Magellan's New Skipper Changes Course

Fidelity's flagship returns to its roots as a go anywhere fund.

Throughout the 1980s, the name Fidelity Magellan was synonymous with mutual fund excellence. Peter Lynch, who ran the fund from 1977 until 1990, produced a 2,700% total return over that period. His two immediate successors, Morris Smith and Jeff Vinik, continued to outpace the stock market. But under Vinik's replacement, Robert Stansky, Magellan morphed into a swollen plodder. Its asset base crossed $100 billion in 1999 but today stands at just $50 billion -- a result of losses incurred during the 2000Ð02 bear market and a steady stream of redemptions by shareholders.

Magellan, which is closed to new investors, now has a new skipper. Harry Lange, a lanky midwesterner with an aw-shucks, Jimmy Stewart-type demeanor, took over last October. Lange, 54, is a former auto-industry engineer who crafted market-beating returns during a nine-year stint running Fidelity Capital Appreciation. Before that, he ran several Fidelity technology-sector funds.

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Lange, who enjoys ballroom dancing in his off hours, showed how quick he was on his feet by rapidly reshaping Magellan's holdings. In Lange's first four and a half months at the helm, Magellan narrowly outran Standard Poor's 500-stock index. A slow talker who weighs his words carefully, he recently spoke with us at one of Fidelity's Boston offices about his philosophy of picking stocks and running what remains the nation's eighth-biggest fund.

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KIPLINGER'S: You've said that Magellan is a "go anywhere" fund. What does that mean?

LANGE: "Go anywhere" means that the fund can invest in domestic and international, large cap and small cap, growth and value -- the whole range. I have some parameters, though. The limit on foreign is 25%. As a guide, I aim for a median market capitalization for my holdings of $30 billion or more. So Magellan won't become like a small-cap international fund. The core will be large-capitalization U.S. stocks.

Does that big overseas stake represent a top-down call on foreign markets versus the U.S. market? I build the portfolio from the bottom up. I'm finding lots of attractive stocks overseas -- and I've always been interested in international stocks. I spent the past two weeks in Japan and China. There are a lot of high-growth economies out there. A lot of those markets aren't that efficient and we are finding some really amazing opportunities.

Three of your ten biggest holdings, at last report, were Japanese stocks. What about Japan has caught your attention? The economy seems to have turned for real. After 15 years of deflation, real estate prices are starting up. There are indications that consumer prices are starting to rise as well. Consumer confidence is rising, business confidence is up, and there is enough momentum that it really feels like the turn. And some Japanese stocks are now cheaper than their U.S. counterparts.

How small a company are you willing to invest in? Generally, we will look at anything from about $500 million and up in market cap.

What's the perfect Harry Lange stock? I like a company that has a real sustainable advantage, one that kind of "owns" a little space of a market that it can build onto or use to expand into adjoining areas. I like a stock I can lock up and put away for three to five years and know that it's still going to be a great company. I like managements that look out for shareholders, that have long-term viewpoints and that have a mentality of wanting to grow their businesses. I don't like managements that want to make acquisitions to get into all kinds of other fields. If a company meets those criteria, it would be a great stock for me, regardless of the price-earnings ratio.

What are some examples of the kinds of companies you're describing? A good example from my previous fund was Starbucks. It's a great brand and even though many thought the stock was too expensive, I ended up holding it my entire time at Capital Appreciation, and it gained 600% or 700%.

At last report, Google was one of Magellan's top holdings -- a controversial stock. At the time I first bought it, given the explosive growth of earnings and looking a few years out, Google was not selling for a huge premium, based on its P/E, relative to other media stocks. So I didn't think it was as controversial as some other stocks because Google is producing real earnings and real cash flow.

So you compare Google with media stocks, not tech stocks? Right, with other media stocks because it's taking dollars from traditional media.

How much growth do you expect from Google in the future? All I'll say is that a lot of people think that the search-engine results are so valuable to advertisers that Google can double or even triple its prices and still be a good deal versus traditional advertising.

How important is a stock's price in your decision? It's a medium factor. If you're talking about really great companies -- say, some of the freight-forwarding companies or a Starbucks or a Whole Foods Market -- that have been growing for 20 years, they always have high P/E ratios. So if 30 or 35 seemed like a fair P/E, I wouldn't sell just because the P/E hit 40. So I do pay up, particularly for the great companies. You can get burned if you get rid of a winner just because the price feels a little too high temporarily.

When do you sell? For good companies, deteriorating fundamentals is the main reason. It could be that things are slowing down, or the company misses a product cycle, or management acquires something in a different area. But there are other areas, such as tech, where I will trade around a bit more based on valuation. If investors become overly pessimistic toward these stocks, I will buy a bit more and if they are overly optimistic, I'll sell into strength.

How do you feel about energy stocks? The fund is overweighted in energy. But it's not a crazy overweight. I don't think of myself as an energy expert, but my view is that energy prices are going to be a lot higher in the next five years than they have been historically.

Does your background as an engineer help you as an investor? It's been a big help, especially when I visit companies that do any kind of manufacturing or that have an engineering side where people are designing products.

Can you take any lessons from the dance floor to the trading floor? I'm not sure, but I really am a lot more interested in the soft issues than in crunching the numbers. It's strange because I grew up loving science and being very good in math and I became an engineer. I thought I was totally left-brained at the time. But now if you give me a test, I'm 100% right-brained -- off the charts.

What kinds of returns should Magellan investors expect with you at the helm? I wouldn't be satisfied if I didn't beat the market by 300 basis points [three percentage points] a year.

Manuel Schiffres
Executive Editor, Kiplinger's Personal Finance