Analysis of Fidelity Low-Priced Stock Fund
March 6, 2019
Analysis of Fidelity Fund Portfolios
Fidelity Low-Priced Stock Fund (FLPSX) has had the same lead manager since inception over 29 years ago. The fund currently has $31.5 billion in assets, and sports a relatively low 0.62% expense ratio and 11% turnover. The fund follows a broad and somewhat unusual strategy, described by the issuer as follows:
Normally investing primarily in common stocks. Normally investing at least 80% of assets in low-priced stocks (those priced at or below $35 per share or with an earnings yield at or above the median for the Russell 2000 Index), which can lead to investments in small and medium-sized companies. Earnings yield represents a stock’s earnings per share for the most recent 12-months divided by current price per share. Potentially investing in stocks not considered low-priced. Investing in domestic and foreign issuers. Investing in either “growth” stocks or “value” stocks or both.
The fund’s prospectus benchmark is the Russell 2000 Index, which includes stocks of companies with market capitalization below $7.15 billion (dollar-weighted average of $2.3 billion and median of $0.78 billion). Despite the selection of a small-cap benchmark (perhaps retained for historical reasons), the fund is centered on mid-cap equities, and especially those with value characteristics. Therefore, a fund or ETF implementing a mid-cap value rather than a small-cap index is a more appropriate reference.
Although Fidelity Low-Priced Stock has a long history, for the purpose of this analysis we will use an 11-year period beginning in 2008, close to the October 2007 market peak. This period spans the financial crisis and is more relevant for recent and prospective investors. Here is how the fund and several of its mid-cap value competitors performed according to conventional statistics:
Although the fund produced the lowest nominal return, it also had the lowest standard deviation and beta (measures of return volatility), which resulted in competitive risk-adjusted returns (measured by Sharpe and Sortino ratios). The iShares S&P Mid-Cap 400 Value ETF (IJJ) had a slightly higher return but the highest standard deviation. The iShares Morningstar Mid-Cap Value ETF (JKI) had the highest return and moderate volatility, which resulted in risk-adjusted returns identical to those of FLPSX. The Fidelity® Mid Cap Enhanced Index Fund (FMEIX), which the issuer suggests as an alternative to FLPSX, generated a return in the middle of the evaluation set, but with a second-lowest volatility. Finally, the Vanguard Mid-Cap Value Index Fund Investor Shares (VMVIX) had the second-best return with average volatility. Clearly, the main value added by the fund was the reduced volatility but not an exceptional return.
Fidelity Low-Priced Stock currently holds over 40% in large-cap and 36% in foreign stocks, in addition to 6% in cash. This implies that a single-index benchmark may not the best fit for the fund, although it is useful for simplified classification purposes. Given the eclectic composition of the fund, we will allow up to six ETFs to construct a reference portfolio using the simplest variant of Alpholio™’s patented methodology (to learn more, please visit our FAQ). The reference portfolio tracked the fund’s returns reasonably well over the same analysis period:
However, since mid-2013 the fund failed to outperform it:
The sheer size of the fund may have made competing in the small- and mid-cap domains more difficult. The inverse of turnover ratio indicates that the fund tends to keep its holdings for an average of nine years; it currently has well over 800 different positions, with top ten constituting about 28% of its portfolio. It also worth noting that the fund added two new managers in 2011.
Here is the static composition of the reference ETF portfolio:
The fund had average effective exposures to the Invesco BuyBack Achievers™ ETF (PKW), WisdomTree Europe SmallCap Dividend Fund (DFE), Invesco S&P 500 Equal Weight Technology ETF (RYT), iShares U.S. Healthcare Providers ETF (IHF), First Trust Consumer Discretionary AlphaDEX Fund (FXD), and iShares U.S. Insurance ETF (IAK).
This reference portfolio is quite different from a typical small-cap or mid-cap value index, which underscores the difficulty with categorization of the fund. For instance, currently the fund’s biggest holding (almost 7% weight) is the stock of UnitedHealth Group Inc. (UNH), a company with an approximately $233 billion market cap. While this may be a result of significant appreciation of a position established a long time ago, investors who choose the fund today based on its benchmark or category may be quite surprised with the actual contents of their portfolios.
