FIDELITY
REAL ESTATE HIGH INCOME FUND II
ANNUAL REPORT
DECEMBER 31, 1998
(2_FIDELITY_LOGOS)(REGISTERED TRADEMARK)
CONTENTS
PERFORMANCE 3 HOW THE FUND HAS DONE OVER
TIME.
FUND TALK 4 THE MANAGERS' REVIEW OF FUND
PERFORMANCE, STRATEGY AND
OUTLOOK.
INVESTMENTS 5 A COMPLETE LIST OF THE FUND'S
INVESTMENTS WITH THEIR
MARKET VALUES.
FINANCIAL STATEMENTS 8 STATEMENTS OF ASSETS AND
LIABILITIES, OPERATIONS, AND
CHANGES IN NET ASSETS, AS
WELL AS FINANCIAL HIGHLIGHTS.
NOTES 10 NOTES TO THE FINANCIAL
STATEMENTS.
REPORT OF INDEPENDENT 12 THE AUDITORS' OPINION.
ACCOUNTANTS
THIS REPORT AND THE FINANCIAL STATEMENTS CONTAINED HEREIN ARE
SUBMITTED FOR THE GENERAL INFORMATION OF THE SHAREHOLDERS OF THE FUND.
THIS REPORT IS NOT AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE
INVESTORS IN THE FUND UNLESS PRECEDED OR ACCOMPANIED BY AN EFFECTIVE
PROSPECTUS.
MUTUAL FUND SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED
BY, ANY DEPOSITORY INSTITUTION. SHARES ARE NOT INSURED BY THE FDIC,
FEDERAL RESERVE BOARD OR ANY OTHER AGENCY, AND ARE SUBJECT TO
INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF PRINCIPAL AMOUNT
INVESTED.
NEITHER THE FUND NOR FIDELITY DISTRIBUTORS CORPORATION IS A BANK.
FOR MORE INFORMATION ON THE FUND, INCLUDING CHARGES AND EXPENSES, CALL
JEFF GANDEL AT 617-563-6414 FOR A FREE PROSPECTUS. READ IT CAREFULLY
BEFORE YOU INVEST OR SEND MONEY.
REAL ESTATE HIGH INCOME FUND II
PERFORMANCE: THE BOTTOM LINE
There are several ways to evaluate a fund's historical performance.
You can look at the total percentage change in value, the average
annual percentage change or the growth of a hypothetical $100,000
investment. Total return reflects the change in the value of an
investment, assuming reinvestment of the fund's dividend income and
capital gains (the profits earned upon the sale of securities that
have grown in value).
CUMULATIVE TOTAL RETURNS
PERIODS ENDED DECEMBER 31, PAST 1 YEAR LIFE OF FUND
1998
Fidelity Real Estate High -13.66% 20.72%
Income II
ML High Yield Master 3.66% 21.68%
NAREIT Index -18.82% n/a
Real Estate Funds Average -15.46% n/a
High Current Yield Funds -0.44% n/a
Average
CUMULATIVE TOTAL RETURNS show the fund's performance in percentage
terms over a set period - in this case, one year or since the fund
started on September 27, 1996. For example, if you had invested $1,000
in a fund that had a 5% return over the past year, the value of your
investment would be $1,050. You can compare the fund's return to the
performance of the Merrill Lynch High Yield Master Index - a market
value-weighted index of all domestic and yankee high-yield bonds.
Issues included in the index have maturities of one year or more and
have a credit rating lower than BBB-/Baa3, but are not in default. You
can also compare the fund's returns to the performance of the National
Association of Real Estate Investment Trusts (NAREIT) Index, a market
capitalization weighted index that tracks the common stocks of all
tax-qualified Real Estate Investment Trusts listed on the New York
Stock Exchange, American Stock Exchange, and NASDAQ. To measure how
the fund's performance stacked up against its peers, you can compare
it to the real estate funds average, which reflects the performance of
mutual funds with similar objectives tracked by Lipper Inc. The fund
formerly was included in Lipper's high current yield category (which
included 246 funds for the past one year), but will be included in the
real estate funds category (100 funds) in the future. These benchmarks
include reinvested dividends and capital gains, if any, and exclude
the effect of sales charges.
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, PAST 1 YEAR LIFE OF FUND
1998
Fidelity Real Estate High -13.66% 8.69%
Income II
ML High Yield Master 3.66% 9.07%
NAREIT Index -18.82% n/a
Real Estate Funds Average -15.46% n/a
High Current Yield Funds -0.44% n/a
Average
AVERAGE ANNUAL TOTAL RETURNS take the fund's cumulative return and
show you what would have happened if the fund had performed at a
constant rate each year. (Note: Lipper calculates average annual total
returns by annualizing each fund's total return, then taking an
arithmetic average. This may produce a different figure than that
obtained by averaging the cumulative total returns and annualizing the
result.)
