Equity allocations will typically range from 20–80% of the fund's total assets, although the portfolio managers may allocate substantially all assets to either stocks or bonds, depending on their view of the markets. Investment options include individual Fidelity mutual funds, unaffiliated exchange-traded funds (ETFs), and other direct investments. Given the fund's flexible nature, investors who are interested in adding a non-core, or "satellite," holding to complement any already diversified portfolio may wish to consider this new offering.

The fund's co-lead managers, Jurrien Timmer and Andrew Dierdorf, have extensive experience in analyzing market dynamics and constructing asset allocation portfolios for Fidelity's shareholders. Mutual Fund Guide contributor Wayne Taylor recently spoke with the two managers to learn more about Fidelity Dynamic Strategies Fund.

Q: Thanks to you both for making the time to visit with us. You've just launched Dynamic Strategies. Jurrien, let me start with you. How does this new addition fit into Fidelity's asset allocation fund lineup?

Timmer: I think it's fair to say that this new offering fits at one extreme of the wide spectrum in our asset allocation funds lineup. That spectrum ranges from the "strategic" asset allocation strategy of Fidelity Freedom Funds^® at one end to the "opportunistic" allocation strategy we employ in Dynamic Strategies at the other. The Freedom Funds are a series of portfolios with maturity dates based on when a shareholder intends to retire. The individual portfolios are constructed and monitored using quantitative models to rebalance assets in various asset classes so that the portfolios gradually become more conservatively positioned as shareholders reach their target dates. The asset allocation strategy is already built into the product. In the middle of the spectrum are the Fidelity Asset Manager^® funds, which instead of targeting a date in the future target the level of risk an investor wishes to take—from Asset Manager 85% Fund's considerable majority stake in equities to Asset Manager 20% Fund's minority equity stake. Compared with the Freedom Funds, Dynamic Strategies is as far to the opposite extreme as one can get.

Q: How so?

Timmer: As opposed to the built-in asset allocation strategy of the Freedom Funds, Andrew and I take a more active asset allocation approach. Our fund is more aggressive in terms of its allocation of assets. As managers, we'll tend to be more opportunistic in our asset allocation decisions, based on how we assess market conditions and investment trends. Where Freedom Funds and Asset Manager Funds might tend to be "core" holdings in an investor's portfolio—housed in a 401(k) plan, for instance, as default holdings for targeting a specific time frame or risk level—Dynamic Strategies is more of a noncore, or "satellite," holding. Asset allocation will be done within the new fund so investors don't have to worry about diversifying assets—just as with the others in the group—but with Dynamic Strategies, Andrew and I will be doing the asset allocation in a more tactical way.

Q: Andrew, would you expand on this notion of tactical asset allocation?

Dierdorf: I'd be happy to. Let's start by looking at our neutral asset allocation mix (or benchmark weighting) which will be a composite of 50% stocks, 40% bonds, and 10% short-term investments. The corresponding indexes we'll use to measure the relative performance of those asset classes are the Standard & Poor's 500^SM Index, the Lehman Brothers^® U.S. Aggregate Index and the Lehman Brothers 3-Month U.S. Treasury Bill Index. Our tactical asset allocation approach comes into play as a function of Dynamic Strategies' investment mandate, which allows us to vary the levels of equity exposure versus that neutral mix quite substantially, if we wish. The expected range of equity exposure would be between 20% and 80% of assets, but we also have the mandate to go broader than that, even to the point of investing the fund completely in equities or completely in cash—although those extremes are probably unlikely to occur. It's a very open mandate nonetheless, which gives us the ability to move in and out of assets classes without much restriction, based on our view of the markets and where we think there may be opportunities to achieve "alpha," or returns that exceed those of our composite index.

Q: Let's talk more about that potential for added return, Andrew. Where do you expect it to come from?

Dierdorf: Our goal is to add value through two sources. The primary method for alpha generation will be through the use of the fund's core building blocks, mainly Fidelity mutual funds. This also is how our other asset allocation funds look to generate their alpha. Using these core mutual fund holdings, we'll be leveraging Fidelity's vast research capabilities and would expect to benefit from the bottom-up, fundamental security analysis that our individual fund managers use to achieve strong returns. The secondary source of alpha will be sought through tactical and strategic asset allocation moves. Those moves may be executed in one of two ways: among assets classes, which is to say by overweighting or underweighting stocks, bonds, and short-term investments; or within asset classes, by choosing to overweight particular investment themes—market sectors, investment styles, or interest rate sensitivities, for example.

Q: Jurrien, other than Fidelity mutual funds, what other investment vehicles might the fund look at to generate alpha?

Timmer: As Andrew indicated, we have a very open mandate, with few restrictions to limit the kind of securities we invest in. As a practical matter, however, I'd expect the lion's share of the fund's assets to be invested either in Fidelity mutual funds or in ETFs (exchange-traded funds).

Q: What are ETFs, and how might they benefit the fund's performance?