Consequently, the fund’s active share is currently close to 96%. While a high (generally, greater than 60%) active share is necessary for outperformance of an actively managed fund, it is not always sufficient. In the fund’s case, it suggests a mismatched benchmark rather than different weighting of securities within the benchmark, a domestic small-cap index.
Historically, the fund has held a substantial amount of cash in search of attractive investment opportunities. While understandable, such an active management approach can cause a considerate departure from the target cash allocation in the investor’s overall portfolio. Despite its low turnover, in each of the past two years the fund had significant capital gain distributions, which made the fund less suitable for taxable accounts.
To learn more about the Fidelity Low-Priced Stock and other mutual funds, please register on our website.
August 29, 2018
Analysis of Fidelity International Capital Appreciation Fund
Fidelity®, a well-known asset management firm, proposes eight model portfolios comprising the firm’s mutual funds, predominantly actively managed ones. These portfolios are said to be risk-based, diversified, and constructed for a hypothetical investor to use as inspiration.
Use our model portfolios to help generate ideas
If you prefer to pick the funds you want in your portfolio, our model portfolios* show one way you might construct a well-diversified portfolio of Fidelity mutual funds based on your risk tolerance and financial situation. These combinations provide illustrations of potential opportunities for greater potential risk-adjusted returns over the long term.
In this post, we analyze historical performance of these model portfolios in relation to their reference ETF portfolios. Each reference portfolio has a fixed ETF membership and weights to represent average exposures of the model portfolio. Since each model portfolio is built from up to 12 funds, a reference portfolio may contain up to the same number of ETFs. A reference portfolio is constructed to most closely track periodic returns of the model portfolio, which is assumed to be rebalanced monthly to its target fund weights.
To cover the recent economic cycle, i.e. both the financial crisis and the subsequent market rebound, the common analysis period is from January 2008 through June 2018. The Fidelity Government Cash Reserves (FDRXX) money market fund is substituted by the SPDR® Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) that has similar characteristics.
Model portfolios are analyzed in the increasing risk order.
The 20/80 (i.e. 20% equity + 80% fixed income) Conservative model portfolio consists of 14% domestic stocks, 6% foreign stocks, 50% bonds, and 30% short-term assets, in nine mutual funds. Over the analysis period, this portfolio failed to add value over its reference ETF portfolio.
The reference portfolio had a slightly lower volatility (measured by the annualized standard deviation of monthly returns) and comprised just six ETFs.
The reference positions were in the aforementioned BIL, iShares S&P 500 Growth ETF (IVW), iShares Intermediate-Term Corporate Bond ETF (IGIB, formerly CIU), Vanguard Total Bond Market ETF (BND), SPDR® Bloomberg Barclays TIPS ETF (IPE), and PWB – Invesco Dynamic Large Cap Growth ETF (PWB).
Moderate with Income Portfolio
The 30/70 Moderate with Income model portfolio consists of 21% domestic stocks, 9% foreign stocks, 50% bonds, and 20% short-term assets, spread over 11 mutual funds. Overall, this model portfolio added a small amount of value over its reference ETF portfolio; however, almost all of its relative gains were lost after mid-2015.
The reference portfolio had a slightly lower volatility and held just five ETFs.
The reference positions were the aforementioned BIL, IVW, BND, and CIU (IGIB), as well as the iShares MSCI EAFE Small-Cap ETF (SCZ).
The 40/60 Moderate model portfolio consists of 28% domestic stocks, 12% foreign stocks, 45% bonds, and 15% short-term assets, implemented by 12 mutual funds. Since mid-2015, the model portfolio underperformed its reference portfolio.
The reference portfolio had a lower volatility and was built with just five of the aforementioned ETFs.
The 50/50 Balanced model portfolio consists of 35% domestic stocks, 15% foreign stocks, 40% bonds, and 10% short-term assets, in 12 mutual funds. From mid-2013 onward, this model portfolio substantially underperformed its reference portfolio.
The reference portfolio had a lower volatility and was built with just five ETFs.
The reference positions included the aforementioned IVW, BIL, and SCZ, as well as the iShares Core U.S. Aggregate Bond ETF (AGG), and iShares Morningstar Large-Cap Growth ETF (JKE).