$100,000 OVER LIFE OF FUND
Real Estate High Inc II ML High Yield Master
00673 ML002
1996/09/27 100000.00 100000.00
1996/09/30 100015.46 100103.87
1996/10/31 101680.42 101200.94
1996/11/30 105246.94 103246.93
1996/12/31 109515.21 104041.39
1997/01/31 111734.97 104840.96
1997/02/28 114208.16 106311.66
1997/03/31 116045.52 105130.92
1997/04/30 115287.34 106327.48
1997/05/31 116763.18 108443.04
1997/06/30 122379.11 110121.72
1997/07/31 126954.06 112764.42
1997/08/31 126675.92 112510.70
1997/09/30 138012.42 114431.67
1997/10/31 136149.32 115191.10
1997/11/30 137072.72 116222.73
1997/12/31 139818.20 117384.75
1998/01/31 139710.02 119104.30
1998/02/28 137538.73 119624.61
1998/03/31 140671.46 120655.52
1998/04/30 137335.36 121228.62
1998/05/31 136828.52 122012.86
1998/06/30 136474.17 122677.18
1998/07/31 129516.45 123376.78
1998/08/31 119169.93 118052.96
1998/09/30 123288.45 118288.43
1998/10/31 121429.19 116315.17
1998/11/30 122119.15 121644.09
1998/12/31 120721.10 121684.47
IMATRL PRASUN SHR__CHT 19981231 19990129 160719 R00000000000031
$100,000 OVER LIFE OF FUND: Let's say hypothetically that $100,000 was
invested in Fidelity Real Estate High Income Fund II on September 27,
1996, when the fund started. As the chart shows, by December 31, 1998,
the value of the investment would have grown to $120,721 - a 20.72%
increase on the initial investment. For comparison, look at how the
Merrill Lynch High Yield Master Index did over the same period. With
dividends reinvested, the same $100,000 investment would have grown to
$121,684 - a 21.68% increase.
(checkmark)UNDERSTANDING PERFORMANCE
How a fund did yesterday is no guarantee of
how it will do tomorrow. The stock market, for
example, has a history of long-term growth
and short-term volatility. In turn, the share
price and return of a fund that invests in stocks
or bonds will vary. That means if you sell your
shares during a market downturn, you might
lose money. But if you can ride out the
market's ups and downs, you may have a
gain.
REAL ESTATE HIGH INCOME FUND II
FUND TALK: THE MANAGERS' OVERVIEW
An interview with Mark Snyderman, who manages the fund's commercial
mortgage-backed investments, and Barry Greenfield, manager of the
fund's real estate investment trust positions.
Q. HOW DID THE FUND PERFORM, MARK?
M.S. For the 12 months that ended December 31, 1998, the fund returned
- -13.66%. During the same period, the Merrill Lynch High Yield Master
Index - a broad measure of the high-yield bond market - returned
3.66%, while the real estate funds average returned -15.46%, according
to Lipper Inc. The fund also outperformed the NAREIT Index, maintained
by the National Association of Real Estate Investment Trusts, which
returned -18.82% during the past year.
Q. WHAT CAUSED THE FUND TO UNDERPERFORM THE MERRILL LYNCH INDEX YET
OUTPERFORM THE REAL ESTATE FUNDS AVERAGE AND THE NAREIT INDEX?
M.S. The primary reason was because the fund is comprised of two
sub-portfolios that invest in commercial mortgage-backed securities
(CMBS) and real estate investment trusts (REITs), while the Merrill
Lynch index is a measure of performance for a broad range of
high-yield bonds. REITs dropped precipitously during the period as
investors questioned the sustainability of earnings and the future of
the U.S. economy in light of global financial troubles. However, the
fund's high-yield sub-portfolio stabilized performance, allowing the
fund to outperform funds that invest primarily in REITs.
Q. WHAT OTHER FACTORS INFLUENCED THE CMBS MARKET?
M.S. There was a supply and demand imbalance in the CMBS market in the
second half of the period. Part of the decline in demand was caused by
events that were unexpected and unique to the high-yield mortgage bond
market. As demand for CMBS dried up over the last six months,
resulting in significant widening of yield spreads and declining
prices, the situation was amplified as half the buyers in the market
disappeared in late September and became sellers of mortgage bonds.
Crimmi Mae, one of the biggest buyers of these securities, declared
bankruptcy and a number of other market participants experienced
margin calls due to high debt levels. This situation exerted
significant selling pressures on high-yield mortgage securities.
Q. THE INVESTMENT ENVIRONMENT WAS EVEN MORE DIFFICULT FOR REITS. CAN
YOU TELL US A BIT MORE ABOUT THIS SITUATION, BARRY?
B.G. Despite the strongest real estate fundamentals in more than a
decade, the list of reasons for REITs' poor showing in 1998 is a long
one. It includes fears about overbuilding and that REITs were
unjustifiably bidding up property prices. The REIT market came under a
lot of pressure during the period as investors questioned the
sustainability of long-term earnings, following a period of aggressive
merger and acquisition activity that drove up prices. Adding to the
difficulties were legislative hurdles. Certain lodging companies that
operate as paired-share REITs - common stocks of two different
entities under the same management that trade as one unit - were hurt
as they sought to restructure their business to reflect legislative
changes that prohibit them from acting in the same capacity for new
properties. Finally, the near-collapse of hedge fund Long-Term Capital
Management resulted in the near shutdown of the CMBS market as a
source of REIT financing. The inability to raise new capital halted
construction and many acquisitions were dropped. Analysts lowered
expected growth rates and stock prices tumbled.
Q. WHAT SEGMENTS OF THE REIT MARKET PERFORMED WELL? WHAT HOLDINGS HURT
PERFORMANCE?
B.G. In the second half of the year, the entire REIT market declined.
Essentially, there was no place to hide. However, I did move some
assets into diversified hotels, malls and office buildings to
stabilize performance, reduce risk and increase yields in the
portfolio. Apartment Investment & Management Co., a REIT that operates
diversified apartment communities, held up fairly well due to its
reliable earnings and strong fundamental business outlook. Kimco
Realty, a REIT involved in the ownership and operation of community
shopping centers, also provided stable returns. On the negative side,
Starwood Hotels & Resorts hurt performance as the stock suffered from
legislative changes that reduced the usefulness of its paired-share
structure. The fund's holdings in Patriot American Hospitality also
were hurt by the legislative changes, weakened demand in certain
regions and an excessively leveraged balance sheet.
