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Fund Spy: Morningstar Medalist Edition

A Look Inside Fidelity's Core Bond Lineup

With three Morningstar Medalists in the intermediate-term bond category, the firm has built an impressive core bond effort with a straightforward, risk-conscious approach.

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Unlike some of its wider-ranging competitors, Fidelity plays it relatively straight when it comes to its lineup of intermediate-term bond taxable options. The firm's managers don't make meaningful interest-rate bets and tend to maintain sizable allocations to Treasuries for diversification, even in Fidelity's more adventurous strategies. And while the portfolio managers do make some use of derivatives, these are largely cash bond strategies.

While the funds are more benchmark-aware than some--Fidelity is notably one of the only firms not to launch an unconstrained option in recent years--they are not closet indexers. Instead of making big macro bets, the focus is on identifying mispricings at the sector and security levels, often with a contrarian edge. So, for example, the firm's funds have increasingly favored corporates--and even junk bonds--during the past year as that sector has come under pressure, while significantly underweighting mortgages, which the team views as overvalued. Fidelity has built an impressive team of analysts and has invested in a suite of tools that supports security analysis in corporates, mortgages, and structured fare. Its mortgage team has done a particularly good job at dedicated charges such as  Fidelity GNMA (FGMNX), and its efforts play a big role in the success of the core funds.

Fidelity's portfolio managers also share a risk-conscious approach to fixed-income management. After a rough stretch in 2007 and 2008, the firm revamped its risk management policies and, under fixed-income CIO Christine Thompson, has continued to refine the tools used to measure and assess portfolio exposures and to integrate risk management into the day-to-day management of the funds.

The funds are team-run, and the underlying group of portfolio managers has been relatively stable since the credit crisis, with the exception of the recent departure of Pramod Atluri from the core/core-plus team. 

Finally, Fidelity's bond funds are well-priced. At a 45-basis-point expense ratio, the no-load share classes of these funds all earn Morningstar Fee Levels of Low relative to the competition.

 Fidelity Total Bond (FTBFX)
Gold-rated Fidelity Total Bond is the most aggressive Fidelity entrant in the intermediate-term bond Morningstar Category and takes a wide-ranging approach to beating its Barclays U.S. Aggregate Bond Index benchmark. With the flexibility to invest up to 20% in junk-rated credits and a mid-single-digit allocation to emerging-markets debt, the fund takes advantage of Fidelity's impressive high-yield team as well as the firm's expertise in managing emerging-markets debt. However, it also typically holds a sizable slug of Treasuries to provide diversification in rockier credit markets. Veteran lead manager Ford O'Neil has also shown a knack for adjusting the fund's sector exposures, often with a contrarian edge, and he isn't afraid to add aggressively to the fund's position in credit when he thinks valuations are particularly compelling. The fund has struggled some in weaker credit markets, although it navigated a rocky 2011 with skill. All in all, O'Neil has put together a strong long-term record: The fund's 5.0% 10-year annualized gain tops roughly three quarters of its peers'. 

 Fidelity Investment Grade Bond (FBNDX)
Lead manager Jeff Moore, who is also a co-portfolio manager on Fidelity Total Bond and works closely with O'Neil on the firm's core/core-plus team, takes a similar but slightly more constrained approach at Fidelity Investment Grade Bond. (Pramod Atluri was briefly named as a manager on this fund before leaving the firm in August.) While Moore has some flexibility to invest beyond the Aggregate Index, he typically sticks to investment-grade fare with only a modest allocation to high yield. So, although Moore has recently upped the fund's junk-bond exposure to 8% in light of recent weakness in the market, that stake typically runs in the low single digits; it's also entirely focused on BB rated fare. The fund's record under Moore is only middling, thanks to a rough stretch in 2007 that was due to exposure to a now-defunct ultrashort portfolio. However, Fidelity has taken a number of steps to improve its risk processes following the credit crisis, and the fund's performance since 2009 looks considerably better. From 2009 through August 2015, its 6.2% annualized gain tops roughly two thirds of its peers and comfortably beats its benchmark's 4.3% return.

 Fidelity Intermediate Bond (FTHRX)
Fidelity Intermediate Bond falls under the purview of Fidelity's limited-term bond team. Although lead manager Robin Foley took over here in October 2013, she is a Fidelity veteran and works closely with Rob Galusza, who has been a manager on the fund since mid-2009. The fund is Fidelity's most conservative entrant in the intermediate-term bond category when it comes to both credit and interest-rate risk. Its duration is kept close to that of the Barclays U.S. Intermediate Government/Credit Bond Index. At 3.8 years as of July 2015, that leaves it considerably short of the intermediate-term bond category average. It also tends to tread lightly in lower-rated fare with BB credits accounting for a modest 3% of assets recently. The fund's risk profile means that it's often out of step with the category and lags when bond yields fall sharply (as they did in 2014) or when high-yield credits outperform. As a result, it has only middling returns relative to the group since Galusza took over. However, it held up relatively well when bond yields spiked in the summer of 2013, and its record relative to its benchmark is solid: From July 2009 to August 2015, the fund's 4.8% annualized gain comfortably tops its benchmark's 3.6% return during the same period.

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Sarah Bush has a position in the following securities mentioned above: FBNDX. Find out about Morningstar’s editorial policies.