(Barron's) - Fidelity isn’t known for macro hedge funds that make bets on entire markets. The Boston-based mutual fund company with $4.3 trillion under management originally made its name by having the best individual stock pickers, most notably Peter Lynch of Magellan fame.
But times have changed. Both stocks and bonds have declined in 2022 as inflation and interest rates have gone up. With the S&P 500 down 13% this year, there’s not much even the best stock pickers can do to generate positive returns. That’s why Fidelity’s decision to launch two new liquid alternative funds that aim to generate positive returns even in down markets is potentially so compelling.
The two new “alts” funds, Fidelity Advisor Macro Opportunities Fund (ticker: FAQFX) and Fidelity Advisor Risk Parity Fund (FAPZX), which launched July 7, are targeted specifically at advisors and institutional investors. They are part of the alternative investment world because they use strategies more typically seen in hedge funds, employing leverage and derivatives to control risk, not because they focus solely on specialized sectors like private credit or commodities, popular kinds of “alt” funds for advisors. According to their prospectus, they will each have five share classes, from A-shares with a front-end load of 5.75% to no-load Z-shares.
With an expense ratio as low as 0.80% for Macro Opportunities and 0.64% for Risk Parity’s Z share classes, these two new alt funds are worth paying attention to. They are cheap for liquid alternative funds which, for instance, charge 1.56% for the average fund in Morningstar’s Macro Trading category and extremely cheap compared to hedge funds, which typically take a big chunk of profits, often 20%, as a fee.
“If you look at the decade prior to the end of 2021, you really didn’t need any alts,” says Vadim Zlotnikov, president of Fidelity Asset Management Solutions, the division that runs the two funds. “You could have just bought a 60/40 portfolio of U.S. equities and bonds and done phenomenally well. You’re starting to see some of those return expectations become lower. We know that advisors are looking for some alternatives that can credibly provide diversification.”
Risk parity. The Risk Parity fund’s strategy is unique, Zlotnikov says, as it looks at risk differently than competing parity funds. Parity funds’ strategies are typically based on computer models and fit within the broader quant fund universe. Rather than measure the volatility of asset classes such as stock, bonds, and commodities and try to balance those risks, which is the traditional parity approach, Fidelity’s fund tries to balance the risks between different kinds of risk premia—growth, inflation, real rates, and liquidity.
In the growth risk-premium category, one would find equities which compensate investors for the risk that economic growth falters and we enter a recession. (Risk parity funds tend to focus on the risk side of the risk-reward financial equation.) In the inflation and real rates categories you’d probably find different kinds of bonds sensitive to the risk of inflation rising or interest rates rising. But perhaps most interesting is the “liquidity” category that compensates investors for the risk of investing in illiquid assets that are hard to sell. Zlotnikov says the fund will be buying publicly traded proxies for private equity and real estate in this category such as business development companies.
Like most risk-parity funds, the fund will use leverage to balance out the risk between, say, low volatility Treasuries and high volatility stocks. The aim, Zlotnikov says, is for the fund’s volatility to be comparable to a 60/40 stock/bond portfolio—10% to 11% annually—but for it not to behave like a 60/40 portfolio during securities’ market declines.
Macro opportunities. While Fidelity Advisor Risk Parity offers a novel approach, Fidelity Advisor Macro Opportunities seems more interesting for advisors seeking to benefit from Fidelity’s historical strength—active management. Risk Parity is largely rules-based to maintain a balance between the four different risk premium categories. Meanwhile, Macro Opportunities allows much more flexibility.
“If you think about how much of the risk [in the Risk Parity fund] comes from active allocation, it’s only 1% or 2%,” Zlotnikov says. “So, [active allocation’s contribution] is still important, but it’s small. In the case of Macro Opportunities, 100% [of the risk and return] comes from skill and active allocation.”
Macro Opportunities manager Jordan Alexiev can go long or short, i.e., bet for or against, equity, debt, currency, and commodities markets worldwide using derivatives like futures contracts, ETFs and Fidelity’s existing mutual funds at his own discretion. That’s like a true macro hedge fund. “[The macro fund] has a very high degree of discretion and flexibility to utilize what is the best of [Fidelity’s] research,” Zlotnikov says. “The constraints are risk constraints, so it really cannot exceed a volatility in rough terms of 10%.”
The question then is does Fidelity have the skillset to run such a broad flexible strategy? The answer appears to be yes. Alexiev will have two separate well-staffed research groups supporting him. Twenty people are in Fidelity’s Global Asset Allocation Group headed by managing director Neville McCaghren. They do quantitative numbers-crunching research on different asset classes. There are another 12 people working under managing director Lisa Emsbo-Mattingly in the Asset Allocation Research division. They do fundamental analysis, trying to understand the business cycle’s impact on asset classes and countries throughout the world.
This support is on top of the huge stable of individual security analysts who run some of the Fidelity funds Alexiev can invest in if he likes. Moreover, Zlotnikov’s group, Fidelity Asset Management Solutions, runs a collective $622 billion in traditional asset allocation funds, such as Fidelity’s Freedom series of target date funds. So, shifting between asset classes is in their wheelhouse.
Whether these strategies work as planned in the current market is yet to be seen. Other top managers such as T. Rowe Price and Vanguard have had only middling success in alts.
Though he couldn’t disclose which kind, Zlotnikov says Fidelity will be launching more alt funds in the coming months. Given the manager’s expertise in individual stocks and bonds, it might be more exciting to see it launch alt strategies that emphasize those strengths such as merger arbitrage, long-short equity or convertible bond arbitrage ones.
Either way, though, it’s a new frontier for Fidelity to explore.
By Lewis Braham
August 1, 2022