Q. MARK AND BARRY, WHAT ARE YOUR OUTLOOKS FOR THE MONTHS AHEAD?
M.S. As I mentioned earlier, we experienced a very peculiar situation
in the high-yield mortgage market, where half of the buyers were
over-leveraged with debt, causing a huge dislocation in the market.
When you lose significant demand for bonds, yield spreads widen
dramatically and it takes some time for buyers to re-enter the market.
Nevertheless, the dramatic sell-off in this sector of the market has
created some opportunities for the fund, and we are beginning to see
signs that buyers are returning since many commercial mortgage
securities looked attractively valued. If this trend continues, we
could see an increase in demand, tighter yield spreads and higher
prices. All of these factors should be favorable for the fund's
performance.
B.G. As always, the fund remains fully invested in the property
sectors that show the best fundamentals, strong growth prospects and
healthy balance sheets. With REIT yields at record levels relative to
the 10-year Treasury note, REITs should start to rebound. If investors
begin to seek higher yields, then we could see a recovery and better
fund performance.
THE VIEWS EXPRESSED IN THIS REPORT REFLECT THOSE OF THE PORTFOLIO
MANAGERS ONLY THROUGH THE END OF THE PERIOD OF THE REPORT AS STATED ON
THE COVER. THE MANAGERS' VIEWS ARE SUBJECT TO CHANGE AT ANY TIME
BASED ON MARKET AND OTHER CONDITIONS.
(checkmark)FUND FACTS
GOAL: to provide high current income by investing
primarily in commercial mortgage-backed
securities and real estate investment trusts
START DATE: September 27, 1996
SIZE: as of December 31, 1998, more than
$192 million
MANAGERS: Mark Snyderman, since inception;
joined Fidelity in 1994; Barry Greenfield, since
inception; joined Fidelity in 1968
FIDELITY REAL ESTATE HIGH INCOME FUND II
INVESTMENTS DECEMBER 31, 1998
Showing Percentage of Total Value of Investment in Securities
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CORPORATE BONDS - 1.3%
MOODY'S RATINGS (UNAUDITED) (D) PRINCIPAL AMOUNT VALUE (NOTE 1)
CONVERTIBLE BONDS - 0.7%
CONSTRUCTION & REAL ESTATE -
0.4%
REAL ESTATE INVESTMENT TRUSTS
- - 0.4%
Rockefeller Center - $ 1,000,000 $ 770,000
Properties, Inc. 0% 12/31/00
MEDIA & LEISURE - 0.3%
LODGING & GAMING - 0.3%
ShoLodge, Inc. 7.5% 5/1/04 B2 1,170,000 719,550
TOTAL CONVERTIBLE BONDS 1,489,550
NONCONVERTIBLE BONDS - 0.6%
CONSTRUCTION & REAL ESTATE -
0.3%
REAL ESTATE - 0.3%
LNR Property Corp. 9.375% B1 615,000 590,400
3/15/08
MEDIA & LEISURE - 0.2%
LODGING & GAMING - 0.2%
ShoLodge, Inc. 9.75% 11/1/06 B1 415,000 261,450
SERVICES - 0.1%
AMRESCO, Inc. 9.875% 3/15/05 Caa3 370,000 259,000
TOTAL NONCONVERTIBLE BONDS 1,110,850
TOTAL CORPORATE BONDS 2,600,400
(Cost $2,994,501)
ASSET-BACKED SECURITIES - 0.3%
Saxon Asset Securities Trust:
8% 12/25/27 (b) BB 400,000 354,016
8.6% 12/25/27 (b) B 345,000 212,486
TOTAL ASSET-BACKED SECURITIES 566,502
(Cost $573,925)
COLLATERALIZED MORTGAGE
OBLIGATIONS - 0.4%
PRIVATE SPONSOR - 0.4%
Credit-Based Asset Servicing
and Securitization LLC
Series 1997 2:
Class 2-B, 7.2141% 12/29/25 Ba3 854,676 302,342
(b)(c)(g)
Class 2-C, 7.2141% 12/29/25 B3 2,550,000 382,500
(b)(c)(g)
TOTAL COLLATERALIZED 684,842
MORTGAGE OBLIGATIONS
(Cost $1,192,619)
COMMERCIAL MORTGAGE
SECURITIES - 17.2%
MOODY'S RATINGS (UNAUDITED) (D) PRINCIPAL AMOUNT VALUE (NOTE 1)
ACP Mortgage LP floater B $ 1,864,926 $ 1,491,940
Series F, 7.3892% 2/28/28
(b)(c)
Artesia Mortgage CMBS, Inc.
