Month: November 2015

Fund Spotlight: The Fidelity Magellan Fund (FMAGX)

After several years of lackluster performance under previous managers, the Fidelity Magellan Fund (FMAGX) is back on track and has now beat the S&P 500 over the past 3 years. It has also outperformed the benchmark year to date in 2015. The fund has delivered total 1- and 3-year returns of 7.90 percent and 18.07 percent, respectively, plus a year-to-date return of 4.55 percent. The S&P 500 generated returns of 5.20 percent and 14.33 percent over the past 1 and 3 years, plus 2.70 in 2015. This has Magellan beating the broader market by no less than 1.85 percent over these periods.

The fund’s recent performance outshines its subpar 5-, 10- and 15-year returns of 12.73 percent, 6.23 percent and 3.05 percent, respectively, a period that saw the once high-flying fund with $100 billion in assets under management shrink to $16.6 billion due to 15 consecutive years of outflows. Compared to the S&P 500, the fund trailed by no less than 1.51 percent over those periods.

Much of the fund’s current success can be attributed to manager Jeff Feingold, who assumed the reins in late 2011. Feingold also has a significant personal stake in the fund, demonstrating that his interests are aligned with those of shareholders. Under his stewardship, Magellan has gone from a laggard to a leader, and is once again worthy of investor consideration alongside larger funds such as Contrafund (FCNTX).

Investment Strategy

Established in 1963, the two-star Morningstar-rated FMAGX is a diversified equity strategy large-cap growth fund that seeks capital appreciation. It invests in domestic and foreign stocks in both the growth and value categories across all market capitalizations and styles. Both a fundamental analysis approach and quantitative modeling are used to select particular investments that show fast business growth, quick earnings growth or value along with improving financials. Evaluation factors include margins, insider buying, cash flow and returns on invested capital.

While the fund sticks closely to the weightings of its S&P 500 benchmark, it does favor growth stocks. Feingold also includes cyclical plays similar to his management style overseeing the Fidelity Trend Fund (FTRNX). An eye toward mid- and small-cap shares keeps the market cap weighting below that of the benchmark. In addition to a close working relationship with a quantitative analyst, Feingold can rely on more than 130 global equity analysts at Fidelity.

Portfolio Composition and Holdings

The fund manager uses a balanced approach that incorporates high-quality names when constructing the portfolio as well as stock, sector and style diversification as a way to reduce the volatility associated with growth stocks. FMAGX has a 47 percent exposure to giant-cap shares as well as 35 percent and 16 percent exposures to large- and mid-cap shares, respectively. The fund also holds a small 2 percent stake in small-cap stocks. Containing 142 individual issues, most assets are invested in the information technology, financials, healthcare and consumer discretionary sectors. Relative to the S&P 500 Index, all of these sectors are overweight, led by more than 5 percentage points of exposure added to healthcare. Combined, these four sectors account for 79 percent of the fund’s assets. All four of these sectors have done well in 2015 and aside from consumer discretionary, the fundamental outlook for these sectors remains bright, particularly the financial sector. Financials do well when interest rates are rising, and as soon as the Fed decides to hike rates, we’ll be in a rising rate cycle that favors the sector.

FMAGX has a 91 percent allocation in domestic equities and the remainder overseas, predominantly in developed markets in Europe. The fund is quite diversified, as the top 10 holdings only make up 24 percent of assets under management. The top issues in descending order are Apple (AAPL), General Electric (GE), J.P. Morgan (JPM), Berkshire Hathaway (BRKA) and Amazon (AMZN). Shares of Medtronic (MDT), Bank of America (BAC), Citigroup (C), American Tower (AMT) and LyondellBasell (LYB) round out the top 10. FMAGX has an average market cap weighting of approximately $57 billion, a P/E ratio of 18.35 and a price-to-book ratio of 2.52. Compared to the large-growth category, FMAGX has a small average market cap, as well as lower P/E and lower book value.

Performance Review

Since taking over, Feingold’s constrained approach has enabled him to lower the fund’s beta and standard deviation while turning in a performance that has beaten the large-growth category averages. The generally rising market during his tenure has enabled Feingold’s investment style to thrive. The fund has benefited from its positions in financial giants J.P. Morgan Chase (JPM) and Bank of America (BAC) as well as its stake in Capital One Financial (COF). Rising rates will help these holdings continue to perform well. Top 10 holdings LyondellBasell (LYB) and CF Industries (CF), another material sector holding, also had a positive impact on performance.

Fees, Expenses and Distributions

The fund’s expense ratio of 0.68 percent can fluctuate due to performance-fee adjustments. The fee adjusts based on performance, but can only rise or fall by a maximum of 0.20 percent over the calculation period, which is 36 months. Due to poor performance in the past, the fee is toward the lower end of its historical range, but it has begun to inch upward due to its performance over the most recent 3-year period. This no-load fund does not have 12b-1 fees. There is an initial investment minimum of $2,500. The fund has a trailing 12-month yield of 0.69 percent.