Growth with Income Portfolio
The 60/40 Growth with Income model portfolio consists of 42% domestic stocks, 18% foreign stocks, 35% bonds, and 5% short-term assets, allocated across 12 mutual funds. From mid-2013 onward, this model portfolio significantly underperformed its reference portfolio.
The reference portfolio had a lower volatility and was built with just five of aforementioned ETFs.
The 70/30 Growth model portfolio consists of 49% domestic stocks, 21% foreign stocks, 25% bonds, and 5% short-term assets, allocated in 12 mutual funds. From late 2008 onward, this model portfolio significantly underperformed its reference portfolio.
The reference portfolio had a lower volatility and consisted of just six ETFs.
The reference positions included the aforementioned IVW, SCZ, BIL, and BND, as well as the First Trust Consumer Discretionary AlphaDEX® Fund (FXD), and iShares California Muni Bond ETF (CMF).
Aggressive Growth Portfolio
The 85/15 Aggressive Growth model portfolio consists of 60% domestic stocks, 25% foreign stocks, 15% bonds, and no short-term assets, allocated in 12 mutual funds. From mid-2010 onward, this model portfolio significantly underperformed its reference portfolio.
The reference portfolio had equal volatility and consisted of just five ETFs.
The reference positions included the aforementioned IVW, SCZ, CMF, and PWB, as well as the Invesco DWA Momentum ETF (PDP).
Most Aggressive Portfolio
The 100/0 Most Aggressive model portfolio consists of 70% domestic stocks, 30% foreign stocks, and no bond or short-term assets, built from nine mutual funds. From early 2008 onward, this model portfolio significantly underperformed its reference portfolio.
The reference portfolio had a lower volatility and consisted of just five ETFs.
The reference positions included the aforementioned SCZ, IVW, and PDP, as well as the First Trust US Equity Opportunities ETF (FPX), and iShares U.S. Consumer Services ETF (IYC).
Over the past eight and a half years, the majority of Fidelity model portfolios failed to outperform their reference ETF counterparts. Only the Moderate with Income portfolio added a small amount of value on a cumulative basis. With nine to 12 distinct mutual funds, the model portfolio were also much more complex than their reference portfolio of five to six ETFs. From reference positions in IVW, JKE and similar ETFs, it is evident that all model portfolios had a strong tilt toward growth equities. Finally, although this analysis used net total returns of both mutual funds and ETFs, despite using several low-cost “enhanced” index funds model portfolios had higher expense ratios than those of their reference portfolios.
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December 18, 2017
Analysis of Fidelity Blue Chip Growth Fund
A recent piece in Barron’s profiles the Fidelity International Capital Appreciation Fund (FIVFX). This $2.2 billion no-load foreign large-cap growth fund has a 1.14% expense ratio and 167% turnover. According to the article
[the fund] has returned an average of 11.3% annually over the past five years, better than 90% of its peers.
The current manager took over the fund in January 2008. Therefore, all of the following analyses will that month.
The prospectus benchmark for the fund is the MSCI All Country World Ex-US Index. (This benchmark is not perfect, as the fund currently has about 13% of assets in domestic equities.) One of the accessible implementations of this index is the SPDR® MSCI ACWI ex-US ETF (CWI). Alpholio™ calculations indicate that through September 2017, the fund returned more than the ETF in 99% of all rolling 36-month periods, 96% of 24-month periods and 80% of 12-month periods. The median cumulative (not annualized) outperformance over a 36-month period was 17.4%.
A rolling returns comparison does not account for the fund’s exposures or volatility. This is where Alpholio™’s patented methodology can provide additional insights. The simplest variant of this methodology constructs a reference portfolio with fixed ETF membership and weights, which most closely tracks periodic returns of the analyzed fund.
To facilitate an easy substitution, the number of ETFs in the reference portfolio was limited to three in this analysis. Here is the resulting chart with related statistics of the cumulative RealAlpha™ for the Fidelity International Capital Appreciation (to learn more about this and other performance measures, please visit our FAQ):
The fund cumulatively returned 8.6% less than the reference portfolio and did so with a higher volatility, measured as the standard deviation of monthly returns.
