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June 11, 2024

Fidelity builds alternatives business hire by hire, as competitors scale through acquisition

Roughly seven years after Fidelity Investments made building out alternatives capabilities a priority for the firm, the Boston-based giant’s assets under management in alternative strategies remain a rounding error for a firm that reported $4.58 trillion of AUM as of Dec. 31.

Fidelity’s alternative businesses currently boast combined AUM of more than $14 billion across a range of offerings, including distressed debt, real estate debt, direct lending, core real estate and digital assets, up from $2 billion in 2019.

But Fidelity executives say they’re not losing sleep over a pace of progress that might seem deliberate vis-a-vis some competitors.

Boston Globe photo (Fronczke)

Fidelity Investments' Harley Lank, David Gaito and Karin Fronczke

“Our business is ahead of plan and ahead of schedule,” said Harley Lank, the firm’s Boston-based head of high income and alternatives. Building out capabilities step by step, hire by hire, with a focus on Fidelity’s culture is positioning the firm for long-term success, he said.

The path Fidelity trod in adding direct lending to its alternatives quiver in recent years has been a case in point.

Five years ago, direct lending “was a capability that we did not have and we felt, for a lot of reasons … we should have, first and foremost because we’re in business to help clients meet their financial goals, objectives and needs,” Lank said.

The firm thought long and hard about buying — there were some attractive acquisition opportunities at the time, noted Lank — but in the end “decided that building from scratch was the way to go, even if it took longer to get to scale.”

That choice reflected a conviction, shared by top Fidelity executives, that “culture is really important to us,” said Lank. “Making sure we get the right investment talents in Fidelity is really important in the long run,” he added.

Some of the firm’s biggest competitors, by contrast, have relied on acquisitions to accelerate their push into alternatives.

In January, BlackRock, the world’s biggest money manager with more than $10 trillion in AUM, said it will buy Global Infrastructure Partners and its more than $100 billion under management in infrastructure equity and debt for $12.5 billion. That will pave the way for BlackRock, which already had $51 billion in infrastructure AUM as of March 31, to quickly become a dominant player in that fast-growing corner of the alternatives universe.

T. Rowe Price Group, a $1.49 trillion, Baltimore-based firm with its own storied culture, has also used mergers and acquisitions to build its alternatives business. In December 2021, T. Rowe acquired Oak Hill Advisors, a New York-based alternatives firm that had $56 billion of capital under management at that time across private, distressed, special situations, liquid, structured credit and real asset strategies, for $4.2 billion.

Fidelity likewise seriously looked at buying rather than building but ultimately decided the best way forward was to build on “adjacencies” or existing investment strengths, said Chris Pariseault, the firm’s head of institutional portfolio managers. The close to $100 billion business in high income segments such as high-yield bonds, leveraged loans, distressed debt and CLOs that Lank oversees made direct lending a great fit for Fidelity’s next foray into alternatives, Pariseault said.

David Gaito, a private credit veteran Fidelity hired away from PNC Bank three years ago to build a team as head of direct lending, echoed that conviction.

With about 25 hand-picked investment professionals now, Fidelity’s team has “everything we need today to be successful,” Gaito said. “We’ve raised more than $2 billion of equity capital. We have over $5 billion of buying power when you include the leverage ability of that equity (and) we’re excited about that,” he said.

And in some ways, the performance of the business has exceeded expectations, Gaito said. For example, Fidelity’s team has led the majority of the nearly 60 loan investments it’s made, which only three years in, “is a testament to the brand and the team,” he said.

Fidelity executives concede their direct lending business may still look like the fabled tortoise in the race with the hare but, in line with that story, a tortoise they insist can be a winner.

“We were late to the game … relative to some of our competitors in the alternative space” and Fidelity’s direct lending business may not have as many assets now as “we would if we had acquired someone,” Lank said. But “the leadership of Fidelity was willing to make that sacrifice … to make sure that the foundation we were building was absolutely rock solid,” he said.

“We’re very, very pleased with the early success that we’ve had (and) over time we think we’re going to continue to be even more successful,” Lank said.

Still, at a moment when the number of asset owners forging ties with direct lending managers is proliferating — Pensions & Investments’ 2023 annual survey of more than 400 of the world’s biggest asset managers showed direct lending AUM climbing 11.8% to $42 billion for U.S. institutional tax-exempt investors — it's an open question whether taking the slow road could impose considerable opportunity costs should, for example, Fidelity get to the dance just as everyone has found their partners.

