst's rating from Morningstar (albeit with just two stars in the firm's star-rating system).

That said, the fund's selling point in the large-cap growth space is that it has a concentrated portfolio, by Fidelity's standards, of 50 to 60 issues. When Fidelity's strength has long been considered the depth and breadth of its stock-picking capabilities, focusing on fewer picks concentrates the risks and in some ways limits what the firm does best.

While the fund is in the top quartile of its peer group over the last 15 years, it is in the bottom 20 percent through the most recent five- and 10-year periods, meaning its best days were more than a decade ago.

It's important to recognize the lessons here because while Fido was shuttering these funds it was rolling out five new funds for its Series group of funds. While new issues like Fidelity Series Intrinsic Opportunities and Fidelity Series Opportunistic Insights - run by star managers Joel Tillinghast and Will Danoff, respectively - would appear to be an expansion of what the firm does best, investors might be better off simply going for established funds in the same spaces that built the company's reputation.

The same could be said for BlackRock Global Long/Short Equity, Janus Diversified Alternatives, both recent new registrations,- and countless other new funds that seem shiny and exciting as they first come to market, but which have potential to be tomorrow's quiet closing.

The moral of the story: If you plan on using a fund as part of your portfolio for years, make sure you're buying something that will still seem like a smart idea years from now, rather than the market's current flavor-of-the-day.

Chuck Jaffe, senior columnist for MarketWatch, can be reached at cjaffe@marketwatch.com.

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