The following chart with associated statistics depicts the constant composition of the reference ETF portfolio for the fund:
The fund had equivalent positions in the iShares MSCI EAFE Growth ETF (EFG), iShares International Developed Property ETF (WPS), and First Trust Dow Jones Internet Index Fund (FDN). These ETFs constituted average exposures of the fund over the evaluation interval.
The following chart with statistics demonstrates the capital asset pricing model (CAPM) of the fund with respect to the dominant ETF in the reference portfolio:
After adjustment for risk, the fund produced a substantial positive alpha. Although this alpha was economically significant (t-statistic of 1.44), it was not statistically significant (t-statistic below two). While this simple model implies a good fit between the fund and the ETF (high R-squared), it only employs a single explanatory variable.
The final chart with statistics shows the traditional measures of performance of the fund and its reference ETFs:
The high-growth equivalent position in FDN counter-balanced the lower-growth positions in EFG and WPS to produce a reference portfolio closely resembling the fund.
In sum, under current management the Fidelity International Capital Appreciation Fund could be effectively replaced by a fixed-weight portfolio of just three ETFs. (A larger number of ETFs in the reference portfolio would produce an even closer substitute, albeit at the expense of higher complexity.) The relatively high turnover of the fund was likely responsible for considerable capital gain distributions in three out of the last four years, which made the fund less suitable for taxable accounts.
To learn more about the Fidelity International Capital Appreciation and other mutual funds, please register on our website.
December 21, 2015
Analysis of Fidelity Real Estate Investment Portfolio
A recent piece in Barron’s profiles the Fidelity Blue Chip Growth Fund (FBGRX). This $21 billion no-load fund sports a 0.89% net expense ratio and 51% turnover. According to the article
Year to date [the fund] has returned 6.5%, beating the 1.2% for the Standard & Poor’s 500 index, and the 5.7% for its benchmark, the Russell 1000 Growth Index. The fund has beaten 93% of its large-cap growth peers in the past five- and 10-year periods.
The current manager took over the fund at the beginning of July 2009, so that date will serve as a starting point for our further analyses. The prospectus benchmark for the fund is the Russell 1000® Growth Index. One of the low-cost implementations of this index is the iShares Russell 1000 Growth ETF (IWF). Alpholio™’s calculations show that the fund returned more than the ETF in approximately 88% of all rolling 36-month periods, 65% of 24-month periods and 71% of 12-month periods. The median amount of rolling 36-month outperformance was about 5%.
Comparing only returns does not account for risk. To get a better insight into the fund’s performance, let’s employ a variant of Alpholio™’s patented methodology that constructs a reference portfolio of ETFs with fixed membership but variable weights. This portfolio dynamically tracks the fund’s composition and core exposures over time. Here is the resulting chart of cumulative RealAlpha™ for Fidelity Blue Chip Growth:
The fund produced about 0.7% of the regular and 1.3% of the lag annualized discounted RealAlpha™ (to learn more about this and other performance measures, please visit the FAQ). Most of the positive RealAlpha™ was generated over just one year beginning in the second quarter of 2013. At 15.4%, the fund’s standard deviation was a bit higher than that of its reference ETF portfolio. The fund’s RealBeta™ was around 1.13.
The following chart illustrates changes to ETF weights in the reference portfolio:
The fund had major equivalent positions in the iShares Morningstar Large-Cap Growth ETF (JKE; average weight of 30.7%), PowerShares QQQ (QQQ; 19.5%), iShares S&P Mid-Cap 400 Growth ETF (IJK; 12.4%), Vanguard Consumer Discretionary ETF (VCR; 11.0%), iShares Morningstar Mid-Cap Growth ETF (JKH; 7.1%), and iShares Russell 2000 Growth ETF (IWO; 5.3%). The Other component in the chart collectively represents additional five stock ETFs with smaller average weights.
Under current management, the Fidelity Blue Chip Growth Fund added a decent amount of value on a truly risk-adjusted basis; however, its outperformance was concentrated in a relatively short period of time. This actively-managed fund’s reasonable expense ratio adds to its appeal. Although consisting mostly of long-term capital gains, the fund’s recent substantial distributions (over 5% of NAV in each of 2013 and 2014) made it less suitable for taxable accounts.