Series 1998 C1:
Class G, 6.871% 10/25/31 - 999,248 600,837
(b)(c)
Class NR, 6.423% 10/25/31 - 1,499,623 387,266
(b)(c)
BKB Commercial Mortgage Trust
Series 1997 C1:
Class F, 8.7871% 4/26/04 B 1,476,000 1,372,449
(b)(c)
Class G, 8.7871% 4/27/09 CCC 1,790,500 1,145,920
(b)(c)
Class H, 8.94% 10/25/22 (b)(c) - 1,810,596 362,119
Blaylock Mortgage Capital
Corp. Series 1997 A:
Class B5, 6.425% 10/15/03 (b) B- 250,000 169,961
Class B6, 6.425% 10/15/03 (b) CCC 250,000 112,539
Class B7, 6.425% 10/15/03 (b) - 335,000 103,798
DLJ Mortgage Acceptance Corp.:
Series 1994 MF4 Class C, 8.5% - 1,046,000 793,326
4/18/01 (b)
Series 1994 MF11 Class B2, Ba2 2,400,000 2,027,251
8.1% 6/18/04 (b)
First Chicago/Lennar Trust I - 4,000,000 3,070,000
Series 1997 CHL1 Class E,
8.1117% 4/1/39 (c)
FMAC Loan Receivables Trust:
Series 1997 A Class F, - 925,542 631,682
8.1063% 4/15/19 (b)(c)
Series 1998 A Class E, BB 2,500,000 1,701,563
7.9265% 9/15/20 (b)(c)
Kidder Peabody Acceptance - 1,914,000 1,232,437
Corp. I Series 1994 M1 Class
D, 8.1284% 7/25/01 (b)(c)
LB Multifamily Mortgage Trust Caa1 512,980 353,956
Series 1991 4 Class A1,
7.2559% 4/25/21 (c)
Meritor Mortgage Security - 12,919,000 2,397,766
Corp. Series 1987 1 Class B,
9.4% 2/1/00 (b)(g)
Morgan (JP) Commercial - 4,885,341 1,413,696
Mortgage Finance Corp.
Series 1997 C4 Class NR,
7.38% 12/26/28 (b)
COMMERCIAL MORTGAGE
SECURITIES - CONTINUED
MOODY'S RATINGS (UNAUDITED) (D) PRINCIPAL AMOUNT VALUE (NOTE 1)
Mortgage Capital Funding, Baa3 $ 2,500,000 $ 2,261,719
Inc. Series 1998-MC3 Class
E, 7.355% 11/18/31 (c)
Nomura Depositor Trust Series - 1,000,000 854,375
1998-ST1A Class B1A, 8.2966%
1/15/03 (b)(c)
Resolution Trust Corp.:
floater Series 1991 M2 Class Ba3 631,745 543,301
A1, 6.8773% 9/25/20 (c)
Series 1991 M2:
Class A3, 7.2498% 9/25/20 (c) Ba3 945,529 765,878
Class A2, 7.6548% 9/25/20 (c) Ba3 2,166,543 1,819,896
Structured Asset Securities
Corp.:
Series 1995 C1 Class F, - 3,000,000 2,384,531
7.375% 12/25/25 (b)
Series 1996 CFL:
Class G, 7.75% 2/25/28 (b) B 3,250,000 2,957,500
Class H, 7.75% 2/25/28 (b) B- 1,500,000 1,054,815
Structured Mortgage Trust
Series 1997-2:
Class C, 7.41% 1/30/06 (WAC) - 650,000 429,914
(b)(c)
Class D, 7.41% 1/30/06 (WAC) - 800,000 504,125
(b)(c)
TOTAL COMMERCIAL MORTGAGE 32,944,560
SECURITIES
(Cost $30,897,860)
COMPLEX MORTGAGE SECURITIES -
0.5%
INTEREST ONLY STRIPS - 0.0%
BKB Commercial Mortgage Trust BBB 16,809,935 67,240
Series 1997 C1 Class X-1,
1.2074% 12/26/01 (b)(c)(e)
PRINCIPAL ONLY STRIPS - 0.5%
Structured Asset Securities - 2,143,008 846,488
Corp. Series 1996 CFL Class
P, 0% 2/25/28 (b)(f)
TOTAL COMPLEX MORTGAGE 913,728
SECURITIES
(Cost $536,539)
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COMMON STOCKS - 77.2%
SHARES VALUE (NOTE 1)
CONSTRUCTION & REAL ESTATE -
76.6%
REAL ESTATE - 3.9%
Boardwalk Equities, Inc. (a) 201,400 $ 2,223,888
Fortress Investment Corp. (b) 100,000 1,687,500
Lexford Residential Trust 50,000 925,000
LNR Property Corp. 11,400 227,288
Trizec Hahn Corp. (sub-vtg.) 121,300 2,496,537
7,560,213
REAL ESTATE INVESTMENT TRUSTS
- - 72.7%
AMB Property Corp. 227,500 5,005,000
AMRESCO Capital Trust, Inc. 90,000 855,000
Apartment Investment & 358,100 13,316,839
Management Co. Class A
Apex Mortgage Capital, Inc. 59,800 575,575
Boston Properties, Inc. 98,200 2,995,100
Bradley Real Estate, Inc. 84,900 1,740,450
(SBI)
Brandywine Realty Trust 11,600 207,350
CBL & Associates Properties, 100,600 2,596,738
Inc.
CCA Prison Realty Trust 119,100 2,441,550
CenterPoint Properties Trust 60,900 2,059,181
Clarion Commercial Holdings, 113,300 481,525
Inc. Class A
Colonial Properties Trust 106,800 2,843,550
(SBI)
Cousins Properties, Inc. 86,500 2,789,625
Crescent Real Estate Equities 146,100 3,360,300
Co.
Duke Realty Investments, Inc. 111,500 2,592,375
Eastgroup Properties, Inc. 100,700 1,856,656
Equity Office Properties Trust 158,696 3,808,704
Equity Residential Properties 82,600 3,340,138
Trust (SBI)
FelCor Lodging Trust, Inc. 59,200 1,365,300
Gables Residential Trust (SBI) 62,800 1,456,175
General Growth Properties, 61,300 2,321,738
Inc.
Glenborough Realty Trust, 124,500 2,536,688
Inc.
