A recent mutual fund story in Barron’s covers the Fidelity OTC Portfolio (FOCPX). This $11 billion fund sports a relatively low 0.76% expense ratio but has a high 102% turnover. According to the fund’s profile, its strategy is based on

Normally investing at least 80% of assets in securities principally traded on NASDAQ or an over-the-counter [OTC] market, which has more small and medium-sized companies than other markets. Investing more than 25% of total assets in the technology sector.

Although the article quotes a five-year annualized return of the fund, it is worth noting that that current manager has headed the fund only since July 1, 2009 (just under five years ago, as of this writing). Therefore, all further analyses will use that shorter timeframe. (It could also be argued that an even shorter observation period should be applied because the new manager likely did not change the inherited portfolio of the fund overnight.)

The fund’s prospectus benchmark is the NASDAQ Composite® index, whose practical implementation is the Fidelity NASDAQ Composite ETF (ONEQ). Alpholio™ calculated that since the current manager took over, on average the fund returned 1.94% more than the ETF in each of the rolling 12-month periods. However, the median difference was 3.35%, which indicates that the majority of differences were much smaller (i.e. a left skew of the distribution). The fund’s rolling returns beat those of the ETF about two-thirds of the time.

Alpholio™’s calculations also indicate that the fund’s returns were quite volatile. Since the new manager took the helm in mid-2009, the fund’s annualized standard deviation of 18.3% was higher than 16.1% for the ETF. As a result, at 1.12 the fund’s Sharpe ratio (a simplest measure of risk-adjusted returns) was smaller than 1.20 for the ETF in the same period.

Let’s take a further look at Fidelity OTC Portfolio from Alpholio™’s perspective. Here is the cumulative RealAlpha™ chart for the fund during the current manager’s tenure:

Cumulative RealAlpha™ for FOCPX

The fund’s cumulative RealAlpha™ was unremarkable except for a brief and rapid rise in mid-2013. Overall, the annualized discounted RealAlpha™ of the fund was about 2% on a regular and about 1% on a lag basis (to learn about the difference between these two measures, please visit the FAQ). The lag RealAlpha™ curve was below its regular counterpart, which means that not all new investment ideas worked out as well as expected. The volatility of the reference ETF portfolio was lower than that of the fund by about 1.5%.

The following chart depicts ETF weights in Fidelity OTC Portfolio’s reference portfolio in the same analysis period:

Reference Weights for FOCPX

As expected based on the fund’s declared strategy, the PowerShares QQQ™ ETF (QQQ) was the largest equivalent position with an average weight of 44.2%, followed by the Vanguard Small-Cap Growth ETF (VBK; 22.1%), iShares Russell 2000 Growth ETF (IWO; 7.6%), SPDR® Morgan Stanley Technology ETF (MTK; 7.6%), iShares Nasdaq Biotechnology ETF (IBB; 5.8%), and iShares North American Tech-Multimedia Networking ETF (IGN; 5.5%). The Other component in the chart represents two more ETFs will smaller average weights.

The final chart shows a hypothetical buy-sell signal for the fund derived from the smoothed cumulative RealAlpha™ presented above:

Buy-Sell Signal for FOCPX

An investor following this signal would have avoided a period of fund’s relative underperformance from late 2011 through early 2013, while capturing the aforementioned strong rebound in mid-2013.

This analysis demonstrated the importance of focusing on a shorter tenure of the current manager instead of assessing a full historical performance of a fund. On a truly risk-adjusted basis, Fidelity OTC Portfolio generated a modest amount of RealAlpha™ most of which accrued during six months in mid-2013. Since then, the fund’s cumulative RealAlpha™ has been largely flat. Therefore, there is currently no indication that the fund will significantly outperform its reference ETF portfolio in the near future.

To learn more about the Fidelity OTC Portfolio and other mutual funds, please register on our website.

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