MUTUAL FUND Investor Guide THE Investor Guide TO FIDELITY …
MUTUAL FUND Investor Guide
THE Investor Guide TO FIDELITY FUNDS
Matthew D. Sauer Founder & Chief Investment Officer
Matthew Sauer is the Founder and Chief Investment Officer of the Mutual Fund Investor Guide family of newsletters. Each month he analyzes and provides buy, sell and hold recommendations for hundreds of mutual funds and ETFs in the Investor Guide to Fidelity Funds, Investor Guide to Vanguard Funds, as well as the ETF Investor Guide.
Prior to founding the Mutual Fund Investor Guide, Matt was the President and Chief Investment Officer of the Fidelity Independent Adviser, ETF Report, and Sector Momentum Tracker.
Matt Sauer earned his Juris Doctor from Albany Law School of Union University in Albany, NY. Mr. Sauer is a licensed attorney in the State of New York. He received his Master of Business Administration, from the State University of New York at Albany and his Bachelor of Arts in Political Science and Economics from Bucknell University.
SPECIAL REPORT:
Best Fidelity Bond Fund for 2016:
Floating Rate High Income Fund (FFRHX)
The Federal Reserve finally ended its extraordinary monetary policy with a quarter-point interest rate increase in December. Rates have risen at the low end of the yield curve; 2-year Treasuries are seeing an increase in yield, but those out five years and beyond are staying flat or declining. Depressed commodity markets should keep a lid on rate hikes in the first half of 2016, presuming inflation remains low and current economic trends prevail. Investors can guard against sudden interest-rate spikes with shorter-term bonds, but this often comes at the expense of income.
Floating-rate loans adjust with interest rates and may provide an alternative to bonds in the current rate environment. These debt instruments pay a lower current rate of interest, but if interest rates increase, the rate of interest on the loans will also increase, so the bonds will maintain their value. A regular bond that pays a fixed coupon must fall in price as interest rates rise to adjust to the new market rate, but a floating-rate security's income rises to meet the new yield instead.
Fidelity Floating Rate High Income Fund (FFRHX)
Established on August 16, 2000, Fidelity Floating Rate High Income (FFRHX) is a mutual fund that seeks a high level of current income, while mitigating the risk from rising interest rates. Duration is a measure of interest rate risk. The fund has a duration of 0.25 years; investors can expect a 1 percent increase in interest rates to cause a roughly 0.25 percent drop in the fund's NAV. Fidelity Total Bond (FBNDX) has a duration of 5.5 years, so investors can expect the NAV of FBNDX to drop about 5.5 percent if interest rates rise 1 percent. Suffice it to say, if bond
prices drop as a result of rising interest rates, FFRHX should be one of the least affected funds.
The fund has been under the direction of Eric Mollenhauer since April 1, 2013, and had over $9 billion under management entering 2016. He has more than two decades of experience in the bank loan and high-yield investment markets. FFRHX invests at least 80 percent of net assets under management in floating-rate loans, which are typically lower-quality debt instruments, in addition to other floating-rate debt securities. The debt issuers are usually companies with lower credit ratings. Floating-rate securities are senior in the issuing firm's capital structure and are typically secured by corporate assets. They also reset their interest rates every 30 to 90 days to a point slightly above the current short-term benchmark. The fund purchases investment-grade debt, money market securities and repurchase agreements. To select investments, fund managers use fundamental analysis of each domestic and foreign issuer's industry position and financial condition as well as overall market and economic circumstances.
Investment Strategy
Prior to Mollenhauer's leadership, FFRHX was one of the most conservative funds in the bank loan category. Christine McConnell, the fund's former manager, concentrated on higher-quality sub-investment-grade securities and intermittently held a significant portion of the total portfolio in cash to manage liquidity. This strategy served investors well during the financial crisis of 2008 when the fund was down 16.5 percent compared with the category average of 30 percent, but led
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The Investor Guide to Fidelity Funds
it to trail the vast majority of its peers during the ensuing years' risk-on markets. The improving U.S. economy created an environment that generally favors lower-rated speculative loans.
Mollenhauer intended to enact a more opportunistic strategy than his predecessor, but until last year the market provided few chances to put the plan into effect. Bank loans had been trading at or near par with low default rates. As a result, the overall credit quality profile of the fund hasn't changed much. As of November 2015, the fund had approximately half of its assets in a mix of 3 percent BBB-rated and 43 percent BB-rated securities. The fund has maintained its investment in CCC or lower rated debt securities at 3 percent, while also maintaining its allocation of B-rated securities at 39 percent. Cash nearly doubled over the past year to 8 percent of assets. FFRHX is slightly overweight energy at 4.4 percent of assets versus 3.8 percent in the benchmark S&P/LSTA Leveraged Performing Loan Index. This has caused a slight drag on performance in recent months, but the hunt for value will pay off for investors.