Home Properties of N.Y., Inc. 120,600 3,105,450
Innkeepers USA Trust 85,000 1,004,063
Kimco Realty Corp. 240,400 9,540,875
Liberty Property Trust (SBI) 51,200 1,260,800
Mack-Cali Realty Corp. 237,750 7,340,531
Meditrust Corp. unit 130,400 1,972,300
New Plan Excel Realty Trust 236,220 5,241,131
Northstar Capital Investment 85,000 1,360,000
Corp. (b)
Ocwen Asset Investment Corp. 60,000 288,750
Parkway Properties, Inc. 48,400 1,512,500
Patriot American Hospitality, 40,800 244,800
Inc. unit
Post Properties, Inc. 101,600 3,905,250
Public Storage, Inc. 198,400 5,369,200
Realty Income Corp. 50,000 1,243,750
Reckson Associates Realty 279,200 6,194,750
Corp.
Simon Property Group, Inc. 272,000 7,752,000
Starwood Hotels & Resorts 248,550 5,638,978
Trust
Summit Properties, Inc. 61,500 1,060,875
COMMON STOCKS - CONTINUED
SHARES VALUE (NOTE 1)
CONSTRUCTION & REAL ESTATE -
CONTINUED
REAL ESTATE INVESTMENT TRUSTS
- - CONTINUED
Sun Communities, Inc. 51,200 $ 1,782,400
Sunstone Hotel Investors, 91,900 867,306
Inc.
Taubman Centers, Inc. 175,000 2,406,250
Town & Country Trust 60,000 963,750
Vornado Realty Trust 210,000 7,087,500
Weeks Corp. 14,200 400,263
Weingarten Realty Investors 28,900 1,289,663
(SBI)
139,378,692
TOTAL CONSTRUCTION & REAL 146,938,905
ESTATE
TECHNOLOGY - 0.6%
COMPUTER SERVICES & SOFTWARE
- - 0.6%
Realty Information Group, 88,300 1,114,788
Inc. (a)
TOTAL COMMON STOCKS 148,053,693
(Cost $157,781,280)
PREFERRED STOCKS - 2.4%
CONVERTIBLE PREFERRED STOCKS
- - 1.0%
CONSTRUCTION & REAL ESTATE -
1.0%
REAL ESTATE INVESTMENT TRUSTS
- - 1.0%
Apartment Investment & 28,515 1,055,055
Management Co. $0.90
Innkeepers USA Trust Series 40,000 785,000
A, $2.16
1,840,055
NONCONVERTIBLE PREFERRED
STOCKS - 1.4%
CONSTRUCTION & REAL ESTATE -
1.4%
REAL ESTATE INVESTMENT TRUSTS
- - 1.4%
Crown America Realty Trust 40,600 1,984,325
Series A, $5.50
Walden Residential 36,100 785,175
Properties, Inc. $2.30
2,769,500
TOTAL PREFERRED STOCKS 4,609,555
(Cost $5,003,936)
CASH EQUIVALENTS - 0.7%
MATURITY AMOUNT
Investments in repurchase $ 1,331,697 1,331,000
agreements (U.S. Treasury
obligations), in a joint
trading account at 4.72%,
dated 12/31/98 due 1/4/99
(Cost $1,331,000)
TOTAL INVESTMENT IN $ 191,704,280
SECURITIES - 100%
(Cost $200,311,660)
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SECURITY TYPE ABBREVIATIONS
SBI - SHARES OF BENEFICIAL INTEREST
WAC - WEIGHTED AVERAGE COUPON
LEGEND
(a) Non-income producing
(b) Security exempt from registration under Rule 144A of the
Securities Act of 1933. These securities may be resold in transactions
exempt from registration, normally to qualified institutional buyers.
At the period end, the value of these securities amounted to
$29,342,382 or 15.2% of net assets.
(c) The coupon rate shown on floating or adjustable rate securities
represents the rate at period end.
(d) Standard & Poor's credit ratings are used in the absence of a
rating by Moody's Investors Service, Inc.
(e) Security represents the right to receive monthly interest payments
on an underlying pool of mortgages. Principal shown is the par amount
of the mortgage pool.
(f) Principal Only Strips represent the right to receive the monthly
principal payments on an underlying pool of mortgage loans.
(g) Partial interest payment received on the last interest payment
date.
OTHER INFORMATION
The composition of long-term debt holdings as a percentage of total
value of investments in securities, is as follows (ratings are
unaudited):
MOODY'S RATINGS S&P RATINGS
Aaa, Aa, A 0.0% AAA, AA, A 0.0%
Baa 1.2% BBB 0.0%
Ba 2.9% BB 1.1%
B 1.0% B 6.2%
Caa 0.3% CCC 0.8%
Ca, C 0.0% CC, C 0.0%
D 0.2%
The percentage not rated by Moody's or S&P amounted to 8.8%. FMR has
determined that unrated debt securities that are lower quality account
for 8.8% of the total value of investment in securities.
INCOME TAX INFORMATION
At December 31, 1998, the aggregate cost of investment securities for
income tax purposes was $201,260,360. Net unrealized depreciation
aggregated $9,556,080 of which $6,940,617 related to appreciated
investment securities and $16,496,697 related to depreciated
investment securities.
At December 31, 1998, the fund had a capital loss carryforward of
approximately $4,711,000, all of which will expire on December 31,
2006.
The fund elects to defer to its fiscal year ending December 31, 1999
approximately $3,585,000 of losses recognized during the period
November 1, 1998 to December 31, 1998.
