Fidelity's New Contract With America

As head of Fidelity Investments' bond operations, Thomas J. Steffanci produced a profoundly enviable record. In just five years, he built a business with 63 funds and $27 billion in assets. His funds outperformed their industry peers each year until 1994--and even then, returns were only slightly below average. "If last year was a disaster, a lot of fund groups have disasters every year," says John Rekenthaler, editor of Morningstar Mutual Funds.

Within Fidelity, though, 1994 was indeed seen as disastrous. Aggressive investments by some of Steffanci's managers, combined with rising interest rates, produced lousy results at key funds. Most embarrassing were hits to the firm's most conservative short-term funds--the vehicles investors count on never to lose money. Shareholders pulled out hundreds of millions of dollars.

REINED IN. In late January, Fidelity acted to prevent such surprises again, announcing Steffanci's resignation and the reorganization of his bond operations under J. Gary Burkhead, Fidelity's chief of investments. Five fund managers were re-assigned; separately, emerging-markets specialist Robert Citrone left to join hedge fund Tiger Asset Management. The moves signaled an attempt to curb Fidelity's conservative funds, which under Steffanci had tried to juice yields by taking risky bets in emerging-market debt. Says an insider, "the funds that strayed will get pulled back in." Steffanci wouldn't comment.

The moves may finally soothe investors, who pulled $800 million from Fidelity's bond funds in December and $100 million more in January. But now, Fidelity must grapple with an issue facing many funds in the wake of last year's historic bond-market debacle: How can it balance performance with conservatism? Burkhead's reorganization, say insiders, was aimed at instilling some caution into the bond group's high-octane investment culture. But if Fidelity pulls back too hard, shareholders could suffer. "If they go too conservative, they're less likely to recoup" losses, says Sheldon Jacobs, editor of the No-Load Investor newsletter.

Steffanci had created a fiercely aggressive corps of fund managers, building teams of specialists in derivatives and emerging-market debt. Managers, encouraged to think like stockpickers, could double their salaries if their funds performed. The approach encouraged risk-taking that appeared, at times, inappropriate. Fidelity was stunned when one of its most conservative products, the Short-Term Bond fund, lost 4.1% last year--worse than three-quarters of similar competing funds. Investors pulled out in droves, with assets plummeting more than 40%, to $1.5 billion. The reason: manager Donald G. Taylor, investing heavily abroad, was burned by a hefty stake in Mexico. Another big fund managed by Taylor, Spartan Short-Term Income, fell 4.6%, and assets dropped to $610 million from $1.5 billion.

Numbers like those get attention fast--hence Burkhead's intervention. He wouldn't comment, but insiders say he wants to establish a clear line between Fidelity's conservative funds and its high-risk funds.

NO HOTDOGGING. That's probably why Taylor, for one, has been reassigned to more aggressive vehicles. Following Citrone's departure, the emerging-markets group has been placed under junk-bond chief Robert Lawrence, indicating that Fidelity will significantly pare back investments in those markets. The final change: Robert A. Beckwitt, the star manager of Fidelity's $11.1 billion Asset Manager fund, will leave the bond group to join the equity group. Beckwitt says his investment strategy won't change. Taylor wouldn't comment.

Some question whether Burkhead is going far enough. One possible problem: The bond group's compensation system, which remains unchanged, generates handsome annual performance bonuses without accounting for risk. Even so, Fidelity has made its message perfectly clear: After losing 11% of its bond-fund assets, the firm wants to keep hotdogging in check. Risk has its place--but it's not in conservative investments.

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