Mollenhauer occasionally invests cash in more aggressive instruments to produce higher returns during healthy markets; relinquishing a small portion of the fund's historic downside protection is unlikely to significantly increase its future risk. Security selection follows a bottom-up approach emphasizing positions recommended by Fidelity's analytical research team. Investments are scrutinized based on the loan's collateral coverage and the issuing firm's financial stability and cash flow. The fund should remain among the more cautious investment offerings in the bank loan category. Aligning his own interests with those of his shareholders, Mollenhauer has $1 million invested in the fund's portfolio.
Holdings
As of November 30, 2015, FFRHX held 84.61 percent of its assets in term and revolving loans. The remainder of assets under management was invested in other floating-rate instruments, fixed-rate corporate bonds and cash, with weightings of 1.60 percent, 4.82 percent and 8.97 percent, respectively. The regional diversification of the fund is 91.0 percent domestic holdings and 9.0 percent foreign. Companies based in Australia, the Netherlands and Israel accounted for the largest percentage of foreign holdings.
The top 10 holdings make up 15.0 percent of the fund's assets. Debt securities are issued by Albertson's, Dell, Community Health, Hilton Worldwide and Fortescue Metals Group as well as by Caesars Properties, Altice Financing, BMC Software and Laureate Education.
The fund is overweight telecom, energy, gaming, hotels, cable/satellite television, mining and utilities, and is underweight chemicals, automotive, broadcasting, publishing/printing and business equipment/services.
Historical Performance
With a portfolio of bonds, loans and other debt instruments, FFRHX, like its peers, is designed to generate the best returns in a strong and improving economy. It can suffer in a down market or in other periods when investor appetite for riskier assets wanes. Through the end of 2015, the fund generated returns of -1.17 percent, 1.03 percent, 2.30 percent, 3.57 percent and 3.85 percent on an annualized basis for the previous 1-, 3-, 5- and 10-year periods and the life of the fund, respectively. The bank loan category for these same periods showed a return of -1.25 percent, 1.44 percent, 2.87 percent and 2.89 percent.
Morningstar ratings show FFRHX delivering below average returns for the
most recent 3- and 5-year periods, as expected given the conservative approach that was kept after 2008, with above average returns for the past 10 years and average returns since the fund's inception.
Income
FFRHX pays a monthly income distribution and currently yields 5.09 percent.
Purchasing and Fees
The minimum initial investment in FFRHX for IRA and taxable accounts is $2,500. There are no restrictions on subsequent investments. The fund requires a minimum maintenance balance of $2,000. While the fund does not have a check-writing feature, it does support direct deposits and automatic account builder functions.
In addition to an expense ratio of 0.70 percent, FFRHX has a short-term redemption fee of 1.00 percent and a short-term redemption period of 60 days. There are a maximum number of exchange redemptions as well. The fund does not have any 12b-1 fees.
Risk and Volatility Measurements
Morningstar rates FFRHX's risk level as "average" among the bank loan category. Fixed income securities face interest-rate risks because the face value of the bonds will decline as rates increase; however, this risk is mitigated by holding floating-rate securities that can increase their yield. FFRHX is subject to increased credit risk due to its lower-rated investment-grade bond positions.
FFRHX has a turnover rate of 26 percent. Its beta is 1.05 versus the benchmark S&P/LSTA Leveraged Performing Loan Index; 0.16 versus the Barclays U.S. Aggregate Bond, the standard fixed-income benchmark; and 0.13 versus the bank loan category. A rating of 1.0 shows no deviation from
2 PHONE: (888) 252-5372 S P ECIAL R E P O R T
SPECIAL REPORT: BEST FIDELITY BOND FUND FOR 2016
the benchmark index. Interest rates are one of the major factors affecting bond prices; therefore, the impact effect of floating-rate securities is visible in the much lower beta.
The Sharpe ratio is a measure of adjusted historical performance determined by dividing the fund's excess returns by the return's standard deviation. This gives a risk-adjusted measurement of the fund's returns. FFRHX has a Sharpe ratio of 0.43 based on a standard deviation of 2.31, compared with the equivalent figures for the bank loan category of 0.63 and 2.43.
