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November 17, 2006 9:01 pm

How to keep a keen ear for growth stories

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Harry Lange, the manager of Fidelity’s Magellan fund, spends four hours a day listening to his voice mail. While this habit may seem more fit for a workday torture chamber, Lange says these voice mails – the bulk of which are pitches from analysts, telling him why he should buy or sell stock in a particular company – are his favourite mode of receiving information.

“There’s a lot of duplication,” says Lange, who had an excellent record for many years as manager of Fidelity’s Capital Appreciation fund. “I get the printed materials, I get e-mail and I get voice mail. I like to get voice mails because it’s a lot easier to get a read on how enthusiastic the person is by the tone of their voice. It’s what I judge by – there are a lot of soft issues besides just the numbers.”

Lange, who recently passed his one-year anniversary at the helm of Magellan, is known in the industry as “an old-fashioned stock picker”. He says he is on the hunt for solid growth companies with a market capitalisation between $10bn and $60bn – such as Staples, the office supply giant, and Nike, the athletic gear company, which are among of the fund’s biggest holdings.

“At the time I took over the fund, growth stocks were the cheapest they’d been in many years so I was fairly aggressive about changing [Magellan] to my growth style,” he says.

Lange’s inclination toward growth companies marked a dramatic shift from Robert Stansky, his predecessor, who made few bets beyond emphasising large companies. Under Stansky, Magellan held a little over 200 stocks, but its top seven holdings – including General Electric, Microsoft and ExxonMobil – accounted for more than 20 per cent of assets under management. Some Fidelity watchers charged that Magellan had “become a closet tracker fund” investing in only the biggest companies.

Initially, Mr Lange’s growth strategy seemed to work. For the first seven months of his tenure, Magellan posted returns of 8 per cent – beating the S&P 500 and its benchmark the Lipper Large Cap Growth Category, which posted returns of 7 and 2 per cent respectively.

This change in fortunes pleased Magellan shareholders who had seen the fund lose half its value during Stansky’s last five years on the job, and post an average annual return of minus 2.85 per cent, lagging the overall market by 1.67 percentage points.

But Lange’s focus on growth has not been as successful in recent months: the market turned in May, and Magellan suffered for it. It has not profited to the full from the subsequent rally. From June until now, the fund has returned 2 per cent while the S&P 500 and the Lipper Large Cap Growth Category have returned 9 and 5 per cent respectively.

Rather than retreat, Lange says that the change in the market has emboldened his strategy. “There have been several times when growth stocks have been beaten up like this – the biggest one was after the tech telecom [bubble] burst in 2000,” he says. “But just when you feel the worst, it’s the time you have to step up more. It’s hard to do. But I always remember that actual risk is inversely proportional to perceived risk. It’s one of the things I learned early on and it’s something that’s guided me a lot.”

Lange says he is taking advantage of the fact that growth stocks are the cheapest they’ve been in 30 years by doubling up on equities he believes in – particularly in areas such as technology and biotechnology.

“Stocks that have good earnings growth will end up being rewarded and those stocks will perform better,” he says. “Whether the market is up or down, I am convinced that that is going to happen. Right now it hasn’t. The companies with the worst revenue and earnings growth have performed the best this year.”

Another change Lange has instigated is the shift to international stocks. Modern notions of “style discipline” do not apply to Magellan, which is still an old-fashioned “go-anywhere” fund. Today, about 25 per cent of Magellan is invested in companies based outside the US. Nokia, the Finland-based mobile phone manufacturer, and Schlumberger, the oilfield – services provider headquartered in France, are the fund’s biggest holdings respectively representing 3.6 and 3.3 per cent of the portfolio.

This move toward foreign stocks was not necessarily by design, says Lange. Ordinarily he has a bias against international stocks because of the added currency and political risks.

“The hurdle rate is a lot higher. In my mind, I want twice the amount of reward for an international stock versus a domestic one because there’s always some risk that I won’t see.”

In spite of this “high hurdle,” Lange has been drawn to international companies because of the increased growth. “The US economy is not growing nearly as fast as a lot of the emerging markets – China, India, even Japan now. Those markets aren’t always as efficient either. A lot of times you can almost apply what you’ve seen in the US. Having the benefit of seeing what happens in the US markets, you can see how things unfold in the foreign markets.”

He says he plans on maintaining the fund’s international allocation at about 25 per cent. Most of that allotment is in Asia, though he is intrigued by opportunities in Europe. “I’m not as familiar with Europe; I’ve spent a lot of time in Asia and I know their countries and economies a lot better. I am sure there are great opportunities in Europe and over time I will add them. I am just looking for those other opportunities wherever I can.”

One change Lange has not made is increasing the number of stocks in the portfolio. When he took the job, he’d planned on expanding the fund to 400-600 stocks. At the moment, Magellan has 272 stocks. “The main reason is that our trading desk has been extraordinary and the markets are more liquid so I am able to get the stocks I want – I am able to get the first choice,” he says.

“I had thought that I was going to have to buy second and third choice stocks in order to get the position I want, but it hasn’t been the case. We’re able to execute these big trades without moving the market much so I’ve been able to stick to my first choice.”

Lange also sees advantages to being a long-only fund manager, despite the trend towards mutual funds that mimic hedge funds. “It’s nice when [company] management comes in to talk to us, that they understand we’re looking to buy the stock. You’d hate to have management thinking that we’re asking them tough questions because we’re thinking of shorting the stock. You can’t say forever that policies won’t change, but I feel comfortable with long only, that you know management is on your side, which is a big advantage for my style.”

He takes a long-only approach for assessing his own performance, too. “One year is a short time horizon to measure. Capital Appreciation had an extraordinary record but it had a couple of rough patches too.”

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