The discussion as to whether the growth or value investment approach is a better strategy has been around for decades. Over various periods, each investing technique has outperformed the other. While growth stocks have had the advantage in the recent eight-year period, value stocks have outperformed their counterparts in 2016. During the first quarter of the year, value-focused mutual funds capitalized on the downturn in the markets to acquire quality stocks with very attractive valuations. This shrewd strategy boosted the total returns of these funds. On average, small-, mid- and large-cap value funds delivered a 2.2 percent return while the three similar categories of growth funds experienced an average 2.2 percent loss. Value stocks are poised to benefit from the current environment of economic expansion and a slow rise in interest rates. Fidelity’s Value Discovery Fund (FVDFX) can help investors diversify portfolios heavily weighted toward growth funds.
Fund Overview
Established in 2002, FVDFX has a four-star Morningstar rating. The large value fund seeks capital appreciation by investing primarily in common stocks that managers believe are undervalued relative to key factors like sales, total assets, earnings and growth potential. The team also compares the share price of the company to organizations in the same industry. The fund invests in domestic and foreign securities. On Dec. 15, 2015, FVDFX had a dividend income distribution of $0.17 per share and a reinvestment price of $22.70.
Investment Strategy
Employing a reasonable and disciplined approach to stock selection, lead manager Sean Gavin has guided the fund since January 2012. His principal philosophy does not necessarily equate a low-value stock with value, but he does believe a high-quality stock selling at a discount is an attractive opportunity. This viewpoint helps to maintain the fund’s low risk profile. Gavin also believes that over time a stock’s market value will converge with its intrinsic value to represent the share’s true underlying worth.
When selecting high-quality names, fund managers look for companies operating in a specific niche or possessing a strong competitive position that builds a barrier, or moat, to entry. The share price must have experienced significant price dislocation. The managers also consider factors such as above-average returns on invested capital, a higher return on equity, strong cash flow and the potential for long-term growth. The belief is that firms with high-quality franchises and attractive valuations provide a large margin of safety. The goal is to benefit from these companies’ lower earnings volatility and higher long-term growth. This strategy enables the fund to focus on capital preservation and take advantage of the intrinsic upside potential. The fund’s portfolio is structured to maintain a higher quality rating as well as a lower beta than the benchmark Russell 3000 Value Index. Because Gavin is a patient investor, the fund has a relatively low turnover ratio.
Gavin does not strictly adhere to the benchmark’s composition or sector weightings. The fund portfolio can deviate from index weightings by as much as 800 basis points in either direction. While it is still broadly diversified, FVDFX typically has less exposure to capital-intensive sectors, such as energy, materials and utilities, where it is generally difficult to find companies that meet the fund’s stringent investment standards. If the company under consideration still meets the fund’s investment criteria, Gavin will seek arbitrage opportunities in the mergers and acquisitions market as an opportunity to own the acquiring company at a more favorable valuation.
Portfolio and Holdings
With $1.83 billion in assets under management, the fund has 87.3 percent in domestic equities and approximately 10 percent allocated to its foreign investment sleeve, which is heavily concentrated in developed Europe. With slightly more than 100 individual holdings, the portfolio comprises mainly giant-, large- and mid-cap companies. The small- and micro-cap share exposure is less than 10 percent. The fund is overweight financial services, healthcare and technology sectors and underweight consumer defensive, real estate and utilities. The top 10 holdings comprise 26.83 percent of invested assets. The fund’s largest holdings are Johnson & Johnson (JNJ), JPMorgan Chase (JPM), General Electric (GE), Berkshire Hathaway (BRK.A) and Wells Fargo (WFC). Oracle (ORCL), EMC Corp. (EMC), Chevron (CVX), Allergan (AGN) and Teva Pharmaceuticals (TEVA) round out the fund’s top 10 investments. The portfolio has an average market capitalization of $36.55 billion, which is approximately 30 percent less than the benchmark average. FVDFX has a P/E ratio of 14.32 and a 1.59 price-to-book ratio.
Performance and Risk
While generally tracking the underlying index, the fund includes an astute selection of out-of-benchmark holdings like the biopharmaceutical company Dyax (DYAX) and Alphabet (GOOG), the parent of search engine Google. These companies were major contributors to the fund’s historical performance. Excluding underperforming benchmark components such as Citigroup and Kinder Morgan also contributed to the fund’s performance. Stocks that detracted from the fund’s overall performance include fertilizer manufacturer CF Industries, pharmaceutical company Sanofi and drilling equipment supplier BW Offshore. For the most recent 1-, 3- and 5-year periods, FVDFX generated total returns of -3.93, 10.91 and 9.93 percent, respectively. These compare to the category averages of -3.33, 8.14 and 8.50 percent over the same periods. The fund has a 3-year beta and standard deviation of 0.92 and 10.77, which are less than the category averages of 0.98 and 11.70. FVDFX has a high return rating as well as a below-average risk rating from Morningstar. During Gavin’s tenure, FVDFX has kept pace in rising markets while losing only 90 percent as much as its benchmark during pullbacks. The fund has outperformed 94 percent of its category peers since 2012.
Fees and Expenses
The fund has a below-average fee level rating from Morningstar based on its 0.84 percent management expense ratio. While there are no subsequent investment minimums, the fund does request an initial investment of $2,500 to establish an account.
The Benefits of the Value Discovery Fund
FVDFX is a better option than the company’s Blue Chip Value Fund (FBCVX). While the former has a four-star, Bronze rating from Morningstar, the latter is rated at three stars. The portfolio turnover for FVDFX is 45 percent versus the 138 percent for FBCVX, thus reducing trading expenses. Most value funds have a low exposure to the technology sector. At 22 percent, FVDFX has double the 11 percent weighting of the benchmark index. The fund is also underweight energy and consumer staples, two sectors typically overweight in value funds. As a result, FVDFX is a more traditional value fund. For investors who are overweight growth and without exposure to healthcare and financials via sector funds, FVDFX is a good vehicle to increase their value exposure. Investors with existing healthcare, financials, consumer staples or utilities funds should ensure that they are not overweighting their exposure to value stocks.
Currently, we recommend FVDFX as a Strong Buy with a ranking of 90.