Recommendation
Assets under management saw a considerable outflow in the past year, from
more than $15 billion to more than $9 billion today. The delayed Federal Reserve rate hike and concerns about high-yield debt were a bad combination for the fund, but with a current yield of 5 percent, investors have considerable cushion if market volatility endures.
Although another rate hike seems unlikely until at least the second half of 2016, the U.S. economy remains on track, and members of the Federal Reserve's Federal Open Market Committee (FOMC) focus on domestic economic data above all else. Recently, Federal Reserve Bank of Atlanta President Dennis Lockhart, a voting member of the FOMC, said he views the March meeting as "live," indicating he
might vote to increase interest rates at that meeting if the data supports it. The bond market is not expecting another hike so early, and bond investors could be in for a negative shock. In contrast, FFRHX is largely immune from this risk, as the portfolio's yield would rise to offset most if not all of any dip in prices.
FFRHX's comparatively lower risk and low expense ratio, as well as fourout-of-five star and Bronze analyst ratings by Morningstar, support a buy recommendation. The fund's overall rating is based on a weighted average of its 3-, 5- and 10-year performance figures associated with the applicable Morningstar metrics.
2016 Runner Ups
Fidelity Strategic Income (FSICX) is managed by lead manager Joanna Bewick and co-manager Ford O'Neil. The fund delivers a diversified blend of higher-yielding bonds, ranging from foreign bonds to junk bonds and U.S. government debt. The fund's target is 40 percent high yield, 30 percent Treasuries, 15 percent in developed markets and 15 percent in emerging markets. The fund yields 3.85 percent and offers a good mix of credit and interest rate risk.
Seeking to generate a high level of current income, Fidelity High Income (SPHIX) wades into the junk bond
market to generate high yields. The fund had 6.9 percent of assets in energy versus 11.9 percent in the benchmark at the end of November 2015, which helped it outperform the benchmark in 2015. This fund has a high amount of credit risk. Given the current state of the market, if interest rates were to rise on the back of a stronger economy, SPHIX would gain more from falling credit risk than it would lose from interest rate risk. With a current yield of 7.17 percent, SPHIX is attractive for the income.
Pursuant to its goal of generating a high level of current income, the Fidelity Corporate Bond Fund (FCBFX) invests 80 percent of net assets in in-
vestment-grade corporate bonds and other debt instruments as well as their associated repurchase agreements issued by domestic and foreign companies. The fund attempts to replicate the risks and returns of the Barclay's U.S. Credit Bond Index. The remaining 20 percent may be invested in lower-quality debt securities. The average maturity of the fund's holdings, with a 6.82-year duration, sensitizes it to rising interest rates. With a low 0.45 percent expense ratio and 3.57 percent yield, the fund is always a good option for a diversified portfolio, but in 2016, it will perform best if interest rates stay low.
If you have any questions or comments about these funds, we would be delighted to speak with you. Please call us at (888) 252-5372, Monday through Friday 8:30am to 5:30pm, eastern time. You can also email me at Matt@.
mutualfundinvestorguide
mutualfundIG
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The Investor Guide to Fidelity Funds
1-Year Return
FUND CHARACTERISTICS
3-Year Average Annual Return
5-Year Average Annual Return
10-Year Average Annual Return
Since Inception Average Annual Return
Morningstar Category
30-Day Yield %
Turnover
NAV
Net Assets
Overall Morningstar Rating
Investment Minimum/Required Balance
Front/Deferred Load
Expense Ratio
Short-Term Redemption Period/Fee
Performance as of 12/31/15
1.17% 1.03% 2.30% 3.57% 3.85% Bank Loan 5.09% 26% $9.12 $9.5 Billion 4 Stars $2,500 None 0.70% 60 days / 1%
ETF Investor Guide Each month we provide buy, hold and sell recommendations for hundreds of ETFs from companies including Fidelity, iShares, SPDR and PowerShares. Additionally, you will have access to our model portfolios, specifically created for conservative, moderate and aggressive investors. To learn more, call (888) 252-5372.
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To Become a Member simply call me at (888) 252-5372.
Disclosure: Mutual Fund Investor Guide, LLC (MFIG) is an independent company unaffiliated with any of the fund companies discussed in this newsletter, including Fidelity Investments. These results include the reinvestment of all dividends and capital gains. Model trading does not involve financial risk; model trading cannot completely duplicate the financial risk associated with actual trading. MFIG is not an investment advisor and does not provide specific investment advice. This newsletter has been prepared solely for informational purposes. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. All investments involve risk including total loss of principal.
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