Outlook

Although it is reasonably priced compared to other no-load large-cap funds, FMAGX may not be a bargain in the future if performance continues to beat the market, but that’s a good problem to have. The main issue for investors is whether the encouraging recent performance is sustainable over the long term. The top holdings are consistent with the fund’s stated large-cap growth goals as well as its commitment to reduced volatility. While the fund appears to be headed in the right direction, many analysts still give FMAGX a neutral rating. The time to dive into FMAGX may not be here yet, but the fund has changed course and is worth a look when considering large-cap options. The current sector exposure, for example, has the fund well positioned for current market conditions.

Market Perspective: Stocks Rally as Investor Concerns Wane

The stock market enjoyed one of its largest monthly gains in history last month, with the S&P 500 Index rising 8.30 percent. After testing the August lows at the end of September, stocks rallied strongly in October, with sectors such as pharmaceuticals and biotechnology finally rebounding after a period of consolidation.

Economic data was so strong during October that the Federal Reserve dropped the sentence about overseas economic weakness as a potential threat to growth. GDP growth in the third quarter was 1.5 percent, according to the government’s first estimate. That is faster than the Atlanta Fed’s GDP Now model, which was forecasting only 1.1 percent growth ahead of the report. Economists had a consensus forecast of 1.8 percent and many are still looking for 2 percent or more. If incoming third quarter data improves over the next month, those estimates may yet be hit. The Atlanta Fed’s initial forecast for GDP growth in the fourth quarter is 2.5 percent.

As for the Federal Reserve’s interest rate policy, the omission of the statement about overseas weakness sent the odds of an interest rate hike sharply higher. Based on futures market contracts, speculators raised the odds of a December hike to 50 percent at the end of October. The odds of a January or March rate hike increased to 57 percent and 72 percent, respectively. Those numbers are all up about 10 percent to 15 percent from where they were prior to the Fed statement. As for the Fed itself, the language change signals a rate hike could come at any meeting, but it will take improved economic fundamentals to push the Fed over the edge.

The market’s reaction to the less dovish Fed statement demonstrates financials are set to rally once the Fed decides to hike.  Fidelity Select Financials (FIDSX) gained 2.3 percent on the release of the Fed’s statement on October 28. Stocks initially tumbled on the news, but the financial sector held gains from earlier in the day and continued rising into the close. During the month, bank earnings were mixed, with large banks lagging a bit due to lower revenues from their trading divisions. Small banks that focus on lending to consumers and businesses were in better shape. The month ended with a buyout offer: regional bank KeyCorp is targeting smaller First Niagara, a positive sign for the industry.

Although stocks were rallying back from August’s losses in October, they also benefited from a strong earnings season. Analysts were forecasting a better than 5 percent drop in earnings for the S&P 500, with the energy sector responsible for most of the anticipated losses. Earnings beats from Exxon (XOM) and Chevron (CVX) helped curtail energy losses and the sector has delivered the biggest positive surprises, but the improvement in S&P 500 earnings growth mainly came from the healthcare and technology sectors. Healthcare has more than doubled its 6.2 percent earnings estimate midway through earnings season, while technology swung from a small loss to 3.2 percent growth.

In terms of stock market impact, earnings beats by Amazon (AMZN), Microsoft (MSFT) and Alphabet (GOOG) powered the Nasdaq. Shares of Amazon started October at about $500 a share and they closed at $625 per share, a gain of 25 percent. Google moved from $600 and change to more than $700 per share, while Microsoft rallied from the low $40s to low $50s. All benefited from the rise of high-margin cloud services. Telecom also rallied strongly and had the best earnings of all S&P 500 sectors, with growth of 22 percent, driven by strong results from AT&T (T). As a small sector in the index, however, the impact is limited

There were a couple of notable earnings misses during the month as well, though their impact was limited to their own firms. International Business Machines (IBM) missed revenue estimates and, later in the month, it announced the SEC was investigating the way it recognizes revenue. Shares slid to a new 52-week low in the wake of the latter revelation. Wal-Mart (WMT) disappointed investors and blamed higher wages, the result of its decision to hike wages earlier this year. The difference between Wal-Mart, a brick-and-mortar retailer that relies on human labor on the one hand, and the more virtual Amazon with its automated warehouses and cloud computing services, could not be starker. Amazon’s market capitalization eclipsed that of Wal-Mart’s back in the summer, but since then they have wildly diverged. Amazon’s market cap is now 60 percent higher: $293 billion versus $183 billion.

The Fed’s December meeting will loom over the coming weeks and the release of the October meeting’s minutes could swing interest rate expectations in either direction. China’s economic slowdown remains a concern, and the country will also gain attention as the International Monetary Fund plans to vote on whether to add the yuan to the special drawing rights (SDR) currency basket. The yuan is likely to depreciate due to economic weakness, but a strong bounce is possible if the IMF adds the yuan to the currency basket. With exports sliding, however, China doesn’t want to see too much currency strength. Since the yuan is still highly tied to the dollar, a rally in the greenback would be bad news for Chinese exporters.

The U.S. dollar is at an important juncture, only a few percentage points away from its 52-week high. A move higher would spark bullish buying that would likely spark a new bull rally. Small caps tend to outperform when the dollar is strong, and although they lagged in October, small caps outperformed strongly on days when the dollar rallied versus the euro. Oil prices will be key for commodity markets and high-yield debt, with higher oil prices better for both. Crude oil finished October still fighting around the $45 level. As long as black gold can hold above the low $40s, investors will maintain at least a neutral outlook on the sector.