Keeping the Faith at Fidelity
from Winter 1998
by Jason Zweig
No one could argue that FMR Corp., the parent company of Fidelity Investments, the world’s largest mutual fund manager, is uninformed. When you own more than 3% of all the publicly traded equity of corporate America, you are aware of the relative advantages of staying private and going public. And FMR is private—defiantly so—and plans to stay that way.
The firm is owned 49% by members of the Johnson family and 51% by its employees. Chairman Edward C. “Ned” Johnson III, now 68, owns 12% of the voting stock; his daughter and heir apparent, 37-year-old senior vice president Abigail P. Johnson, owns 24.5%. The entire family stake is held by Johnson’s immediate relatives; there are no cousins and in-laws to pressure FMR to go public or to second-guess management strategy. About 4,000 of Fidelity’s 27,000 employees have some equity stake; several veterans, including president James C. Curvey and legendary portfolio manager Peter Lynch, are believed to hold more than 1% each.
In a typical year, say headhunters familiar with Fidelity, as much as two-thirds of a senior employee’s compensation can be made up of restricted FMR shares (often in the form of participating preferred stock, which has piled an ample dividend atop rising share values). When shares are vested, employees can continue to hold them or sell them back to Fidelity at near-book value.
For Fidelity’s private shareholders, an IPO offers enormous allure. In 1997, FMR earned $536 million in net income on $5.9 billion in total revenues. If it sold its stock to the public, the entire firm would probably be valued at about $20 billion, reckons Thomas W. Courtney, Jr., president of the Courtney Group, a New York investment bank specializing in money management firms. And certainly there are plenty of people inside Fidelity who would love for the company to go public.
“Whenever I visit Fidelity,” says Courtney, “my friends there ask me what the latest multiples are for asset management companies. Obviously they’re calculating the value of their holdings, and they hope a public offering may happen some day.” After all, in 1998, two leading mutual fund companies—Federated Investors and Waddell & Reed—went public. Another, Neuberger & Berman, has registered an IPO prospectus with the Securities and Exchange Commission but, after this year’s market turbulence, has postponed its plans to go public.
But, at least for a money management firm, there’s a dual danger in going public: The securities markets on which the firm depends for its very revenues could dry up, simultaneously shriveling its business and its stock alike. If an oil refiner or a computer software producer goes public shortly before a stock market crash, its shares will suffer, but the health of its underlying business may be unimpaired. Not so with a mutual fund company—as the shareholders of Federated Investors and Waddell & Reed have already learned to their chagrin. The shares of both these fund companies, which went public this spring, lost about a third of their value after the stock market sickened in the summer.
FMR dates back to 1946, when Edward C. Johnson II, formerly a lawyer at the Boston firm of Ropes and Gray, assumed control of the Fidelity Fund, which then had less than $13 million in assets. “Mr. Johnson,” as the aristocratic founder was called, proved himself to be not just a formidable stockpicker, but an extraordinary recruiter of talent. Among the fund managers he hired: Gerry Tsai, whose Fidelity Capital Fund earned spectacular returns in the 1960s (and who later built what became Primerica Corp.), and Peter Lynch, who from 1979 to 1990 led Fidelity Magellan to the highest performance of any mutual fund.
Perhaps more important, Mr. Johnson, whose ancestors had prospered from Boston’s China trade in the 19th century, was an avid student of eastern religions and a believer in questioning the conventional assumptions of how a money management business should be run. Instead of buying and indefinitely holding a small number of blue-chip companies, Mr. Johnson created a culture in which Fidelity managers were encouraged to trade stocks more rapidly—and to invest wherever and whenever they thought bargains could be found.
Ned Johnson, who succeeded his father in 1972, took that experimental approach to the next level. As Ned Johnson has recalled, “My father...believed that being too secure led to trouble. From the firm’s earliest years, he encouraged us to oppose orthodox thinking. This philosophy has given us the freedom to try out new ideas, learn from our mistakes, and build on our successes.” Under Ned Johnson, FMR popularized the money-market mutual fund, offered 263 new funds, opened its first overseas research offices, began selling directly to the public instead of through brokers, and explored dozens of new businesses having nothing to do with mutual funds. Like his father, Ned Johnson is a student of Asian ideas. He is particularly fond of the Japanese concept of kaizen—continuous, daily, incremental improvements in a company’s goods and services. To monitor the progress of kaizen, a company must relentlessly measure the quality of its products and processes- over both the short term and the long term.
Today, FMR is far more than the nation’s biggest fund company. To be sure, at roughly $595 billion, Fidelity’s mutual fund assets are greater than the gross domestic products of Argentina, Denmark, and Ireland combined. But FMR also runs the nation’s second-largest discount brokerage—and sells insurance, offers credit cards, runs a limousine service and an executive search firm, publishes newspapers serving 130 communities in Massachusetts, sells computer software, operates a hotel, runs a high-tech mail-sorting service in Kentucky, and provides fiber-optic telecommunications services in Buenos Aires.
Free from pressure to divest some of its odd diversification efforts, Fidelity likes being private. After all, Fidelity’s employees know well what publicly traded companies have to put up with. Its analysts and portfolio managers meet with thousands of public firms every year, often commandeering hotel suites at industry conventions to give management a private grilling. “We’ve seen firsthand what the pressures on public companies are like,” says Fidelity’s chief of administration and government affairs, David Weinstein. “The key drawback is the short-term focus: the need to satisfy quarterly earnings targets and the difficulty of investing in long-term strategic projects.”
There is, of course, a paradox here. The portfolio turnover rate at Fidelity’s dozen largest U.S. stock funds averages 71%, meaning the firm’s chief stockpickers hang on to their typical stock for a mere 17 months. That’s a slightly longer-term focus than many mutual fund managers have (the average holding period in the fund business is just 14 months), but it shows that Fidelity wants its public investments to pay off in a year or two. When it comes to its own internal investments, however, the firm is far more patient. That’s the luxury of being private.
“We may lose money on a business for five or 10 years,” says Weinstein, “but being private enables us to make that kind of long-term commitment.” In May 1998, Fidelity opened the Seaport Hotel at Boston’s World Trade Center—after 17 years of development. And Fidelity set up its insurance division to offer variable annuities and variable life policies in 1986. “It took almost a decade to start turning a profit,” Weinstein recalls, “ but now we’re the 12th-largest variable annuity issuer in the country.”
What’s more, FMR has a history of trying new techniques with its old lines of business. Up until the 1970s, Fidelity sold almost all its funds through commissioned stock brokers; then it abandoned that focus to sell directly to the public, usually with no sales charge. In the early 1990s, Fidelity shifted back to selling partly through brokers, creating the Fidelity Advisor group of commission-carrying funds. Fidelity also was a pioneer of vertical integration in the fund business, gradually eliminating outside service providers like transfer agents and fund administrators until the firm processed all its shareholders’ transactions under its own roof. In each case, industry analysts thought Fidelity was crazy—and in each case, the changes ended up pushing Fidelity to higher levels of revenue and profits. Being a private company has enabled Fidelity to tinker with its business model without having to answer to swarms of restless public shareholders.
When asked whether Fidelity will always remain private, Weinstein answers adamantly and deliberately: “I cannot foresee a time when Fidelity would go public. Private ownership has always been a core guiding principle for our company. Mr. Johnson [the company’s founder] always believed in the power of private ownership. There have been many suggestions over the years, from within and from the outside, that Fidelity should go public. We have always categorically rejected those suggestions. In the long run, we believe, Fidelity is better off as a private company.”