Timmer: ETFs are basically index funds—vehicles whose assets are invested so as to replicate the return of a particular set of securities, such as the S&P 500^® index, for instance, or often, a set of securities that is much more narrowly defined, such as those relative to a particular theme or niche market, like solar power, for example. ETFs can be traded, like individual stocks or bonds, at any time during the course of a daily market session. In managing Dynamic Strategies, we'd expect to use ETFs really for two primary reasons: first and most important, to be able to tap into investment themes for which there aren't any Fidelity funds available; and second, since ETFs can be bought and sold so quickly, as vehicles that allow us to maintain sufficient liquidity to take advantage of opportunities in a timely manner.

Dierdorf: But going back to what I mentioned earlier, the primary building blocks for the fund are always going to be Fidelity mutual funds. Part of what we're trying to do with Dynamic Strategies is to take advantage of the areas where Fidelity's research capabilities and expertise shine through. Jurrien and I are not stock pickers; we defer that to the security analysts and portfolio managers who devote their careers to making solid stock selection decisions. But to the extent that there are macro-level themes that Jurrien and I want to build into the portfolio and there aren't any Fidelity funds that cover those themes, that's when we'll dip into the ETF space.

Q: On average, how many different funds do you expect Dynamic Strategies to be invested in at any one time?

Timmer: We believe in broad diversification. As we're talking here (about two weeks after our launch) we have positions in at least two dozen Fidelity funds and a handful of ETFs. Indirectly, through these components, we have exposure in our fund to something like 4500 stocks. These are stocks that run the gamut of investment style, market capitalization, and domestic versus international.

Q: What kinds of themes are you finding of interest in the closing months of 2007?

Timmer: Let me give you a hypothetical about the kinds of long-term themes we're looking at and that might well be expressed in the fund. Globalization is a trend that has interested many investors for some years now. Indeed, we all know that this is a huge theme and that globalization is here to stay. But the question from our point of view as portfolio managers is "how do we leverage off the globalization theme?" One avenue might be through global energy or commodities, as the developing world builds out its infrastructure. But what's the best way to gain specific exposure to those two themes? Emerging-markets economies would be one way, so our fund might look to Fidelity's market- or region-specific international funds to cover that base. But then let's say we want to get more specific and have access to individual geographic markets such Australia or Russia, where Fidelity doesn't have a country fund. Here is where ETFs might play a valuable role.

Q: The two of you are running this new fund as co-managers. What does each of you bring to the table?

Timmer: I think we bring complementary skill sets to the fund. One way of looking at it would be to see me—with my background in market research—as the qualitative part of the dual-manager approach. My role tends to center on asking such questions as "what will the world economy look like over the next five years?" and "how should we invest to take advantage of this view?" Andrew brings more of the quantitative skill set, focusing his attention on portfolio construction and risk management. The idea is that we bring disparate skills, both of which are essential to managing the fund.

Dierdorf: Fidelity has a long history and deep experience in the asset allocation business. It dates back to our introduction of the Asset Manager Fund family back in 1988 and more recently with the Freedom Funds in 1996. Dynamic Strategies is the natural evolution of the asset allocation philosophy, and my experience, which indeed has been more on the quantitative side, has been very focused on taking what we've learned from these earlier asset allocation products and building it into this new offering.

Q: Staying with you, Andrew, why is asset allocation so important as an investment strategy?

Dierdorf: Asset allocation provides diversification so that investors can survive the inevitable ups and downs of the investment marketplace without stretching to the extremes. As Jurrien mentioned earlier, our new fund is not necessarily the kind of core holding that a stake in Freedom Funds or Asset Manager might be. Rather, it's probably better viewed as a "satellite" holding—one that might be added to one's core holdings, perhaps along with other satellite equity funds—to provide additional portfolio diversification and perhaps additional "return-seeking" potential to one's portfolio.

Q: Jurrien, what sort of investor do you think might be inclined to consider Dynamic Strategies as an investment?

Timmer: I think it could be appropriate for any individual investor who wants to complement a core portfolio. If you think of a portfolio as a set of building blocks, many investors have a core set of holdings that give them broad diversification. I would tend to think of Dynamic Strategies as a further building block that one might add to one's core portfolio to seek total return, some further diversification, and, hopefully, some "uncorrelated alpha," by which I mean a return that is not necessarily directly tied to the broad direction of the markets. The fund could tend to be more volatile and a bit farther out on the risk spectrum than most of our other asset allocation funds; however, it also could have the potential to deliver higher returns.

Dierdorf: That said, it's also important to state that our goal is to have a fund that is built for the long term—one that is capable of withstanding both down equity markets and down bond markets, one that essentially is capable of performing well in any market environment, given the flexibility we have to invest where we see the best opportunities.

Q: Even as we speak, the markets are pretty volatile, perhaps not the most conducive of environments in which to be launching. What's your outlook, Jurrien?

Timmer: Long term, we're confident that globalization is a theme with the legs to run further, and we certainly have access to the kinds of investment vehicles that have the potential to help us take advantage of that secular trend. Shorter term, there are a number of uncertainties clouding the markets—particularly here in the States where the domestic economy is slowing under the weight of an intensifying housing slump and ongoing disruptions in the credit markets. Given the short-term volatility in the markets, I expect that we'll be hewing close to neutral in terms of the fund's current asset allocation strategy... at least in the near term.

Q: Thanks to both of you for sharing your thoughts on Dynamic Strategies. And best of luck with it.

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