But the real news is what Fidelity didn’t do. It didn’t touch Fidelity Magellan, its $56 billion flagship. This despite the fact it’s been on the rocks the past six months. Since Sept. 11, when the fund reached its all-time high, Magellan has ranked a hideous 770th out of 818 growth funds, according to Morningstar Inc. As you can see from the graph adjacent to this article, from Sept. 11 through Friday, Magellan has lagged the Standard & Poor’s 500 index by a whopping 16 percentage points. The S&P 500 is the benchmark against which money managers are measured.
Yes, I know you can’t measure a manager by his short-term performance. But six months isn’t all that short-term. Besides, that half-year has dragged down the fund’s performance for the entire 44 months it’s been run by current manager Jeff Vinik. If you’ve owned the fund since Vinik took over in July of 1992, you’ve outperformed the S&P by less than 2 percent a year. Compare this with the 13.4-point advantage during Peter Lynch’s nine years or the 3.4 points during Morris Smith’s two years.
The problem probably isn’t the embattled Vinik, who’s being investigated by the SEC for allegedly talking up stocks that Magellan was selling, and who is rumored by BusinessWeek to be on his way out the door. (Fidelity denies the BusinessWeek story and says Vinik did nothing wrong.) Magellan has simply gotten too big and unwieldy. Fidelity could make the fund more nimble-and better-performing-by closing it to new investors. Or, even better, by breaking it into four or five separate funds. But Fidelity Investments uses Magellan’s stellar long-term performance and gigantic size as a mighty marketing tool. Break up Magellan, or close it, and Fidelity is admitting its managers are mere mortals, not stock-picking supermen.
Like other fund companies, Fidelity gets paid primarily based on a fund’s size rather than on how well the fund does for investors. Last year Magellan grew in size by $17 billion, almost 50 percent. It’s grown some more this year. This has increased Fidelity’s management fee (75 cents on each $100 of Magellan’s $56 billion of assets) to about $420 million a year, up from a mere $270 million at year-end 1994. And way above the $165 million when Vinik took over in 1992. So while fund-holders haven’t done all that well under Vinik, Fidelity’s fees are up 150 percent-all pure pretax profit for Fidelity Investments. That doesn’t include the $28 million or so that Fidelity gets yearly from investors who pay a 3 percent load to buy into Magellan. (Normally, funds give the load to the stockbrokers, who sell the shares to customer. in this case, Fidelity sells most of the shares directly, and just keeps the fee.) The load and management fees have been enormously lucrative for Fidelity Investment’s owners. These include the company’s controlling Johnson family, as well as other Fidelity employees.
People have warned for years that Magellan was getting too big. But Lynch and Smith managed to overcome this problem. So did Vinik until last fall, when the trouble started. Through Sept. 11, when Magellan was loaded with technology stocks and tech was red-hot, Vinik outperformed the S&P by a whopping 7.5 points a year. But he got hurt when techies dove; then he went heavily into bonds, only to have bonds do badly while stocks continued to soar. Lord only knows what multibillion-dollar gambles Vinik is making now.
It’s a question of math. Given Fidelity’s management fees and other expenses, Magellan has to outperform the S&P by 1.25 percent a year just to match it. That doesn’t sound like much when stocks rise 35 percent, as they did last year. But it’s a lot when you consider that, over time, stocks on average have produced only about 12 percent a year. To get a better-than-average return, a $56 billion fund has to make enormous bets. Let’s say Magellan could make a quick $50 million on a hot initial public offering. That would help make the quarter for most funds. At Magellan, 50 mill is a gain of less than a tenth of 1 percent.
Even Morningstar president Don Phillips, a Vinik fan, thinks Magellan has gotten too big to produce the stellar gains that made it famous. “Magellan has shown that great fund managers can flourish in a huge fund,” he says, “but I don’t know how long they can keep it up. Magellan has an outstanding chance of being an above-average fund, but it faces some difficulties in trying to create the top performance record.” Many fund managers-among them Windsor, T. Rowe Price, Tweedy Browne and Mutual Shares-have closed funds at various times, because they felt that having to invest huge amounts of money from new investors would be unfair to current investors. Fidelity, too, has been known to close funds on occasion. Why not Magellan? Forgive me for being cynical, but I think that Fidelity is leaving the fund open because it has such a huge psychic and financial stake in not changing anything about Magellan except maybe the manager.
Neither Vinik nor Fidelity president Edward (Ned) Johnson III would talk about the fund’s performance-or about why Fidelity doesn’t break Magellan up, or at least close it to new investors. “Jeff thinks he has the resources to successfully manage the fund the way it is,” a Fidelity spokeswoman said. “If at some point market conditions or shareholder needs change, and closing the fund is warranted, we would do so.” Magellan’s performance since September isn’t particularly disturbing, she said, because Magellan is designed for long-term investors: “Looking at six months isn’t the appropriate way to evaluate the fund’s performance.”
Maybe so, but Magellan didn’t get to be the most widely held stock in the United States by underperforming the S&P by 16 points over six months. My bet is that Fidelity, the most important and influential stock player in the country, will be trying to move heaven and earth to try to punch up Magellan’s results. But I also think its glory days are gone forever. I suppose it’s possible that Vinik or some other Fidelity hotshot could make Magellan magnificent again for the long term. And maybe Fidelity can also create a tree that grows to the sky.
