Track Record

Part 2: Fidelity Funds - A Deeper Look at the Performance

Track Record

We recently wrote an article that gave a high level overview of the performance of 64 different equity funds from Fidelity Investments. Our goal was to inform investors to be very careful when they hear “rumors” in the financial media about superior fund families. This is in no way to disqualify the very talented individuals that work at Fidelity. These professionals have decades of investment experience and are usually graduates from some of the top institutions in the country. Rather, this is just another example of how the best and brightest of any single investment management firm is no match for the knowledge of the entire market as a whole. As such, choosing to partner with the Market, as a whole, versus the “stellar” investment manager is more than likely going to lead to a better financial result for the end investor.

In this particular article, we are going to address the subset of mutual funds from Fidelity that had a statistically significant alpha at the 95% confidence level, after being adjusted for known risk-factors that have been shown to compensate investors (market, size, and value), for the 20 year period ending December 31, 2014. As a quick reminder, a mere 6 mutual funds of the 64 (9.38%) had a statistically significant alpha at the 95% confidence level. We chose to examine only funds that have a least a 20-year performance history in order to increase our confidence in being able to draw conclusions from the data.

The 6 mutual funds from Fidelity that had a statistically significant alpha were:

  • Fidelity New Millennium Fund (FMILX)
  • Fidelity Select Health Care (FSPHX)
  • Fidelity Select Software & Comp (FSCSX)
  • Fidelity Select Biotechnology (FBIOX)
  • Fidelity Contrafund (FCNTX)
  • Fidelity Low-Priced Stock (FLPSX)

We are first going to address the sector-specific strategies: FSPHX, FSCSX, and FBIOX. What is potentially misleading about their report risk-adjusted alpha is that it entails “idiosyncratic risk” alongside the additional value from the investment manager. In other words, the sector-specific part of the fund is unique (idiosyncratic) to that fund versus a market-based index. Therefore, it is hard to extrapolate whether or not the alpha is a result of manager outperformance or just luck that their particular sector was one of the top performers.

Whenever you run a multiple regression, there is always an error term. The error term is an all-encompassing term that captures everything else that isn’t explained by the independent variables in the regression. The fact that a specific sector-based fund outperformed a market-based index might be nothing other than mere randomness. In fact, Health Care, Biotechnology, and Software and Computer companies have been some of the top performing asset classes over the last 20 years. Because we don’t see similar outperformance trends across many of the Fidelity sector-based funds, it leads us to believe that the alpha associated with these particular funds is nothing more than pure randomness. These sectors just happened to be the top performers over the last 20 years.

From a practical standpoint, utilizing sector-based funds within portfolios is not feasible or prudent. Sectors by themselves have been shown to have significant volatility (technology sector from 2000-2002 for example), which is too much volatility for most investors to stomach. Certain sectors can even be  plus/minus 20-30% during overall bull markets (2004-2007). It is also incredibly hard to predict which sectors are going to outperform in the future. It is easy for us to look back and say that we “knew” healthcare, biotech, and software were going to be the top performing sectors over the last 20-years. The charts below present: the annualized return for each major sector in the United States from 1995 to 2014, and, the Style Drifts for FSPHX, FSCSX, and FBIOX.

As you can see, there is no consistent pattern in return behavior. Nothing about past performance can give us reliable information about future performance.

That leaves us with the New Millennium Fund, the Contrafund, and the Low-Priced Stock Fund. Although these funds have in fact earned a statistically significant alpha over the last 20-years, it is not consistent amongst longer time periods. For example, looking over the entire history of the Fidelity Contrafund (36-years), the reliability of the alpha becomes less impressive. Below is a bar chart for the Contrafund displaying its alpha relative to the Russell 1000 Growth Index.

As you can see, although there are periods of time of great outperformance, there are also periods of continued underperformance. In order for us to have a high degree of reliability of the Contrafund’s ability to deliver superior risk-adjusted performance, we would need 49 years worth of data. Once we control for in-sample bias, which we wrote about extensively here, we would really need 98-years worth of data; much longer than anyone of us is likely to be alive. As a fiduciary, these types of odds don’t bode well with trying to create a positive investment experience. We would, in effect, be gambling with our clients' money.

What is also important to realize is that these fund managers are rotating in and out of certain investment styles in order to look for value. As you can see in the Style Drift Chart below, the Contrafund has rotated amongst large, small, growth, and value. While these style rotations have been accounted for in determining the portfolio’s risk-adjusted alpha, we still do not see a significant enough outperformance to warrant a significant commitment on the part of IFA.

A similar conclusion can be made for both the New Millennium Fund and the Low-Priced Stock Fund. You can find their alpha charts and style drift charts below.

As we have said before, we have yet to find a fund family that can deliver superior and reliable outperformance. Although many of these investment management firms have grown quite large in terms of assets under management, we believe this to be mainly a by-product of salesmanship and a misinformed population. Fidelity’s evolution into becoming a big fish in a small pond is a double-edged sword. The more their assets grow, the more their revenues grow, but the more unlikely that their active investment strategies will outperform. The more money that is steered into any one active investment strategy, the more pressure it puts on the portfolio management team to be on the right side of any trade. This, among their sub-par investment performance, makes it highly unlikely that they can bring value to clients in the future.

 

Here is a calculator to determine the t-stat. Don't trust an alpha or average return without one.

The Figure below shows the formula to calculate the number of years needed for a t-stat of 2. We first determine the excess return over a benchmark (the alpha) then determine the regularity of the excess returns by calculating the standard deviation of those returns. Based on these two numbers, we can then calculate how many years we need (sample size) to support the manager's claim of skill.

See part 1 of the Fidelity Fund performance analysis.


We have taken a deeper look at the performance of several other mutual fund companies and have come to one universal conclusion: they have failed to deliver on the value proposition they profess, which is to reliably outperform a risk comparable benchmark. You can review by clicking any of the links below: