Fidelity's Abigail Johnson Says Fund Firms Did `Stupid Things'

2004-06-02 01:04 (New York)

(Published in Bloomberg Markets magazine.)

By Richard Teitelbaum and Aaron Pressman

June 2 (Bloomberg) -- From her corner office 35 floors above

Boston's financial district, Abigail Pierrepont Johnson,

president of Fidelity Investments' mutual fund division, rips

into competitors for allowing the trading abuses that have

metastasized into the biggest scandal in the industry's history.

``The best I can figure out is that the people who did the

stupid things were thinking about the one-year financial

performance of their companies,'' says Johnson, 42. ``You get a

few more assets in the short term, but it dilutes returns over

the long term.''

Fidelity has so far avoided the taint of corruption, and

that's just one piece of good news for the world's largest mutual

fund company. Profit rose 12.3 percent last year to $907.5

million. In February, managed assets topped $1 trillion as the

company has reeled in new billions -- some at the expense of

competitors involved in the trading scandal.

From last September -- when New York Attorney General Eliot

Spitzer trumpeted investigations into Bank of America Corp.'s

Nations Funds unit, Bank One Corp., Janus Capital Group Inc. and

Strong Capital Management Inc. -- through April, Fidelity gained

$34 billion in fund assets excluding money markets, 15.4 percent

of the U.S. total, according to Boston-based Financial Research

Corp.

In 2002, Fidelity gathered 7.6 percent of net new fund

assets.

Janus, Putnam

Since September, investors have pulled $17.5 billion out of

Janus and $31.2 billion out of Putnam Investments, a unit of

Marsh & McLennan Cos. that was sued for securities fraud by the

Commonwealth of Massachusetts and the U.S. Securities and

Exchange Commission.

During the three years ended on April 30, 63.4 percent of

Fidelity's domestic stock funds beat the average of their peers,

according to Chicago-based research firm Morningstar Inc.

During that period, 68.8 percent of Fidelity's international

stock funds beat their peers, and 69 percent of Fidelity's

taxable bond funds managed to do so as well. All 21 of its

municipal bond funds with three-year records beat their rivals --

as did 20 of its 25 biggest actively managed diversified stock

funds.

That Fidelity is thriving is an endorsement of Johnson's

leadership three years into her tenure, says Lawrence Lieberman,

a managing director at Princeton, New Jersey-based Orion Group

Inc., an executive search firm for the investment management

industry.

`Silenced the Critics'

``She's silenced the critics who questioned whether she was

the right person for the job,'' he says.

Mario Gabelli, chief executive officer at Gabelli Asset

Management Inc., says the strong fund performance vindicates the

firm's faith in fundamental research.

``If you're asking me where your firstborn should go to

work, I would certainly introduce them to Fidelity,'' he says.

``They ask the right questions.''

The scandals -- which have focused on fund companies that

granted special trading privileges to hedge funds -- do pose a

challenge for Johnson. The SEC may hit Fidelity and other firms

with costly regulations such as new compliance procedures.

Guy Moszkowski, a Merrill Lynch & Co. financial services

analyst, calculates that if all of the regulations under

consideration are enacted, they'll cost the industry as much as

$1.4 billion annually.

Franklin Morton, senior vice president of portfolio

management at Ariel Capital Management LLC, which owns shares in

several of Fidelity's competitors, says new rules will spur

managers to pack their bags -- a problem for Fidelity in the

past.

`Like Hedge Funds'

``You'll lose talent to the less-regulated areas of the

business, like hedge funds,'' he says.

The SEC is also considering a requirement that fund chairmen

be picked from outside directors. If adopted, Johnson's father,

Edward C. ``Ned`` Johnson III, 73, CEO and chairman of Fidelity

Investments, would have to surrender his role as chairman of

Fidelity's funds.

Nor have all of Fidelity's almost 30,000 employees escaped

scrutiny. Last October, Massachusetts Secretary of the

Commonwealth William Galvin subpoenaed a Fidelity salesperson,

who has not been identified.

At the time, Galvin said he was investigating whether the

person had helped brokers at Prudential Securities Inc. get

around Fidelity's trading limits.

A spokesman from Galvin's office declined to comment. A

Fidelity spokeswoman said there was no evidence the salesperson

participated in any improper trading.

$1 Trillion in Assets

Aside from the scandals, some investors say that Fidelity's

$1 trillion in assets handicaps its fund performance because of

the difficulty of buying or selling large numbers of shares

without moving prices -- a phenomenon that invariably drags down

returns.

The firm's biggest fund, the $65.1 billion Magellan Fund,

has trailed the Standard & Poor's 500 Index in four of the past

seven calendar years since Robert Stansky took it over. Its

annualized return through April was 7.2 percent versus 8.2

percent for the Index, according to Morningstar.

``Does size kill them at Magellan?`` Gabelli asks. ``The

answer is obviously that it has.''

Stansky blames his own stock picking, not the size of the

fund, for Magellan's recent underperformance. ``Underweighting

the technology sector, including names such as Cisco Systems and

Intel, was the primary reason for the fund's shortfall,'' he

wrote in the fund's annual report released on May 27.

Little Oversight

Abigail Johnson has to finesse cultural issues as well.

Fidelity has long permitted fund managers to invest without much

oversight as long as returns are acceptable. Now, investors --

particularly those in 401(k) retirement programs -- are demanding

that managers adhere to a predictable investing pattern.

``They don't want fabulous returns if it comes with

outrageous volatility,'' says Jim Lowell, editor in chief of

Fidelity Investor, a Needham, Massachusetts-based newsletter.

``Yet Abby has returned the firm to the notion that portfolio

managers do matter, and she doesn't want to lose them.''

The idea that managers should be allowed to run funds with

minimal interference traces back to Fidelity's earliest days.

Abigail Johnson's grandfather Edward C. Johnson II founded the

firm's predecessor, Fidelity Management & Research Co., in 1946

to advise the $13 million Fidelity Fund, started 16 years

earlier.

Granting Autonomy

At the outset, the firm differed from many competitors in

that Edward Johnson didn't manage the fund by committee. He read

the works of sociologist Eric Hoffer, who believed that granting

autonomy to individuals can unleash creative energy.

``When we are in competition with ourselves, and match our

todays against our yesterdays, we derive encouragement from past

misfortunes,'' Hoffer wrote.

In 1952, Johnson hired Gerald Tsai Jr., a young analyst from

Shanghai whom he referred to as his ``No. 2 son.''

Edward Johnson's No. 1 son, Ned, joined the firm in 1957,

also as an analyst. Both men eventually took over new funds as

managers. ``There was no rivalry,'' says Tsai.

In 1965, Tsai, now 75, resigned and went on to start his own

fund, the Manhattan Fund. He later became a financier and, from

1986 to 1988, CEO of Primerica Corp., a predecessor of Citigroup

Inc.

Ned Johnson took the reins of Magellan in 1965 and ran it

through 1971, beating the S&P 500 by an annual average of 22.7

percentage points during that time.

Assets Exploded

In 1977, he became CEO of Fidelity, and two years later he

stopped selling Fidelity's funds through brokers, abolished

almost all of their 8 percent sales charges and began marketing

them directly to the public without such fees.

Assets, just $3.1 billion in 1975, exploded to $39.2 billion

in 1985 and $409.5 billion in 1995.

Ned Johnson was known inside the company for a New England-

style frugality, says Eric Kobren, editor of Fidelity Insight

newsletter in Wellesley, Massachusetts.

Kobren, who worked for the firm in the early 1980s, says he

remembers wrapping up a Christmas party for New York employees

with Johnson at 2 a.m. In the bitter cold outside the building,

Johnson canvassed the stragglers to find one willing to share a

taxi with him to the airport later that morning.

For all his thriftiness, Johnson poured money into the new

technologies necessary to keep pace with growth, introducing a

voice-activated computer response system to the public in 1979

and building a network of regional centers for responding to

computer and phone inquiries.

New Businesses

Fidelity was also branching out into a variety of new

businesses -- among them a discount brokerage in 1978, 401(k)

plans in 1983 and payroll management in 1998.

Fidelity Vice Chairman Robert Reynolds, 52, says the company

has learned not to expect a quick return on its new-business

investments. He began Fidelity's push into the 401(k) market in

1983, and the venture didn't become profitable until the early

1990s.

``Our time horizon for success is longer than any public

company can ever endure,'' he says.

Today, Ned Johnson is seldom involved in the day-to-day

money management; he still queries managers about their stock

picks.

``He's stepping back and trying to get the philosophical

vision of the company right,'' Lowell says. ``Pretty soon it will

have to function without him.''

$10 Billion Stake

In guiding Fidelity into the future, Abigail Johnson has a

lot more at risk than her philosophical vision. She holds 24.5

percent of Fidelity's voting stock -- a stake valued at about $10

billion.

The Johnson family doesn't control a majority of voting

shares; about 50 executives own 51 percent of the voting stock.

Abigail Johnson's father, Ned, owns an additional 12 percent,

according to SEC filings.

Abigail Johnson's brother, Edward C. Johnson IV, 39, who

works at Fidelity's real estate division, owned 5.6 percent of

the firm, according to a Dec. 31, 2000, report by the state of

Utah's Department of Insurance.

Her sister Elizabeth, 41, whose husband, Robert Ketterson,

40, works at Fidelity's venture capital unit, also owned 5.6

percent.

Only directors, officers and employees, or trusts, charities

and partnerships related to them, may own common shares,

according to Fidelity's 2002 annual report. The company typically

buys back shares of employees who leave.

Private Status

Fidelity's private status frees it from myopic attention to

quarterly financial reports, Abigail Johnson says. ``One-year

financials aren't in your control,'' she says.

Johnson, who began working as a summer research associate in

1986, was herself weaned on Fidelity's research culture. ``Bob

Stansky, Steve Petersen, John McDowell, Steven Kaye -- they've

all known me since the day I walked in the door,'' she says,

referring to four widely known fund managers. ``I've worked with

them and for them for many, many years.''

Today, a cabinet top in her office is cluttered with

miniature backhoes, bulldozers and other excavating gear --

mementos from her days as a machinery analyst.

Johnson first interned at Fidelity in 1980, the summer

before she enrolled at Hobart and William Smith Colleges in

Geneva, New York, where she majored in art history.

Famous for guarding her privacy, Johnson has enlisted the

school's faculty and administrators in the effort. A college

spokeswoman referred questions about her back to company

headquarters.

Harvard MBA

``We've been asked by her not to talk about her time here,''

says art history professor Elena Ciletti.

After graduation, Johnson spent two years at Booz Allen

Hamilton Inc., the New York-based consulting firm, where she met

her future husband, Christopher McKown, 49, today president of

Health Dialog Services Corp., which sells health-care advice to

corporate employees.

In late 1988, Harvard MBA in hand, she joined the family

firm and began following machinery and automation stocks

including Caterpillar Inc., Deere & Co. and Ingersoll-Rand Co.

Harry Lange, 52, who ran what is now the Select Industrial

Equipment Portfolio, was her first mentor.

As the pair toured factory floors in the Midwest, Johnson

says, Lange taught her to push beyond ``the usual business school

stuff,'' explaining, for example, the tensions between those

designing industrial equipment and those manufacturing it.

Red Roof Inns

She's quick to laugh about hotels on the road -- budget

places like Red Roof Inns or Jumer's Castle Lodge in Peoria,

Illinois. ``She never complained at all,'' says Lange, now

manager of the Capital Appreciation Fund.

Johnson soon moved on to cover other industries. In April

1993, she was named to head her first diversified stock fund, the

Dividend Growth Fund, which she ran for almost a year, beating

the S&P 500 by 11.6 percentage points.

That was followed by stints managing the OTC Portfolio, from

April 1994 to June 1996, which beat the S&P Midcap 400 Index by

5.5 percentage points annualized, and the Trend Fund, from June

1996 to January 1997, which trailed the S&P 500 by 8.9 percentage

points.