REAL ESTATE HIGH INCOME FUND II
FINANCIAL STATEMENTS
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1998
ASSETS
Investment in securities, at $ 191,704,280
value (including repurchase
agreements of $1,331,000)
(cost $200,311,660) - See
accompanying schedule
Cash 19,352
Receivable for investments 3,894
sold
Dividends receivable 1,111,282
Interest receivable 409,923
TOTAL ASSETS 193,248,731
LIABILITIES
Payable for investments $ 567,324
purchased
Distributions payable 6,357
Accrued management fee 111,532
Other payables and accrued 92,977
expenses
TOTAL LIABILITIES 778,190
NET ASSETS $ 192,470,541
Net Assets consist of:
Paid in capital $ 210,211,453
Undistributed net investment 111,674
income
Accumulated undistributed net (9,245,159)
realized gain (loss) on
investments and foreign
currency transactions
Net unrealized appreciation (8,607,427)
(depreciation) on
investments and assets and
liabilities in foreign
currencies
NET ASSETS, for 19,015,914 $ 192,470,541
shares outstanding
NET ASSET VALUE, offering $10.12
price and redemption price
per share ($192,470,541
(divided by) 19,015,914
shares)
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
INVESTMENT INCOME $ 6,385,402
Dividends
Interest 4,062,055
TOTAL INCOME 10,447,457
EXPENSES
Management fee $ 968,276
Transfer agent fees 30,318
Accounting fees and expenses 99,149
Non-interested trustees' 463
compensation
Custodian fees and expenses 12,440
Registration fees 31,750
Audit 31,185
Legal 3,008
Interest 1,261
Miscellaneous 355
Total expenses before 1,178,205
reductions
Expense reductions (84,767) 1,093,438
NET INVESTMENT INCOME 9,354,019
REALIZED AND UNREALIZED GAIN
(LOSS)
Net realized gain (loss) on:
Investment securities (9,228,104)
Foreign currency transactions (138) (9,228,242)
Change in net unrealized
appreciation (depreciation)
on:
Investment securities (19,146,699)
Assets and liabilities in (47) (19,146,746)
foreign currencies
NET GAIN (LOSS) (28,374,988)
NET INCREASE (DECREASE) IN $ (19,020,969)
NET ASSETS RESULTING FROM
OPERATIONS
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STATEMENT OF CHANGES IN NET ASSETS
INCREASE (DECREASE) IN NET YEAR ENDED DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997
ASSETS
Operations Net investment $ 9,354,019 $ 5,099,884
income
Net realized gain (loss) (9,228,242) 4,273,306
Change in net unrealized (19,146,746) 7,967,115
appreciation (depreciation)
NET INCREASE (DECREASE) IN (19,020,969) 17,340,305
NET ASSETS RESULTING FROM
OPERATIONS
Distributions to shareholders (8,886,001) (5,099,884)
From net investment income
In excess of net investment - (603,357)
income
From net realized gain - (3,665,507)
TOTAL DISTRIBUTIONS (8,886,001) (9,368,748)
Share transactions Net 132,149,141 58,555,795
proceeds from sales of shares
Reinvestment of distributions 8,885,645 7,806,611
Cost of shares redeemed (30,442,411) (17,500,000)
NET INCREASE (DECREASE) IN 110,592,375 48,862,406
NET ASSETS RESULTING FROM
SHARE TRANSACTIONS
TOTAL INCREASE (DECREASE) 82,685,405 56,833,963
IN NET ASSETS
NET ASSETS
Beginning of period 109,785,136 52,951,173
End of period (including $ 192,470,541 $ 109,785,136
undistributed net investment
income of $111,674 and
distributions in excess of
net investment income of
$10,261, respectively)
OTHER INFORMATION
Shares
Sold 11,955,831 4,694,782
Issued in reinvestment of 845,461 638,145
distributions
Redeemed (2,653,000) (1,402,267)
Net increase (decrease) 10,148,292 3,930,660
SEE ACCOMPANYING NOTES WHICH
ARE AN INTEGRAL PART OF THE
FINANCIAL STATEMENTS.
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FINANCIAL HIGHLIGHTS
YEARS ENDED DECEMBER 31, SEPTEMBER 27, 1996
(COMMENCEMENT OF
OPERATIONS) TO DECEMBER 31,
SELECTED PER-SHARE DATA 1998 1997 1996
Net asset value, beginning of $ 12.380 $ 10.730 $ 10.000
period
Income from Investment .786 D .823 D .214
Operations Net investment
income
Net realized and unrealized (2.454) 2.073 .732
gain (loss)
Total from investment (1.668) 2.896 .946
operations
Less Distributions
From net investment income (.592) (.721) (.216)
In excess of net investment - (.085) -
income
From net realized gain - (.440) -
Total distributions (.592) (1.246) (.216)
Net asset value, end of period $ 10.120 $ 12.380 $ 10.730
TOTAL RETURN B, C (13.66)% 27.67% 9.52%
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of period $ 192,471 $ 109,785 $ 52,951
(000 omitted)
Ratio of expenses to average .89% .97% 1.42% A
net assets
Ratio of expenses to average .83% E .94% E 1.42% A
net assets after expense
reductions
Ratio of net investment 7.08% 6.90% 9.90% A
income to average net assets
Portfolio turnover rate 65% 64% 11% A
A ANNUALIZED
B TOTAL RETURNS FOR PERIODS OF LESS THAN ONE
YEAR ARE NOT ANNUALIZED.
C THE TOTAL RETURNS WOULD HAVE BEEN LOWER HAD CERTAIN
EXPENSES NOT BEEN REDUCED DURING THE PERIODS SHOWN
(SEE NOTE 6 OF NOTES TO FINANCIAL STATEMENTS).
D NET INVESTMENT INCOME PER SHARE HAS BEEN CALCULATED
BASED ON AVERAGE SHARES OUTSTANDING DURING THE PERIOD.
