EASY DOES IT: TWO PLAYS FOR THE GO-SLOW NINETIES
FIDELITY: PULLING IN FIRST-TIME FUND BUYERS
Investors are getting more sophisticated. They're not chasing just those funds offering the highest returns. They're looking for other attributes as well, such as minimum risk or tax-free income. Here, we look at the Fidelity Asset Manager Fund, which takes a low-risk approach to investing and which bids fair to become the Fidelity Magellan of the 1990s. We also visit John Nuveen & Co., a firm that's feeding investors' hunger for municipal bonds.
Robert A. Beckwitt was the odd man out when he arrived at Fidelity Investments in 1987. The freshly minted Massachusetts Institute of Technology business-school grad had been hired as the fund giant's first "quant." Of 46 fund managers, he was the only one who used computer models to make investment decisions. The others were traditional stock-pickers who pored through financial statements and quizzed corporate managers.
While his colleagues may not quite fathom his methods, the 34-year-old Beckwitt is nonetheless one of Fidelity's superstars. The fund he developed and now runs, Fidelity Asset Manager, is a blockbuster. With $4.9 billion in assets, Asset Manager is outselling even the flagship Fidelity Magellan Fund. This year, Asset Manager is opening 60 new accounts for each new one in Magellan.
Asset Manager is hardly the swing-for-the-fences fund that Fidelity is known for. Instead, Beckwitt's creation divvies up money among stocks, bonds, and cash to minimize volatility and optimize returns. Since the fund's maximum allocation to stocks is 60%--right now it's at 50%--Asset Manager will usually trail the Standard & Poor's 500-stock index when the market is vaulting. But Asset Manager shines when the market is more tame or even negative. Says Beckwitt: "When the S&P goes down, I'm going to beat it."
Beckwitt isn't forecasting a tumble for stocks, but if that happens, he's confident he'll be able to protect his shareholders. His record so far is impressive:
Since the beginning of 1989, the fund's first full year in operation, Asset Manager has produced an average total return of 15.1% a year. True, the S&P delivered an average 15.8% during that period, but Asset Manager had only about half the volatility of the index.
Asset Manager is also trouncing its competitors. Since 1989, the average asset-allocation fund has shown an annual return of 11.5%. Industrywide, Fidelity Asset Manager accounts for about 40% of all the money in asset-allocation funds. It has been taking in new money at the rate of about $165 million a month for the past 15 months.
ONE-STOP SHOPPING. Fund companies rolled out asset-allocation funds in the wake of the 1987 crash. They were souped-up versions of "balanced" funds, which are as old as mutual funds themselves. Balanced funds usually keep a steady mix of 60% stocks and 40% bonds. But asset allocators also use cash instruments and may frequently adjust allocations in anticipation of market shifts.
Now, asset-allocation funds are attracting new investors, many of whom are first-time fund buyers looking for a simple, low-risk way to create a diversified portfolio. "This is not the go-go 1980s," says Beckwitt. "That's why the time for this fund is now." About 40% of Asset Manager's money comes from such novices, many of whom are ex-bank customers. "The one-stop-shopping concept is very appealing to small investors," says Amy C. Arnott, the analyst for asset-allocation funds at Morningstar Inc. Others are raking it in, too. Merrill Lynch Global Allocation Fund jumped from $176 million in assets in 1991 to $2 billion now.
Asset Manager's tremendous growth also comes from Fidelity's marketing muscle. Besides advertising, Fidelity is promoting Asset Manager through a soft-sell technique: Prospective Fidelity customers are given a questionnaire, called Fund Match, which assesses their investment options based on their goals and risk tolerance. Fidelity usually recommends some investment in Asset Manager or one of its two sister funds: Asset Manager--Growth and Asset Manager--Income.
Unlike many asset allocators, Beckwitt avoids big bets. He makes changes in asset allocation gradually, usually no more than 10% in any quarter. The changes are determined by computer models that track corporate profits, interest rates, and investor sentiment. The fund is typically split 40%-40% between stocks and bonds, with the remaining 20% in cash, but Beckwitt can go as high as 60% in either stocks or bonds.
Beckwitt's models also identify which industry sectors to invest in, but he doesn't select stocks. That's left to Fidelity analysts. The fund's top stocks include the Big Three auto makers and financial companies such as Federal National Mortgage Assn. and Citicorp. Beckwitt is also bullish on mid-cap stocks, since he thinks pension funds will buy them as big stocks stumble.
What gives Asset Manager extra kick is Beckwitt's global reach. About 40% of the stocks, 40% of the bonds, and 10% of the cash investments are in non-U. S. markets. Many asset allocators use only U. S. securities. Beckwitt has been increasing offshore assets since last September, when interest rates in Europe and in Japan started to fall. His short-term investments include high-yielding but speculative-grade Mexican Treasury bills. The risks, of course, are that Mexico may default or the peso may collapse. But Beckwitt doubts that will happen. His yield: about 14%. He also owns Mexican "Brady" bonds, whose principal payments, but not interest, are backed by the U. S. Treasury. They yield 10%.