In 1997, Johnson was tapped to oversee Fidelity's

specialized growth funds and worked under Robert Pozen, president

of the fund division.

In 2001, after he resigned to join President George W.

Bush's Social Security Commission, she stepped into his old

position.

Market Timing Penalties

In February, Pozen, 57, became chairman of MFS Investment

Management, which had earlier agreed to penalties for market

timing levied by the SEC and other regulatory agencies.

As of March 31, Johnson was responsible for $144.5 billion

in bonds and $199.1 billion in money market assets as well as the

$677.7 billion equity division that most controls Fidelity's

fortunes.

At the heart of the unit are the 217 equity research

analysts worldwide who feed fund managers a stream of investment

ideas, ``buy`` and ``sell`` recommendations and updates. Both

analysts and managers tend to operate with a Fidelity mindset --

emphasized since founder Edward Johnson II's days -- that picking

stocks requires a maverick streak.

John Muresianu, a former utility analyst and manager of the

Fidelity American Trust, a U.K.-sold fund, recalls that

Amazon.com Inc., America Online Inc. and Yahoo! Inc. were all

cheap by his estimation in 1997.

500 Percent Gains

That was because investors viewed them as technology stocks

while he, considering the popularity of their brands, decided

they should more properly be valued as top-notch consumer brands,

deserving of higher prices.

Muresianu began buying the three stocks in December 1997 and

sold them all in early 1999, posting gains of 500 percent or more

on the positions. ``They give you the freedom to be a

contrarian,'' he says. ``It means going against the crowd.''

Analysts often seek advice from former fund manager Peter

Lynch, 60, whose office is around the corner from Fidelity's

Boston headquarters.

From 1977 to 1990, Lynch managed Magellan, and over that

time the fund returned 29.1 percent annualized versus 15.3

percent for the S&P 500, according to Morningstar -- a record

that turned him into an investing hero.

Lynch, a vice chairman, was featured in a Fidelity

advertising campaign in the late 1990s, and more than anyone

else, he has been Fidelity's public face.

King Charles Spaniel

One snowy day this past March, Lynch was seated behind his

desk while Aggie, his 2-year-old cavalier King Charles spaniel,

was under the desk, gnawing a chew toy.

``One half of pet owners call their dogs Francis or Aggie or

George,'' Lynch says. ``They used to call them Spot.''

That insight has led Lynch to an investment choice. As of

February, Lynch owned more than 5 percent of Hartville Group

Inc., a North Canton, Ohio-based company that insures pets for

veterinary expenses and has a market value of $64.8 million.

The likelihood that people devoted to their cats or dogs

would buy insurance policies on them is an example of the ``own

what you know'' wisdom that helped make Lynch a media darling.

Lynch shares past experiences with analysts and constantly

questions their assumptions. Brian Posner, now 42, former manager

of the Equity-Income II Fund, says that in 1990, Lynch asked him

why he was avoiding American Express Co. stock.

``I didn't like the balance sheet,'' Posner, now managing

partner of Hygrove Management LLC, recalls. ``He said I was

missing the point.''

American Express

The real negative, Lynch said, was that AT&T Corp. had

introduced a no-fee credit card; American Express's Travel-

Related Services division would suffer as long as it was

dependent on its $55 annual credit card fee to turn a profit. By

mid-1994, Posner says, he noticed that American Express had

reduced costs enough that it could earn money with or without the

fee.

The company became Posner's largest position, and its shares

more than doubled before he left Fidelity in late 1996.

Because Fidelity almost never hires outside fund managers,

analyst recruitment is crucial.

It usually starts on campus. In 1991, Paul Antico, now 35

and manager of the Small Cap Stock Fund, was first contacted

while at Massachusetts Institute of Technology, from which he was

graduating with a bachelor's degree in economics.

In one of his early interviews with the company, Richard

Spillane, then research director, zeroed in on Antico's hobby,

collecting baseball cards.

Antico had given lectures on the subject, and his thesis at

MIT explored whether a ballplayer's race has a bearing on the

resale value of his cards.

