Fidelity Funds – US High Yield Fund‧Morningstar Fund Awards 2010 Special Editorial

Fidelity Funds – US High Yield Fund

Interest rate is a key factor that affects bonds’ return. When interest rates go up, is it possible for investors to find out fixed income vehicles that would be less affected by rate hikes? The answer is yes. The high yield sector is less sensitive to interest rate changes (i.e. better resistance to rising rate) due to its high current coupon nature. This feature drove us to include a high yield bond category in the Morningstar Fund Award. The winner of Morningstar Fund Award High Yield Bond Category for the year 2010 is Fidelity Fund – US High Yield Fund.

Performance

For the year 2010, the fund gained 14.52%, beating 65% of its rivals. It doesn’t look impressively outstanding, but its enviable long-term performance deserves credit. The fund’s registered a 3-year annualized return of 11.03%, placing itself in the best quintile. Investors would be further impressed by its top-decile 5-year annualized return of 7.97%.  

Key to Success

The fund primarily focuses on bottom-up security selection, while market timing and interest rate change magnitude forecast nearly have no place here, although every macroeconomic change falls under the investment team’s radar.  Fund manager Harley Lank spends most of his time studying companies’ long term fundamental prospects to obtain conviction. This approach helps him to stick with his game plan during the downturns. The financial market is full of mixed signals which can be misleading, and we believe the investment team’s ability to focus on the long-term fundamental view is the cornerstone of the fund’s success.  　

During 2010, when lower quality names outperformed high quality ones, the fund’s overweight position at securities rated CCC or below became great contributors.  “As the year progressed, I began to tactically reduce risk in the portfolio, both by reducing the fund’s exposure to lower quality names and by selling those credits that I believed were overvalued.” Lank said.

This brings out the importance of strong research support. Lank thinks highly of the credit research at Fidelity High Income Group. “Strong research enabled me to pick top credits within the Diversified Financial Services, Automotive, Utilities, Energy and Health care sectors, all of which contributed favorably to Fund performance in 2010.”

Flexibility is another strength of this fund. The fund is able to invest opportunistically based on the fund manager’s view through the credit cycle. “This allows me to position the Fund more defensively when the market is becoming close-to-fully valued or shows signs of overheating and to take advantage of opportunities when the market appears oversold.” Lank explained.   

Focuses

The global economic situation is clearly under pressure, and high yield valuations have been slightly rich for some time. How these factors affect the fund’s positioning? “I’ve been tactically reducing risk in the portfolio, by improving the credit-quality of the companies in the Fund, as well as moving higher in the capital structure by investing in more senior securities.” That said, Lank also emphasized his long term perspective. “I take a long term view when investing in companies, and the core holdings in the Fund are those that I believe can offer the best long-term, risk-adjusted return potential.  While there will always be changes on the margin, there aren’t any major shifts that I expect to make in the near-term.”

Lank warned that there are still many risks around the globe that require close monitoring, but that US businesses are better-positioned now than they were a few years ago.  And with the recent sell-off in high yield and other risk assets, high yield valuations have gone from slightly rich to fairly-valued.  “Recent corporate earnings have been good, balance sheets are solid and corporations have a lot of cash on hand making them better-positioned to weather a softer economy. We continue to expect slow economic growth, but importantly, the default environment is expected to remain low, which is an important driver of performance in the high yield market.”  Lank expects that there will be continued volatility in the short-term, but believes the asset class could produce above-coupon returns in the year ahead now that bonds are trading below par.

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Similar to most of Fidelity offerings, this fund showcases a perfect combination of research and portfolio management. On the research front, robust bottom-up security analysis combined with in-depth knowledge of the credit cycle and macroeconomic influences have underpinned the fund’s success, attested by the unparalleled feat that very few rivals have come close to matching. On the portfolio management front, the portfolio manager is capable of bringing the robust research to life in a disciplined but flexible manner. Investors should bear in mind that this fund may experience short stretches of volatility and may be underperformance given its longer-term focus; however, the fund’s long term track record proves that  this side effect does not hurt the value of the fund.