The erstwhile odd man out has parlayed his talents into a mini-empire. In addition to three Asset Manager funds, he runs two bond funds and an institutional asset-allocation fund. He also oversees Fidelity Portfolio Advisory Service, which uses his computer program to allocate assets for individuals. All told, Beckwitt looks after $7.3 billion.
Beckwitt took a roundabout path to the fund business. He grew up in Colorado wanting to be a concert pianist and spent a year at the Juilliard School. He transferred to Princeton University with an eye toward medical school but switched to economics in his senior year. He then developed computer models at DRI/McGraw-Hill before going on to B-school and Fidelity. In forsaking a musical career, Beckwitt gave up the chance to hear the sound of a concert-hall audience applauding his prowess at the keyboard. But the bravos of fund investors have a music of their own.
NUVEEN: IT PAYS TO LEVERAGE
Talk about playing a hot streak. John Nuveen & Co., the granddaddy of the municipal-bond business, is turning up aces nowadays. With short-term interest rates at 20-year lows, bond prices at near-record highs, and tax hikes threatened, Nuveen's $27.3 billion family of funds is at the right place at the right time. And Wall Street approves: The stock has nearly doubled since going public a year ago at $18 a share.
But severe challenges lie ahead. The arch-conservative Nuveen faces heightened competition that will test its ability to adapt. And it must address increasing concerns that its leveraged, closed-end bond funds, the darling of tax-free investors when interest rates are falling, may turn ugly if interest rates climb. Closed-end funds trade on the exchanges like stocks and tend to be more volatile than mutual funds. "Everything has been perfection for the last two years, and perfection in the investment world just doesn't last," warns Catherine Gillis, an analyst who tracks closed-end funds at Morningstar Inc.
So far, at least, Nuveen and its top officers have profited handsomely. The company turned in record revenue and profits in 1992 and posted profits of $17.6 million in the first quarter, up 38% from a year ago. Thanks to an incentive-laden compensation package, Nuveen's top executives pulled down some of the biggest paychecks in the financial arena in 1992: $26.6 million each, in current and deferred compensation, for President Donald E. Sveen and Chief Executive Richard J. Franke.
The key to Nuveen's fate is its leveraged funds. Since they were introduced in 1988, leveraged funds have been growing at a rate of $5 billion a year, with 53 Nuveen leveraged funds listed on the New York Stock Exchange. The leverage comes not from the traditional method--buying stock with borrowed money--but rather by the way Nuveen structures its funds.
Nuveen sells two classes of shares for each fund--preferred and common. Proceeds from the sale of both classes are pooled and are used to buy munis. The interest from the munis will be used to pay both preferred and common shareholders. The preferred shares pay a guaranteed rate that's tied to the rate on short-term debt.
Let's say Nuveen sells $100 million in common shares and $100 million in preferred. With short rates lower than muni rates, perhaps $70 million in munis is all that's needed to pay dividends to the preferred shareholders. The rest of the munis--$130 million--produce income that goes to the common shareholders.
In effect, common shareholders get an interest "bonus" of 30%, because they are getting income from $130 million in munis. Because of the leverage, these funds will outperform ordinary, unleveraged muni funds when interest rates fall and bond prices rise. But if interest rates spike up and muni bond prices fall, the leveraged funds really get hit.
GROWING NEST EGG. Nuveen isn't the only leverage-lover. The hot muni market has attracted major competition from the likes of Merrill Lynch & Co. and Van Kampen Merritt Inc. And competitors such as Allstate and Colonial offer high-yield muni funds that rival the leveraged variety. Nuveen is buttressing its offerings with a high-profile advertising campaign, on which it spends $15 million a year.
Nuveen's bosses are keenly aware of the importance of the leveraged fund business and are scurrying to protect it. In top-level meetings recently, they've begun laying out a strategy to address problems that might surface if rates rise and muni prices fall. To ensure a predictable earnings stream in the future, Nuveen is retaining more earnings in its funds, rather than paying out large dividends today. Also, Nuveen is tying the rate paid on preferred shares to longer-term instruments to reduce the company's exposure to a sudden spike in short rates. That makes for a more predictable payment stream. And since long-term bonds react severely to interest-rate changes, the company is investing in shorter-term bonds to decrease the volatility of its muni portfolios.
It's typical advance planning, Nuveen-style. The firm prides itself on taking the long view, and even though economists are predicting that long rates will remain depressed, Nuveen is preparing for the worst. Says Timothy R. Schwertfeger, executive vice-president for corporate marketing. "We tend to take a very measured approach to what we do."
So far, at least, the Nuveen leverage strategy has been a roaring success. But that has been achieved in the best interest-rate environment in memory. Should rates rise again, Nuveen's containment strategy will minimize the damage--but its winning streak will surely be over. David Greising in Chicago and Geoffrey Smith in Boston