After They Retire

It does, says Antico: The cards of minority players tend to

lag those of nonminority players in price appreciation, though

only after they retire.

Interviews with more fund managers and analysts followed.

Antico says they seemed somewhat disinterested in his economics

background. ``Everyone kept going back to the damn baseball cards

-- how did I decide which to buy and sell,'' he says.

In the early 1990s, Abigail Johnson helped devise an extra

hurdle for job applicants: the prospectus test, or p-test for

short. At the time, Fidelity was inundated with prospectuses for

initial public offerings.

Fidelity would provide a prospectus to the candidate, who

researched the company and wrote a two-page report with a ``buy''

or ``sell'' rating. ``It was a great way for people to compare

thoughts about a candidate,'' Johnson says. ``And it was a

convenient productivity tool.''

10 Percent Stake

For his p-test in December 1996, Subrata Ghose, a former

Fidelity environmental services analyst and now an associate

manager at OppenheimerFunds Inc., was told to research New

England Business Service Inc., a seller of business supplies to

small companies in which he knew Fidelity had about a 10 percent

stake.

Ghose, who has an MBA from Northeastern University, ripped

into the company. ``My thesis was, they were too dependent on the

economy, too dependent on small business,'' Ghose says. ``In a

downturn, they would get killed.''

Managers and analysts argued with him for 45 minutes. ``I

refused to back off,'' says Ghose, now 37. ``They called me a few

days later and said, `You have the job.'''

From the start, analysts are on their own, with no rules or

guidelines about how to cover an industry. Thomas Soviero, 40,

now manager of the Leveraged Company Stock Fund, recalls his

first weeks: ``Someone told me, 'On spreadsheets, we do the years

from left to right here.' That's the extent of the structure

that's here.''

Accelerating Earnings

Fidelity has no iconic methodology for picking stocks the

way, say, American Century Investments Inc., a Kansas City,

Missouri-based fund company, looks at accelerating earnings to

evaluate growth stocks.

``It would be so much simpler if we did 10-year dividend

discount models and ran some screens, but we want analysts to do

something that nobody has ever seen before,'' says Fidelity

Research Director Katherine Collins.

If an analyst wants to buy a study or travel somewhere, no

approval is necessary.

``Fidelity can easily spend $5,000 for an analyst to take a

junket to Tokyo without knowing whether it will pay off or not,''

says Timothy Krochuk, former manager of what is now called the

Focused Stock Fund, who now manages money at GRT Capital Partners

LLC, a Boston hedge fund firm. ``They can afford to take a

chance.''

Within a year or two of their first industry assignments,

analysts may be given charge of one of Fidelity's 40 industry-

specific, or Select, funds.

`Doesn't Freak Out'

``Managing a Select fund is a responsibility,'' Collins

says. ``Is this a person that's comfortable taking a stand on a

company? Is this someone who deals with volatility and doesn't

freak out?''

In the Select funds' holdings, the diversified fund managers

have a snapshot of analysts' best ideas, based on their largest

positions.

As of last November, for example, Anmol Mehra, manager of

the Select Automotive Portfolio, had 11 percent of the fund

invested in truckmaker Navistar International Corp., 7.2 percent

in American Axle & Manufacturing Holdings Inc. and 6.6 percent in

Toyota Motor Corp., Asia's largest automaker.

``An analyst is putting his money where his mouth is,''

Lange says.

One component of an analyst's pay is determined by an

objective system, which tracks how analysts' picks and pans fare.

The larger part is determined by fund managers, who calculate --

sometimes in hundredths of percentage points -- how much each

analyst has contributed to their funds' performances.

$400,000 to $600,000

Lieberman, the search firm executive, estimates that

analysts typically earn $400,000 to $600,000 a year.

Fund managers are forced to cope with Fidelity's huge asset

base, which can handicap returns. According to SEC regulations, a

mutual fund firm can usually buy no more than 15 percent of a

company, and individual funds are limited to 10 percent of a

company's stock.

So managers may be unable to amass meaningful amounts of

stock in a company they like. Buying large blocks of a stock may

run up its price, and selling drives it down, hurting returns.

