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Fidelity Eyes Bigger Clients: Spins Off $102 Billion Institutional Arm


Fidelity Investments is investing $100 million to spin off its institutional investment arm in an effort to rein in new assets from pension funds, endowments and other large foundations.

The Boston-based mutual fund giant, already known for its strong retail presence, is launching a separate company to manage more than $102 billion in institutional money invested by corporate and public employee pension and retirement funds. It will eventually be split from Fidelity Management & Research, the parent company that oversees Fidelity's mutual funds.

"Our objective is to increase Fidelity's investment capacity and flexibility, as well as to continue to improve our service to customers," said Fidelity Chairman and Chief Executive Officer Edward "Ned" Johnson, in a prepared statement.

While Fidelity has more than $700 billion in what could be considered institutional assets, a bulk of that money is invested in mutual funds through employee 401(k) plans. That money will remain parked on the retail side, the company said.

Robert Reynolds, Fidelity's chief operating officer, expects the move to enable the company to double its managed assets, now at $1.1 trillion, over the next 10 years.

As part of the restructuring effort, Fidelity will invest $100 million in the new company over the next couple of years, hiring at least 100 investment professionals and establishing a separate trading desk and research department. At present, Fidelity has 350 people on its money management staff. Fidelity is projecting that it will take 12 to 24 months to get the operation up and running.

"Fidelity, on the domestic stock side, is really hitting all sorts of capacity issues. The amount of money they're running now is placing a lot of strain on the system," said Russ Kinnel, director of fund research at Morningstar of Chicago. "Potentially, this could increase capacity as well as grow their business."

But Kinnel was critical of the way Fidelity has chosen to address the problems that come with having such a large asset base. He believes that down the road, the spin-off can improve capacity a little bit, but it's still a long way from curing the problem of having a glut of money to manage on the domestic equity side.

"Their performance the last couple of years has been okay but not great, part of the reason [being] that they have too much to run," he said, a point perhaps best illustrated by the $36.4 billion Fidelity Low-Priced Stock Fund.

A more valuable effort to manage capacity would be to close funds more quickly, Kinnel said. He also suggested that Fidelity would be better served if it built up a robust small-cap research staff. "Fidelity is a very big player in small- and mid-cap, but internally, they're very thin on resources," he said.

John Benvenuto, a mutual fund analyst at Boston-based Financial Research Corp., characterized the move to launch a separate company as "a tremendous validator for its institutional relationship development. Creating a separate and distinct entity shows a much higher level of commitment."

Fidelity, while certainly a big player in the institutional marketplace, is often faced with concerns from clients that their investment managers have too much of a retail focus. "If there is too much retail focus, institutions may have hesitations about working with the group. This move will send a clear message," Benvenuto said.

Johnson and his daughter Abigail Johnson, president of FMR, will oversee the formation of the new company until they can put together a new management team. "We're considering a number of internal and external candidates to head the company," Fidelity spokesman Vin Loporchio said.

The new firm will share some of Fidelity's resources, but the assets will be held within a separate investment advisor or sub-advisor and managed separately.

"I would expect that they're going to synthesize their research and their buying power," said Lou Harvey, president of Boston-based research firm Dalbar. "One of the powers that Fidelity [wields] is volume and trading. They're not going to give that up. When it comes to things like prices of services and the kinds of services, it will be very different."

Having separate entities for retail and institutional will give Fidelity several advantages. The retail mutual fund side of the business is facing increased regulation, which over time could handcuff business practices, Harvey said. As a result, he noted, it would limit what firms could do in the institutional market where the currency is flexibility.

For example, many fund companies try to avoid owning too large a stake in any particular stock because it can prompt anti-takeover measures such as poison pills. By separating the retail and institutional businesses, Fidelity could employ different trading strategies and perhaps even broaden its portfolio of stocks.

When negotiating with a pension fund, a firm can't afford to be limited by virtue of the fact that it must comply with a rule designed to protect mutual fund investors. On the retail side, fund firms are tethered to a prospectus. On the institutional side, they're not bound to a prospectus unless the client wants a registered product.

"The idea of separating them out is, in the long run, going to be enormously important. I wouldn't be surprised to see other firms move in that direction as well," Harvey said. "It might be perceived as an expensive proposition, but it is a critical strategic move so that they can play in both marketplaces without being encumbered."

Ultimately, Fidelity is seizing an opportunity to take a bigger chunk out of the pension and endowment market, effectively putting pressure on other major players such as Putnam Investments, Wellington Management and Wright Investors. "There's a number of them out there that should be worried about this," Harvey said.

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