To learn more about the Fidelity Blue Chip Growth Fund and other mutual funds, please register on our website.
July 5, 2015
Analysis of Fidelity Magellan Fund
A recent fund profile in Barron’s features the Fidelity Real Estate Investment Portfolio (FRESX). This $4.2 billion fund sports a relatively low 0.8% expense ratio and a 28% turnover. According to the article, the fund’s manager
For 18 years, […] has successfully navigated through real estate booms and doldrums, beating two-thirds of his peers over 15 years, and 85% over five.
The primary prospectus benchmark for the fund is the S&P 500 Index. The secondary, and a more relevant, benchmark is the Dow Jones U.S. Select Real Estate Securities Index. While there is currently no ETF available that tracks this index, one of close long-lived approximations is the iShares U.S. Real Estate ETF (IYR). Alpholio™’s calculations show that since July 2000, the fund returned more than the ETF in about 89% of all rolling 36-month periods.
An alternative reference for the fund is the SPDR® Dow Jones® REIT ETF (RWR). Since September 2001, the fund returned more than this ETF in about 52% of all rolling 36-month periods.
Yet another reference for the fund is the Vanguard REIT ETF (VNQ). Since October 2004, the fund outperformed that ETF in less then 26% of all rolling 36-month periods. However, in all three comparisons only total returns but not risk of the fund and ETFs were taken into account.
Let’s take a closer look at the performance of Fidelity Real Estate Investment Portfolio on a risk-adjusted basis. Applying Alpholio™’s patented methodology, a reference portfolio of ETFs is constructed to mimic the fund. In the simplest variant of the methodology, the reference portfolio has both fixed membership and weights. This type of analysis shows that since late 2004, the fund produced around minus 0.15% of annualized discounted cumulative RealAlpha™ (to learn more about RealAlpha™, please visit our FAQ). The fund had just four equivalent positions in the iShares Cohen & Steers REIT ETF (ICF; constant weight of 51.2%), SPDR® Dow Jones® REIT ETF (RWR; 24.8%), Vanguard REIT ETF (VNQ; 21.3%), and iShares Transportation Average ETF (IYT; 2.8%).
In a more elaborate variant of the Alpholio™ methodology, the membership of the reference ETF portfolio is fixed but weights can fluctuate over time. Here is the resulting chart of cumulative RealAlpha™ for the fund:
Since late 2004, the fund’s cumulative RealAlpha™ has been largely flat to negative. The annualized discounted cumulative RealAlpha™ was around minus 0.1%. At about 26%, the fund’s standard deviation was 0.5% higher than that of the reference ETF portfolio. The fund’s RealBeta™ was about 1.13.
The following chart illustrated changes of ETF weights in the reference portfolio over the same analysis period:
The fund had only four equivalent positions in the SPDR® Dow Jones® REIT ETF (RWR; average weight of 40.9%), iShares Cohen & Steers REIT ETF (ICF; 35.4%), Vanguard REIT ETF (VNQ; 20.9%), and iShares Transportation Average ETF (IYT; 2.8%).
Over the past ten years, the truly risk-adjusted performance of the Fidelity Real Estate Investment Portfolio was unexceptional. Although the fund’s expense ratio is low compared to an average of its category, active management did not add any value. The fund could have easily been substituted by a combination of just a few major real-estate ETFs. It is also symptomatic of a defunct methodology that the article emphasizes comparisons of the fund’s performance to that of its peers (who collectively underperform benchmarks) rather than to ETF alternatives.
To learn more about the Fidelity Real Estate Investment Portfolio and other mutual funds, please register on our website.
September 13, 2014
Analysis of Fidelity OTC Portfolio
A recent piece in The Wall Street Journal focuses on the performance of the Fidelity® Magellan® Fund (FMAGX) under a new manager who started three years ago. This $16.7 billion no-load fund sports a relatively low 0.53% expense ratio but has a somewhat elevated turnover of 77%. According to the article
Magellan has posted average annual returns of 20.3% from Sept. 16, 2011, when Mr. Feingold took over, through the end of August, trailing its benchmark, the S&P 500, at 21.2%, while matching the Russell 1000 Growth Index, according to data from Morningstar. But its returns in that period are above the 18.7% annual average for its peer group, large-cap funds.