The solution, fund managers say, is to use Fidelity

resources to overcome the disadvantages of size.

``So, Fidelity is big -- that's a problem,'' says William

Danoff, 43, manager of the Contrafund. ``So, Fidelity is big --

that's an opportunity.''

Overseas Analysts

For Antico, one way to leverage the firm's size is to

harness Fidelity's overseas analysts to cast his net more widely

than competitors; more than 20 percent of his small-cap fund's

assets are invested in non-U.S. companies.

Antico says a London analyst, Tom Ewing, in 2002 alerted him

to Tracleer, a new drug for pulmonary hypertension manufactured

by Actelion Ltd. in Switzerland. Antico asked an independent

research firm to survey pulmonary specialists about the drug, and

they were enthusiastic.

``It could be used on a much broader set of patients than

existing drugs, showed excellent efficacy and few side effects,''

Antico says. He bought Actelion shares in late 2002 for about 65

Swiss francs and sold them earlier this year for 140 to 150 Swiss

francs.

Fidelity's managers utilize the firm's size in other ways.

When corporations go out on roadshows to peddle their stocks,

Fidelity is often at the top of the itinerary. That means the

firm's managers hear about new companies and new industry trends

before competitors.

Access to Top Managers

``Often they are fly-by-night outfits, but sometimes they're

the new industry leaders,'' Danoff says.

Danoff says he has unusual access to top managers, people

like Bernard Marcus, 75, founder of Home Depot Inc., an Atlanta-

based building supply retailer whose stock Danoff began

recommending while running the Select Retailing Portfolio in

early 1987.

He recalls how Sears, Roebuck & Co. Chairman Edward Brennan

attempted to convince him that the Hoffman Estates, Illinois-

based department store company was turning its business around at

the time of a public stock offering in September 1986.

``I would ask Bernie, `Ed Brennan says he's cleaning up his

act,''' Danoff says. ``He would say, `We're killing him.'''

Sears' stock ended the decade 13.8 percent below the $44.25

offering price, while Home Depot's more than quadrupled.

Imperative to Deliver

``You have access to grayhairs who have been through market

cycles,'' Danoff says. ``I'm not sure John Q. Hedge Fund can do

that.''

The freedom and resources fund managers receive come with a

strong imperative to deliver solid returns. ``The reality is, if

I don't execute, I'm not going to be here,'' says Danoff, who has

managed the $37.3 billion Contrafund for almost 14 years and has

beaten the S&P 500 by 3.8 percentage points annualized through

April, according to Morningstar.

In 1996, Magellan manager Jeffrey Vinik invested over 30

percent of his holdings in bonds and cash when stocks rallied.

Even though Magellan's prospectus allowed it to make such

defensive bets, business magazines berated him, saying he had no

right making big wagers.

Vinik, who resigned in 1996 to manage a hedge fund, did not

return phone calls.

Within the next year or so, several of Fidelity's other big

funds, including Trend and Growth Company, were also trailing

their peers. That prompted Pozen, fund division president at the

time, to set up procedures to ensure that funds strictly adhere

to new guidelines set forth in their prospectuses.

``We went to truth in advertising,'' he says.

Pozen's Changes

Among other changes, Pozen reached a consensus with fund

managers so that stock funds would hold no more than 10 percent

of their assets in cash at month's end.

He made improvements to quarterly performance reviews, so

that managers could understand which positions were paying off,

which weren't and which stocks that weren't held by the fund

would have improved returns.

Pozen also helped implement a new compensation system for

managers based on how their performance stacked up against both

peers and specific benchmarks such as the S&P 500. The system was

largely based on three-year performance to encourage a long-term

outlook.

To discourage managers from making big, swing-for-the fences

bets, a manager did not get paid more for beating, say, 97

percent of competitors in one year than for beating 78 percent of

them.

Tension Remains

Today, Abigail Johnson describes the changes Pozen made in

the equity division as relatively minor. ``It was a slightly

overdue tightening up of some core principles,'' she says.

