Fidelity Low-Priced Stock Fund: A Good 401(K) Investment

The Fidelity Low-Priced Stock Fund, a charmingly named fund that focuses on the mid-cap value sector, was launched by Fidelity in 1989. Since then, Fidelity Low-Priced Stock has been one of the best mutual funds in existence, giving its fundholders a compounding rate of 13.70%. The Fidelity Low-Priced Stock Fund is one of the few mutual funds typically available to 401(k) investors in which the growth of the fund’s value provided drastic results compared to the reality of chugging in contributions month after month hoping for 5-6% capital appreciation per year and a percentage point or two from the dividend.

Specifically, the Fidelity Low-Priced Stock has turned a $10,000 investment during the December 1989 inception into $293,000 today, before deducting the substantial effect of taxes and fees (the former is mitigated heavily if you own it through a tax-advantaged account like a 401(k) and the latter can be mitigated if your retirement plan administrator negotiated a lower expense ratio that the 0.79% that exists for default accounts).

Also, they have the same lead manager, Joel Tillinghast, that has been guiding the Fidelity Low-Priced Stock Fund since its 1989 inception. This is important because a lot of times, there is a disunity between the fund with a great track record and the person actually making the investments.

The classic example of this happened at Fidelity when Peter Lynch was running the Magellan Fund during the 1980s. People flocked to the fund due to Lynch’s success, and the Magellan Fund has come to maintain its relevancy with investors because of its glory years during the 1980s when Lynch achieved 29% annual returns from 1977 through 1990. But if you buy the fund today, that past is irrelevant. The question is: What do you think of Jeffrey Feingold as a capital allocator, and/or do you like his large investments in Coca-Cola, Visa, Berkshire Hathaway, General Electric, and Home Depot? (I endorse those investment selections without hesitation, but Feingold also puts a lot of money into Facebook and Amazon, which give me a lot of skepticism for valuation-based reasons).

If you buy Fidelity Low-Priced Stock, you actually get Joel Tillinghast making the investment decisions. He was the portfolio manager when the fund launched in 1989, and he runs it to this day. You actually get the guy that created the 13.70% annual returns rather than buying a fund whose manager is enjoying the excess of the previous manager’s reputation and gets a bit of an unearned halo effect from the fund’s past glory. That tension doesn’t exist with the Fidelity Low-Priced Stock Fund; you are getting the allocator that you think you’re getting.

Despite its name and classification, the Fidelity Low-Priced Stock fund is not really a mid-cap value fund, but rather, a fund that combines investments in growth stocks as well as deep value picks. The fund name is a little bit of a misnomer.

When I hear the words low-priced stock fund and midcap value, I think of companies that are working through issues and will deliver value through a return to moderate growth that shifts the valuation from “substantial discount” to “fair value.” The real money gets made through the valuation rather than earnings. It’s the return to moderate growth that brings about the sharp changes in valuation. This strategy also has the counterintuitive benefit of bringing about less volatility during economic downturns, as the stock is already trading cheaply and would only transition from cheap to very cheap during a recession (compared to an expensive stock that transitions from overvaluation to undervaluation during a recession).

But that’s only half of what the Fidelity Low-Priced Stock Fund does. If you look at the individual holdings, you will see that it is a mixture of stocks that are value picks and also stocks that ought to be classified as growth.

For instance, the fund has owned a large chunk of Best Buy. That’s exactly the type of selection you’d expect a midcap-value fund that calls itself Fidelity Low-Priced Stock to own. But, if you are search around its large investments, you’ll see things like Autozone and Canadian grocer Metro Inc. That seems like a growth at a reasonable price investing strategy. Others, like Ross Stores, are straight-up growth stocks–what else would you call a corporation with a fifteen year record of 16.5% annual earnings per share growth? And the fund’s biggest investment of all, United Health, accounts for 6% of the assets and has a ten-year earnings growth record of 14% annually.

I mention this not as a criticism of the fund, but rather, to point out how there is an expectations gap between the image conjured up by the name “Fidelity Low-Priced Stock Fund” and the actual investment holdings in the fund. The actual investments seem to be split between value stocks and growth stocks. This growth stock allocation is why the fund’s value torpedoed from $48 to $18 between 2007 and 2008, but it also explains why it recovered so quickly to $42 by 2011.

This also explains why the fund has such a low turnover rate. Fidelity Low-Priced Stock has an annual turnover rate of 10%, meaning that the average stock remains in the portfolio for ten years. That would be unusual for an investment fund that focused exclusively on value picks, as you would expect annual turnover in the 20% to 30% range because value investing involves waiting for discount to fair value to be remedied, and then moving on at that point. But with holdings like Autozone, United, and Ross Stores, the fund’s management team wants to hold onto those corporations with high earnings per share growth and experience wealth creation through business growth rather than valuation shift. This is a salutary investment strategy, but it’s different from what initial impressions might create.

If you look at the prospectus, the fund will give you this guiding light: “ [We normally invest] at least 80% of assets in low-priced stocks (those priced at or below $35 per share), which can lead to investments in small and medium-sized companies. Investing in either ‘growth’ or ‘value’ stocks or both.”

I don’t care much for the arbitrary $35 per share investing line, as it is a junk argument to suggest that this is a signal of value when corporations can divide their business up into as many shares as they’d like. Facebook could do a 4-for-1 stock split and suddenly fall within value parameters without having any characteristic of a value stock, and Berkshire Hathaway’s Class B shares could fall to $36 and be considered the greatest value pick of the generation. I do like that they give themselves an out to consider stocks outside the $35 range–that’s how Autozone ends up in the portfolio–but correlating $35 to value investing is too gimmicky for a fund house that clearly has talent in executing a successful long-term investment strategy.

Fidelity Low-Priced Stock is a solid investment if you see it show up in your 401(k). The individual investment selections are generally impressive, and explain why Tillinghast has been able to deliver extraordinary returns of 13.70% annually since the fund’s inception in 1989. But the nomenclature of the fund is a bit different from how the assets are actually invested, which is a bit of a shame, since I conclude the fund’s assets are managed in a far better way for long-term retirement investors than the name of the fund would suggest.

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Originally posted 2016-04-15 14:40:28.

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