Fund in Focus: Fidelity Low-Priced Stock
With long-tenured portfolio manager Joel Tillinghast at the helm, Fidelity Low-Priced Stock has a reputation for its superior risk-adjusted returns. Tillinghast has maintained the same investment strategy since his start on the fund in 1989: purchase undervalued stocks trading below $35 per share (a threshold that has been increased from $10 to $25 to its current level), and hold these stocks for long periods of time; stocks that appreciate beyond $35 per share stay in the portfolio. The fund’s annual turnover has ranged from 9% to 36% over the past decade.
The gradual reduction in the number of stock splits among publicly traded companies is partly to blame for the increase in the fund’s price threshold. Through most of the 1990s, an average of 64 companies in the S&P 500 had stock splits. In 1997 for example, there were 102 stock splits among S&P 500 components. From 2008-2016, there was an average of just 11 stock splits. In 2016, there were only seven. Fewer stock splits imply a smaller opportunity set for Tillinghast, as the stock splits reduce the price per share for publicly traded stock.
The fund boasts assets under management (AUM) of over $40 billion, making it one of the largest funds in the mid-cap value category. While the fund’s large asset base is a testament to the success of the strategy, this same feature can sometimes pose a challenge for the fund. More specifically, Tillinghast cannot take large positions in some of the small- or mid-cap names he favors without exceeding ownership limits. This has caused the portfolio to gradually move beyond pure small- and mid-cap stocks.
Tillinghast no longer invests solely in domestic equities, with foreign stocks comprising approximately 35% of the portfolio, while the average fund in the category has only 5%. This higher allocation to foreign stocks has not helped the fund over the past ten years. The MSCI All Country World Index ex US has returned just under 1%, while US domestic stocks have returned over 7% over the trailing 10-year time period, as of year-end 2016.
A higher allocation to giant-cap stocks (defined as stocks that account for the top 40% of market capitalization) and micro-cap stocks (stocks that represent the smallest 3%) is another consequence of the fund’s unique strategy. As the opportunity set within “low-priced” small and mid-cap stocks has diminished, Tillinghast has increased his appetite for securities out of these market capitalizations. As of February 2016, the fund has an approximate 20% overweight to giant and micro-cap stocks relative to the category and benchmark.
The fund has maintained a high cash profile (in the double digits since 2013), as Tillinghast has not viewed market valuations as compelling. The high allocation to cash has contributed to the fund lagging the benchmark and peer group over the trailing three-year time period. Conversely, the fund’s high allocation to cash will contribute positively to returns in the event of a downturn in the market.
Despite the challenges as a result of the fund’s size, Fidelity Low-Priced Stock has managed to garner one of the most consistent long-term performance track records of any active manager, across all asset classes. The fund’s investment philosophy lies in the belief that markets are not fully efficient, seeks to invest in areas that other investors neglect, and uses time horizon as an advantage. Tillinghast believes that stocks with low implicit and low explicit expectations outperform over time; in other words, valuation and starting points matter. Positive free cash flow, high economic returns, and sales growth are indicators that Tillinghast looks for in a potential investment. He also believes that value depends on management and aims to invest in companies with trustworthy and skilled managers who are focused on building a firm’s distinctive capabilities and allocating capital prudently.
The fund is managed with an old adage in mind: “The best way to make money is to not lose it.” To that end, the fund will sell positions in the event that valuations become excessive (i.e., if a more attractive valuation exists for a similar company and/or future earnings growth is lower than expected) or if there is deterioration in the company’s business fundamentals. Tillinghast avoids companies where success is driven by binary outcomes (i.e., speculative stage companies that do not have earnings with success dependent on the outcome of a single event). He also avoids companies that cannot earn their cost of capital and/or companies with excessive leverage. To be sure, the fund’s debt-to-capital ratio is consistently below that of the category and benchmark, and has been over the course of its 27-year history. As of February 2017, the debt-to-capital ratio stands at 33%, almost 10 percentage points below that of the mid-cap value category.
Long-term, disciplined dedication to the strategy has resulted in a portfolio with almost 900 holdings (as of February 2017). Nevertheless, Tillinghast finds a way to express his views on certain sectors of the market. For example, Fidelity Low-Priced Stock is usually overweight to consumer discretionary stocks; the current stake is almost double that of the category and benchmark. The fund is also usually underweight in financials, as Tillinghast prefers to avoid companies with complex and or overly-leveraged balance sheets. This positioning hurt the portfolio in calendar year 2016, as financials, particularly as smaller-cap stocks and regional banks surged upwards in anticipation of deregulation, a steeper yield curve, and generally stronger economic growth.
Tillinghast’s long tenure with the fund can be seen as both a positive and a negative. His tenure brings a depth of knowledge and wealth of experience. On the other hand, there is no formal succession plan in place, which exposes the fund to key man risk. While Tillinghast is supported by Fidelity’s deep pool of research analysts, as well as a group of junior portfolio managers who manage a 6% sleeve in the portfolio, filling Tillinghast’s shoes would be no easy task in the event of his departure.
Over the long term, Fidelity Low-Priced Stock has posted an impressive track record. The fund has returned 13.7% annualized since inception (12/27/1989) as of January 31, 2017. This compares very favorably to the primary prospectus benchmark, the Russell 2000 Index, which has returned 9.6%. While the fund’s large size may pose a challenge to the strategy, the fund’s process and strategy have proven to add value over time, while assuming a lower level of risk.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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