Analysis: Fidelity's Abby Johnson faces challenges on many fronts

BOSTON Mon Sep 17, 2012 3:57pm EDT

Abigail Johnson attends the Boston College Chief Executives' Club of Boston luncheon in Boston, Massachusetts November 29, 2011. REUTERS/Brian Snyder

Abigail Johnson attends the Boston College Chief Executives' Club of Boston luncheon in Boston, Massachusetts November 29, 2011.

Credit: Reuters/Brian Snyder

BOSTON (Reuters) - As Abigail Johnson takes control of Fidelity Investments' most important businesses, she will have to deal with some of the biggest threats to the fund group's franchise and profitability in its 66-year history.

Competitors have been gnawing away at Fidelity's market share in mutual funds for years, and it lost the top spot for the amount of money managed to Vanguard Group in 2010. Now, new rules requiring the disclosure of fees to account holders may allow rivals to reduce Fidelity's lead in the administration of workplace 401(k) retirement plans.

Johnson, who is the daughter of the firm's 82-year-old chairman and CEO, Edward "Ned" Johnson III, also will face difficult questions about Fidelity's side investments, which racked up $1.28 billion in operating losses from 2007 to 2009 and include a tomato farm in Maine.

The chief culprit has been ProBuild, a homebuilding supply business that has required large capital infusions to cover losses. Fidelity says diversifying investments is wise; some credit analysts are less enthused as they see it as a sign of a family-controlled firm with weak corporate governance.

The firm and the Johnson family will not want to go through another decade like the last. While it is still a profit machine - Fidelity Financial Services generated operating income of $3.33 billion last year on revenue of $12.8 billion - the firm missed out on some big opportunities. In particular, it did not take advantage of explosive growth in exchange-traded funds at a time spotty funds performance sent clients fleeing.

"Abby and her father can't be happy that fewer people have been buying their stock funds and even more people have been selling them," said Jim Lowell, chief investment officer of Adviser Investments, which has $2.4 billion mostly invested in Fidelity and Vanguard mutual funds.

Johnson, 50, was promoted to be president of Fidelity Financial Services at the end of last month, putting her in charge of all of Fidelity's major lines of business for the first time. She is positioned to succeed her father as the head of a firm founded by her grandfather, Edward Johnson II. Forbes magazine has estimated her wealth at $10.3 billion.

The oldest of three children, Johnson has gained experience overseeing various parts of Fidelity. It has not been a direct nepotistic route to the top.

She started off as an analyst at the firm 24 years ago, after earning an MBA at Harvard. Then she was promoted to fund manager in April 1993 and had a generally strong record over the next four years - outperforming benchmarks while running the Dividend Growth Fund, and the OTC Portfolio, though she lagged when running the Trend Fund

She then oversaw growth and capital appreciation funds and revamped Fidelity's technology infrastructure, before running the entire mutual fund business between 2001 and 2005.

But in a surprise move in 2005, she was removed from running that flagship division and sent to oversee the large but more mundane retirement and benefits plan administration business.

At the time, Fidelity said she and her father differed over revamping the funds unit to improve performance at some lagging funds.

At the workplace retirement unit, total assets Fidelity administers for 401(k) plans, for example, climbed 10 percent to $853.8 billion in 2011 from $774.3 billion in 2007, according to research firm Cerulli Associates. The gains are more impressive than they might seem given the period included the market plunge during the financial crisis.

INTENSELY PRIVATE

Johnson is intensely private and very rarely talks to the media. Fortune magazine reported in 2007 that Johnson appeared to have undergone medical treatment and had lost her hair. Fidelity has always declined to address the report. Fidelity declined requests for interviews for this story.

Current and former senior executives, who declined to be named, say Johnson, much like her father, constantly asks her team about ways to improve the experience for Fidelity's customers. On a personal level, they describe her as a committed mother to her daughters and empathetic, such as arranging a car service for an executive who had injured his leg.

But some of these same executives question whether she has the vision to make the groundbreaking calls that her father did in the 1980s and 1990s. Even today, her father looks over her shoulder, reluctant to step to the sidelines.

Fidelity likely would be better positioned today if it had opened a line of low-cost ETFs a decade ago. But such a move risked cannibalizing the money flowing into the firm's higher-fee mutual funds. Johnson wouldn't take the risk.

"People inside the company certainly pushed her to launch an ETF product when those investments were taking off," according to one former senior Fidelity executive who declined to be named. "That's a big decision Fidelity whiffed on."

Another big problem is investors' long memories. Market declines during the dotcom bust and the financial crisis - sometimes exacerbated by Fidelity's weak stock fund performance - battered many 401(k) retirement and mutual fund accounts.

Some investors deserted to low-cost index funds run by Vanguard and others, and Fidelity has had difficulty winning them back, even though its fund returns have improved in recent years.

Vanguard's stock and bond mutual funds have attracted $274 billion in net inflows from investors since the end of 2008 versus just $52 billion for Fidelity, according to data from Lipper Inc, a unit of Thomson Reuters.

Increased regulation of the retirement account business will allow more accurate comparisons of plan providers. That is likely to help those who charge lower fees than Fidelity, such as Vanguard, according to analysts at Moody's Investors Service.

Still, Johnson's use of technology to reduce costs and quantitative analysis to identify portfolio managers who aren't very good may be critical weapons in battling back. Insiders say the fund unit suffered from a compensation system that rewarded mediocre performance.

Fidelity currently shows more intervention and oversight to keep managers on track while identifying their blind spots, said Chris Davis, an analyst at Morningstar Inc.

"Before, performance was inconsistent because there was no one culture, but a collection of individual cultures," he said.

Fidelity is happy to promote Johnson as the smart technocrat. "Abby is driving Fidelity's technology development efforts as part of her commitment to expanding and improving the products and services the company offers," Fidelity spokeswoman Anne Crowley said.

Fidelity's technology advantage created a juggernaut in the 401(k) administration industry, said Tom Kmak, CEO of fee evaluation firm Fiduciary Benchmarks. Web services, phone apps and other innovations helped Fidelity's online brokerage grab top rankings and make Fidelity a top choice for university retirement plans consolidating financial services vendors.

But it may be the ETF strategy that continues to most haunt Johnson. Patent and regulatory filings indicate there is a plan to create ETF versions of some of the firm's actively managed stock mutual funds. The question for those close to Fidelity is whether any move will be too little, too late. The firm itself declines to comment.

(Editing by Martin Howell and Steve Orlofsky)