The fund’s longer-term record remains inferior. Magellan’s average annual return over the 15 years through August was 3%, lagging behind the 4.5% average for its peers, according to Morningstar.
Indeed, long-term returns of the fund have been dismal: in the bottom 5% of its category for the 10 years ended in August 2014. Alpholio™’s analysis shows this very clearly — here is a long-run cumulative RealAlpha™ chart for the fund:
In that period, the annualized discounted cumulative RealAlpha™ for the fund was a negative 4.25%, while the lag one was a negative 3.25%. The fund’s was also quite volatile; its standard deviation was about 18.5% and RealBeta™ over 1.15.
The primary prospectus benchmark for Fidelity Magellan is the S&P 500® index. One of the practical implementations of this index is the SPDR® S&P 500® ETF (SPY). Alpholio™’s calculations show that the fund returned more than the ETF in less than 42% of all rolling 12-month periods in the past 10 years. The median underperformance was about 2% and the mean one about 1.2%.
However, in the much shorter time span under current management, the fund’s performance has been quite different. For one, the fund’s returns beat those of the ETF in about two-thirds of all rolling 12-month periods. The median outperformance was about 1.8% and the mean one about 1.4%.
The new manager undoubtedly made significant changes to the fund’s portfolio. Here is a cumulative RealAlpha™ chart for the fund, based on data since October 2011, the first full month after the management change:
In that period, the fund’s generated about 0.6% of regular and about 2.2% of lag annualized discounted RealAlpha™ (to learn more about the regular and lag RealAlpha™, please visit our FAQ). The fund also dialed down on risk: its standard deviation fell to 10.7% (about 0.4% above that of the reference ETF portfolio) and its RealBeta™ decreased to 1.02.
The final chart shows the changes of ETF weights in the fund’s reference portfolio over the same analysis period:
The fund had top equivalent positions in the iShares Morningstar Large-Cap Growth ETF (JKE; average weight of 28.1%), iShares Core S&P Total U.S. Stock Market ETF (ITOT; 16.4%); Vanguard Consumer Discretionary ETF (VCR; 12.1%), iShares S&P Mid-Cap 400 Growth ETF (IJK; 11.5%), Vanguard Health Care ETF (VHT; 8.9%), and Vanguard Energy ETF (VDE; 5.7%). The Other component in the above chart collectively represents five additional ETFs with smaller average weights.
Over the past three years under new management, the Fidelity Magellan Fund has significantly improved its performance and lowered its risk. Unlike in the past, the fund has recently generated a modest amount of positive RealAlpha™. However, the fund’s substantial asset base coupled with a large number (currently 160) of holdings may make future outperformance difficult. It should also be noted that in the past year the fund generated a considerable amount of long- and short-term capital gains, totaling about 12.5% of the net asset value (NAV). Such a lack of tax efficiency makes the fund less suitable for taxable accounts.
To learn more about the Fidelity Magellan and other mutual funds, please register on our website.
July 26, 2014
Problems with Categorizing Mutual Funds
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:
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:
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:
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.
February 5, 2014
Analysis of Fidelity Contrafund – Revisited
A recent article from Morningstar illustrates the problems with categorizing mutual funds. To better compare the performance of mutual funds, Morningstar introduced categories back in 1996.
While the investment objective stated in a fund’s prospectus may or may not reflect how the fund actually invests, the Morningstar category is assigned based on the underlying securities in each portfolio.
Morningstar categories help investors and investment professionals make meaningful comparisons between funds. The categories make it easier to build well-diversified portfolios, assess potential risk, and identify top-performing funds. We place funds in a given category based on their portfolio statistics and compositions over the past three years.
Established funds are categorized twice a year, while the newer ones every quarter. Categories continually evolve to support a more granular and accurate classification of funds. The firm currently uses 106 different fund categories.