“Time will tell,” said Gaito but “we’re willing to bet that our strategy is the right one.”

 

Some industry analysts agree, contending that firms with considerable scale and brand power — like Fidelity — should enjoy the luxury of taking a deliberate approach to building their alternatives businesses.

 

Many firms expanding into private credit come with strong, enduring client relationships — not built on private credit capabilities — and are always going to be able to talk with those clients about a new offering, said Kevin Gallagher, a principal with Deloitte asset management strategic adviser Casey Quirk.

 

Those large money managers will have the luxury of “incubating a business slowly over time, if they wish to,” making opportunistic investments and watching how things play out, Gallagher said.

 

Meanwhile, Lank said future extensions of Fidelity’s alternatives ambitions will depend, as always, on what clients want and need — effectively leaving the door open for the manager to branch out into other segments such as infrastructure. While there’s no guarantee the firm will move in that direction, “I think it’s safe to assume that we’ll be exploring large, growing categories like infrastructure where investors seem to have particular interest," he said.

 

Private equity

Meanwhile, Fidelity’s longest standing foray into private markets doesn’t even figure into the firm’s alternative AUM totals.

Karin Fronczke, Fidelity Investments’ global head of private equity for the past four years, said the focus on adding modest private company exposures — including prelisting exposures to companies such as Meta, Spotify and Uber — to Fidelity mutual funds over the past 15 years has provided a mix of direct and intangible benefits for investors.

 

Fidelity funds generally have a 10% limit on illiquid exposures, less than the Securities and Exchange Commission’s 15% ceiling but still considerably above what funds, out of liquidity concerns, typically take on, Fronczke said.

 

Fidelity’s private equity team has been deploying about $3 billion a year on average through its mutual fund offerings into private companies over the last several years, with the company setting a high bar for the team’s operations: “Strategically, our goal is to be one of the best, if not the best, longest term, stickiest partners for companies as an investor,” and getting to know companies years before they list is a key to that goal, Fronczke said.

 

“Why not get to understand that business and the management team a couple of years before they go public?” she asked.

 

While returns from those exposures may be attractive, the bigger benefit, Fronczke said, may be in giving Fidelity’s army of portfolio managers and analysts a fuller understanding of the up-and-coming private companies capable of disrupting the listed companies they invest in.

 

“Each and every day there are new private companies being founded, seeded and growing, that will disrupt those public companies … we need to understand who is going to disrupt the companies in the public space,” she said.

 

“And where we have conviction in the business” — with a large addressable market, a competitive moat and a great management team — “we will choose to invest as well,” she said.

 

That approach has become all the more valuable as more and more companies stay private longer and account for an ever-larger share of the investable universe. When the term “unicorn” was coined just over a decade ago, an unlisted firm with a value of $1 billion or more was seen as a rarity, but today there are 1,500 unicorns with a combined value of $5 trillion, Fronczke noted.

 

Fronczke's 10 member team is spread out across venture capital centers around the globe: Boston, Silicon Valley, London and Hong Kong. Many of those professionals came from traditional venture capital and private equity firms, she noted. Fidelity’s leadership had the foresight to work to “make sure that we were a top player in private investing.”

 

Asked whether Fidelity’s efforts in private companies could expand beyond adding limited exposures to the firm’s huge mutual fund business, a spokeswoman said that is a question for another day.

 

Meanwhile, Fronczke said her team works closely with Fidelity’s industry-leading public analyst team. “We conduct 500 private company meetings per year (and) there’s a public research analyst on almost every single one of those meetings with us.”

 

“Not only do they lend their insights to our diligence process but importantly they get to know and understand and appreciate who the up-and-coming private disruptors are that might impact their public coverage,” Fronczke said. Those 200 analysts are “our key secret sauce,” she said.

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Before making any investment decisions, you should consult with your own professional advisers and take into account all of the particular facts and circumstances of your individual situation. Fidelity and its representatives may have a conflict of interest in the products or services mentioned in these materials because they have a financial interest in them, and receive compensation, directly or indirectly, in connection with the management, distribution, and/or servicing of these products or services, including Fidelity funds, certain third-party funds and products, and certain investment services.

 

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