E FMR OR THE FUND HAS ENTERED INTO VARYING ARRANGEMENTS
WITH THIRD PARTIES WHO EITHER PAID OR REDUCED A PORTION
OF THE FUND'S EXPENSES (SEE NOTE 6 OF NOTES TO FINANCIAL
STATEMENTS).
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FIDELITY REAL ESTATE HIGH INCOME FUND II
NOTES TO FINANCIAL STATEMENTS
For the period ended December 31, 1998
1. SIGNIFICANT ACCOUNTING POLICIES.
Fidelity Real Estate High Income Fund II (the fund) is a fund of
Fidelity Covington Trust (the trust) and is authorized to issue an
unlimited number of shares. The trust is registered under the
Investment Company Act of 1940, as amended, as an open-end management
investment company organized as a Massachusetts business trust. The
financial statements have been prepared in conformity with generally
accepted accounting principles which require management to make
certain estimates and assumptions at the date of the financial
statements. The following summarizes the significant accounting
policies of the fund:
SECURITY VALUATION. Equity securities for which quotations are readily
available are valued at the last sale price, or if no sale price, at
the closing bid price. Debt securities for which quotations are
readily available are valued by a pricing service at their market
values as determined by their most recent bid prices in the principal
market (sales prices if the principal market is an exchange) in which
such securities are normally traded. Securities (including restricted
securities) for which market quotations are not readily available are
valued primarily using dealer supplied quotes or at their fair value
as determined in good faith under consistently applied procedures
under the general supervision of the Board of Trustees. Short-term
securities with remaining maturities of sixty days or less for which
quotations are not readily available are valued at amortized cost or
original cost plus accrued interest, both of which approximate current
value.
FOREIGN CURRENCY TRANSLATION. The accounting records of the fund are
maintained in U.S. dollars. Investment securities and other assets and
liabilities denominated in a foreign currency are translated into U.S.
dollars at the prevailing rates of exchange at period end. Purchases
and sales of securities, income receipts and expense payments are
translated into U.S. dollars at the prevailing exchange rate on the
respective dates of the transactions.
Net realized gains and losses on foreign currency transactions
represent net gains and losses from sales and maturities of foreign
currency contracts, disposition of foreign currencies, the difference
between the amount of net investment income accrued and the U.S.
dollar amount actually received, and gains and losses between trade
and settlement date on purchases and sales of securities. The effects
of changes in foreign currency exchange rates on investments in
securities are included with the net realized and unrealized gain or
loss on investment securities.
INCOME TAXES. As a qualified regulated investment company under
Subchapter M of the Internal Revenue Code, the fund is not subject to
income taxes to the extent that it distributes substantially all of
its taxable income for its fiscal year. The schedule of investments
includes information regarding income taxes under the caption "Income
Tax Information."
INVESTMENT INCOME. Dividend income is recorded on ex-dividend date,
except certain dividends from foreign securities where the ex-dividend
date may have passed, are recorded as soon as the fund is informed of
the ex-dividend date. Non-cash dividends included in dividend income,
if any, are recorded at the fair market value of the securities
received. Interest income, which includes accretion of original issue
discount, is accrued as earned. Investment income is recorded net of
foreign taxes withheld where recovery of such taxes is uncertain. The
fund may place a debt obligation on non-accrual status and reduce
related interest income by ceasing current accruals and writing off
interest receivables when the collection of all or a portion of
interest has become doubtful based on consistently applied procedures,
under the general supervision of the Board of Trustees of the fund. A
debt obligation is removed from non-accrual status when the issuer
resumes interest payments or when collectibility of interest is
reasonably assured.
EXPENSES. Most expenses of the trust can be directly attributed to a
fund. Expenses which cannot be directly attributed are apportioned
among the funds in the trust.
DISTRIBUTIONS TO SHAREHOLDERS. Distributions are declared daily and
paid monthly from net investment income. Distributions from realized
gains, if any, are recorded on the ex-dividend date.
Income and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted
accounting principles. These differences, which may result in
distribution reclassifications, are primarily due to differing
treatments for paydown gains/losses on certain securities, foreign
currency transactions, non-taxable dividends, capital loss
carryforwards, and losses deferred due to wash sales and excise tax
regulations.
Permanent book and tax basis differences relating to shareholder
distributions will result in reclassifications to paid in capital.
Undistributed net investment income and accumulated undistributed net
realized gain (loss) on investments and foreign currency transactions
may include temporary book and tax basis differences which will
reverse in a subsequent period. Any taxable income or gain remaining
at fiscal year end is distributed in the following year.
SECURITY TRANSACTIONS. Security transactions are accounted for as of
trade date. Gains and losses on securities sold are determined on the
basis of identified cost.
2. OPERATING POLICIES.
FOREIGN CURRENCY CONTRACTS. The fund generally uses foreign currency
contracts to facilitate transactions in foreign-denominated
securities. Losses may arise from changes in the value of the foreign
currency or if the counterparties do not perform under the contracts'
terms. The U.S. dollar value of foreign currency contracts is
determined using contractual currency exchange rates established at
the time of each trade.
JOINT TRADING ACCOUNT. Pursuant to an Exemptive Order issued by the
Securities and Exchange Commission, the fund, along with other
affiliated entities of Fidelity Management & Research Company (FMR),
may transfer uninvested cash balances into one or more joint trading
accounts. These balances are invested in one or more repurchase
agreements for U.S. Treasury or Federal Agency obligations.
2. OPERATING POLICIES - CONTINUED
REPURCHASE AGREEMENTS. The underlying U.S. Treasury or Federal Agency
securities are transferred to an account of the fund, or to the Joint
Trading Account, at a bank custodian. The securities are
marked-to-market daily and maintained at a value at least equal to the
principal amount of the repurchase agreement (including accrued
interest). FMR, the fund's investment adviser, is responsible for
determining that the value of the underlying securities remains in
accordance with the market value requirements stated above.