Even so, the tension between the iconoclastic freedom and

discipline remains. In May 2002, Muresianu, then managing the

Fifty Fund, a capital appreciation fund, had built up its cash

position to about 30 percent.

Though the S&P 500 had fallen about 30 percent from its

March 2000 high, he says, he still believed equities were

expensive.

At the time, Muresianu had a formidable record at Fifty,

returning an annualized 9.2 percent from January 1999 to late

June 2002 compared with a return of minus 4.4 percent for the S&P

500. Fidelity senior management -- Muresianu declines to name who

-- demanded a reduction in the fund's cash position and an

increase in its stock holdings.

In a June 19, 2002, memo to Abigail Johnson, Muresianu

wrote, ``To reduce the Fifty cash position today would be

inconsistent with the first principle of our code of ethics,

namely, the injunction to put shareholder interests first.''

Muresianu Resigned

Muresianu resigned and today runs money management firm

Lyceum Capital LP in Concord, Massachusetts. ``Given my views, I

did the only thing I could do: I resigned,'' he says. ``I'm

infinitely indebted to the company.''

A Fidelity spokeswoman declined to comment on Muresianu's

remarks.

That Fidelity has so far not been caught up in the trading

scandals is no accident, because the firm has battled for more

than a decade against market timing -- the practice of quickly

buying and selling funds to take advantage of short-lived

anomalies in the pricing of their holdings.

Market timing is a main focus of Spitzer's investigation.

Before the practice was a public issue, top Fidelity officials

had decided that quick trades in and out of a fund damage long-

term returns.

In early 1990, Dick Fabian, editor of Telephone Switch

Newsletter, a market timing newsletter, placed a ``buy'' and then

a ``sell'' rating on Contrafund. Assets flowed in and out, and

Fidelity responded by temporarily closing the fund to some of the

newsletter subscribers.

Redemption Fees

Throughout the 1990s, Fidelity imposed redemption fees of as

much as 3 percent on many of its international equity and small-

capitalization funds for positions held, for example, less than

30 days.

Most important, says Jack Bowers, editor of the Fidelity

Monitor newsletter in Rocklin, California, the firm routinely

refuses to execute trades of investors it believes are market

timing.

Fidelity has overlapping checks to prevent market timing or

other practices that hurt long-term shareholders.

The firm maintains a chairman's hotline so employees can

report violations and suspicions. Various departments -- internal

audit, risk control and compliance -- gather at least weekly.

Topics might include sales practices or SEC regulations.

Grabbing Market Share

With much of the fund industry still beset by scandal,

Fidelity can grab market share -- as it has in recent months.

Yet as Fidelity's assets grow, the firm's big money makers -

- its lineup of enormous large-capitalization funds -- will

increasingly be forced to buy heavily traded stocks less likely

to provide exceptional returns.

The onus on Fidelity's analysts and managers to deliver

great investment picks will grow accordingly.

``The asset size tends to force funds into more index-like

performance,'' says Russel Kinnel, director of fund research at

Morningstar. ``It does mean you have more average returns.''

He points out that Fidelity rival Vanguard Group has

garnered even greater fund flows since the scandal broke.

It's also unlikely that Fidelity -- and the mutual fund

industry -- will again experience the explosive expansion of the

1980s and 1990s, editor Lowell says. That too represents a

challenge for a firm accustomed to hypergrowth.

`A Mature Industry'

``Fidelity is in a place it's never been before -- a mature

industry,'' Lowell says.

All this likely means the firm will be less willing to take

the kind of risks it has in the past, Kinnel says.

``It means you want to act more responsibly, that you worry

more about reputation and perhaps focusing on things other than

star performance, like customer service,'' he says.

Johnson discounts talk that the business is maturing.

``People will always need to save money,'' she says. ``Everybody

hopes to retire one day. That's a fundamental, basic need of the

country.''

Johnson says her task is to hire and manage talented people

who will keep all of those customers happy. If she succeeds in

that job, Fidelity will stay out in front of its competitors --

and the scandals that have slowed them down.

--Editors: Labich, Jahncke

-0- (BN ) Jun/02/2004 5:04 GMT