Why Did Fidelity Seal The Hatch?

It says it feared a huge cash inflow, but skeptics abound

The 4.3 million shareholders of the Fidelity Magellan Fund finally have something to cheer about. Fidelity Investments, the nation's largest mutual-fund firm, announced on Aug. 27 it would close its $60.9 billion fund indefinitely to all but existing investors and participants in retirement plans. It's perhaps the most important pro-shareholder decision Fidelity management has made in years. In theory, at least, the move will blunt Magellan's huge asset growth, which has hobbled returns in recent years, and will give portfolio manager Robert E. Stansky a better chance of boosting returns. The last day for new investors is Sept. 30.

The closing represents a dramatic change in thinking at the Boston-based giant. For years, critics have blasted Fidelity for allowing assets in its giant funds to grow unabated despite a falloff in performance. Magellan hasn't beaten the Standard & Poor's 500-stock index since 1993, when it was about half its current size (table). Sources say former Magellan portfolio manager Jeffrey N. Vinik had proposed to split the fund into smaller funds to make them more manageable. But under Fidelity's former philosophy, there was no amount of money that its powerful stockpickers couldn't handle. Although Fidelity executives steadfastly hold that size is not an issue, their decision to close the fund anyway speaks volumes.

Fidelity management tried to put a positive spin on the news. Their explanation: Closing the fund would "stabilize uneven cash flows." Stansky says he's worried about a possible surge of new cash coming into the fund now that he has improved the fund's performance. So far this year, the fund has a total return of 21.7% vs. 24.1% for the S&P 500. A flood of new cash, says Stansky, "might make me invest in stocks at a [high] price I don't want to pay." Adds former Magellan manager Peter Lynch, "it seemed like a good time to close the fund when the press is positive and there might be a huge inflow of funds." In the past, Fidelity has temporarily closed a few funds to give managers time to put cash to work.

TIMING TRICK? The company's explanation left analysts shaking their heads. For starters, Fidelity watchers say there's hardly any new money coming Magellan's way. David J. O'Leary, who tracks Fidelity at Alpha Equity Research in Portsmouth, N.H., says shareholders pulled $11 billion in cash out of Magellan since April, 1996, and that cash flow only turned positive in the second half of July. For August, O'Leary estimates that Magellan will attract $4 million in new assets--pocket change to a $60.9 billion fund. The likelihood that cash will suddenly pour into Magellan "is about as likely as Ted Kennedy announcing he's running for President," quips O'Leary.

There's another message in the closing that some find disquieting. "It sounds like Fidelity is saying the market is overvalued," says William Goetzmann, a finance professor at Yale University School of Organization and Management. "It sounds like they're trying to time the market." It was market timing that got Magellan into trouble in early 1996. Former manager Vinik put nearly 35% of the fund into bonds and cash, with disastrous results. Goetzmann says Fidelity should keep the equity funds fully invested and let customers decide how much of their money to keep in stocks and how much to shift to bonds or money markets.

While critics have long called for Magellan's closing, some insiders felt the same way. They lobbied to close it as far back as 1993, arguing that with a passel of other well-known funds, they no longer needed Magellan to market the Fidelity name. Among those who held that view, sources say, was then General Counsel Robert C. Pozen, now the funds' new investment chief.

Of course, Fidelity won't give up as much now as it would have several years ago from the closing. In 1993, Magellan brought in about half the firm's revenues from fund loads. Last year, it brought in less than 10% of load revenues.

Fidelity watchers say the closing shows Pozen is making big changes to restore Fidelity's luster with investors. But it will be up to Stansky to fire up the fund's returns.

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