RESTRICTED SECURITIES. The fund is permitted to invest in securities
that are subject to legal or contractual restrictions on resale. These
securities generally may be resold in transactions exempt from
registration or to the public if the securities are registered.
Disposal of these securities may involve time-consuming negotiations
and expense, and prompt sale at an acceptable price may be difficult.
At the end of the period, the fund had no investments in restricted
securities (excluding 144A issues).
3. PURCHASES AND SALES OF INVESTMENTS.
Purchases and sales of securities, other than short-term securities,
aggregated $200,428,261 and $84,316,961, respectively.
4. FEES AND OTHER TRANSACTIONS WITH AFFILIATES.
MANAGEMENT FEE. As the fund's investment adviser, FMR receives a
monthly fee that is calculated on the basis of a group fee rate plus a
fixed individual fund fee rate applied to the average net assets of
the fund. The group fee rate is the weighted average of a series of
rates and is based on the monthly average net assets of all the mutual
funds advised by FMR. The rates ranged from .1100% to .3700% for the
period. The annual individual fund fee rate is .60%. In the event that
these rates were lower than the contractual rates in effect during the
period, FMR voluntarily implemented the above rates, as they resulted
in the same or a lower management fee. For the period, the management
fee was equivalent to an annual rate of .73% of average net assets.
TRANSFER AGENT FEES. Fidelity Investments Institutional Operations
Company, Inc. (FIIOC), an affiliate of FMR, is the fund's transfer,
dividend disbursing and shareholder servicing agent. FIIOC receives
account fees and asset-based fees that vary according to account size
and type of account. FIIOC pays for typesetting, printing and mailing
of all shareholder reports, except proxy statements. For the period,
the transfer agent fees were equivalent to an annual rate of .02% of
average net assets.
ACCOUNTING FEES. Fidelity Service Company, Inc., an affiliate of FMR,
maintains the fund's accounting records. The fee is based on the level
of average net assets for the month plus out-of-pocket expenses.
BROKERAGE COMMISSIONS. The fund placed a portion of its portfolio
transactions with brokerage firms which are affiliates of FMR. The
commissions paid to these affiliated firms were $34,241 for the
period.
5. BANK BORROWINGS.
The fund is permitted to have bank borrowings for temporary or
emergency purposes to fund shareholder redemptions. The fund has
established borrowing arrangements with certain banks. Under the most
restrictive arrangement, the fund must pledge to the bank securities
having a market value in excess of 220% of the total bank borrowings.
The interest rate on the borrowings is the bank's base rate, as
revised from time to time. The maximum loan and the average daily loan
balances during the period for which loans were outstanding amounted
to $3,796,000 and $2,396,667, respectively. The weighted average
interest rate was 6.31%.
6. EXPENSE REDUCTIONS.
FMR has directed certain portfolio trades to brokers who paid a
portion of the fund's expenses. For the period, the fund's expenses
were reduced by $35,365 under this arrangement.
In addition, the fund has entered into arrangements with its custodian
and transfer agent whereby credits realized as a result of uninvested
cash balances were used to reduce a portion of the fund's expenses.
During the period, the fund's custodian and transfer agent fees were
reduced by $5,823 and $43,579, respectively, under these arrangements.
7. BENEFICIAL INTEREST.
At the end of the period, FMR and its affiliates were record owners of
approximately 49.6% of the total outstanding shares of the fund. In
addition, one unaffiliated shareholder was record owner of more than
10% of the total outstanding shares of the fund.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees of Fidelity Covington Trust and the Shareholders of
Fidelity Real Estate High Income Fund II:
In our opinion, the accompanying statement of assets and liabilities,
including the schedule of investments, and the related statements of
operations and of changes in net assets and the financial highlights
present fairly, in all material respects, the financial position of
Fidelity Real Estate High Income Fund II (a fund of Fidelity Covington
Trust) at December 31, 1998, and the results of its operations, the
changes in its net assets and the financial highlights for the periods
indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the
responsibility of the Fidelity Real Estate High Income Fund II's
management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of
these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which
included confirmation of securities at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable
basis for the opinion expressed above.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 12, 1999
INVESTMENT ADVISER
Fidelity Management & Research Company
Boston, MA
OFFICERS
Edward C. Johnson 3d, PRESIDENT
Robert C. Pozen, SENIOR VICE PRESIDENT
Robert A. Lawrence, VICE PRESIDENT
Barry Greenfield, VICE PRESIDENT
Mark P. Snyderman, VICE PRESIDENT
Eric D. Roiter, SECRETARY
Richard A. Silver, TREASURER
Matthew N. Karstetter, DEPUTY TREASURER
John H. Costello, ASSISTANT TREASURER
Leonard M. Rush, ASSISTANT TREASURER
BOARD OF TRUSTEES
Ralph F. Cox *
Phyllis Burke Davis *
Robert M. Gates *
Edward C. Johnson 3d
E. Bradley Jones *
Donald J. Kirk *
Peter S. Lynch
Marvin L. Mann *
William O. McCoy *
Gerald C. McDonough *
Robert C. Pozen
Thomas R. Williams *
ADVISORY BOARD
J. Gary Burkhead
GENERAL DISTRIBUTOR
Fidelity Distributors Corporation
Boston, MA
TRANSFER AND SHAREHOLDER SERVICING AGENT
Fidelity Investments Institutional Operations Company, Inc.
Boston, MA
CUSTODIAN
The Bank of New York
New York, NY
* INDEPENDENT TRUSTEES