Categories are the foundation of a system that rates and ranks each fund against its “peers.” While this methodology simplifies comparisons by narrowing the scope, it has multiple drawbacks:
- Even with restraint, it tends to proliferate categories (see above)
- It lowers the bar by using an average fund performance in a given category (see a broader explanation in our FAQ)
- If the category assignment is subsequently changed as a result of a review, prior ratings have to be largely discarded because of a different set of peer funds
- Some funds may not lend themselves to an easy categorization because of an eclectic or frequently fluctuating investment strategy (not to be confused with a stated objective).
The article demonstrates the last of the above flaws by describing problems with an accurate classification of the Osterweis (OSTFX) and other funds. The Osterweis Fund is currently assigned to the domestic Mid-Cap Blend category, even though its holdings span a broad range of market capitalization and include foreign stocks.
This is where Alpholio™’s approach comes to the rescue. Our methodology addresses all of the above problems by comparing each fund against a custom reference portfolio of ETFs. The reference portfolio is constructed without any preconception of a fund’s category (although we use a small set of “categories” to narrow down the fund search). Moreover, unlike a static category assignment, the reference portfolio is dynamic in terms of both the membership and weights of its members. This adapts the reference to any changes in the fund’s investment profile and makes the performance assessment (i.e. RealAlpha™) portable across categories.
In addition, our analysis does not rely on a periodic disclosure of fund holdings, which itself suffers from numerous problems. It also avoids issues related to the changing classification of individual holdings in a fund, which is inherent in a “bottom-up” analysis (for example, consider the stock of Apple Inc., which could be classified as growth or value depending on one’s point of view).
To demonstrate, let’s take a closer look at the Osterweis Fund. Here are the weights of ETFs in its reference portfolio since early 2005:
After an equivalent position in the iShares 1-3 Year Treasury Bond ETF (SHY; average weight of 24.6%) representing short-term investments, the fund’s equivalent position with the second highest average weight was in the iShares Core S&P Mid-Cap ETF (IJH; 13.6%). The latter explains why Morningstar classified the fund into the Mid-Cap Blend category.
However, the fund also had significant equivalent positions in the Vanguard Health Care ETF (VHT; 12.3%), iShares Morningstar Large-Cap Growth ETF (JKE; 8.8%), PowerShares Dynamic Market Portfolio (PWC; 8.8%), and iShares Morningstar Mid-Cap Growth ETF (JKH; 8.3%). (The equivalent positions in foreign stock ETFs are in the Other component of the chart.)
The above chart also shows that at times the equivalent position in IJH was nonexistent, which brings into question a stationary classification of the fund into the Mid-Cap Blend category in the past ten years.
It is a similar story with the Fidelity Low-Priced Stock Fund (FLPSX), which the article also uses to illustrate problems with fund categorization:
The fund’s dominant equivalent position was in the Vanguard Mid-Cap ETF (VO; average weight of 18.5%), which again explains its Morningstar Mid-Cap Blend category. However, the fund also had substantial equivalent positions in the iShares Morningstar Small-Cap ETF (JKJ; 17%), Vanguard Consumer Discretionary ETF (VCR; 13.4%), iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD; 12.4%), Vanguard Health Care ETF (VHT; 8.5%), and iShares MSCI EMU ETF (EZU; 7.1%). (Other equivalent positions in foreign equities are in the Other component of the chart.)
As in the case of OSTFX, the ETF weights for FLPSX significantly fluctuated over the nine-year analysis period. For example, the equivalent position in VO was as high as 57.2% and as low as 0%, while JKJ oscillated between 44.8% and 2.2%. Therefore, a fixed classification of this fund into the Mid-Blend category since 2005 is dubious.
In conclusion, Alpholio™’s innovative approach alleviates the disadvantages of a simplified categorizing of mutual funds. The traditional classification methodology will continue to suffer from its inherent tradeoff among the number, accuracy and persistence of categories assigned to mutual funds.
January 23, 2014
Sector ETFs from Fidelity
A recent article in InvestmentNews caused Alpholio™ to revisit its analysis of Fidelity Contrafund originally published in early 2013. The article says
Over the past few years, stock fund managers have struggled mightily to beat their indexes consistently, but you’d never know it by looking at the track record of Fidelity’s William Danoff.
The 23-year veteran and manager of the flagship $111 billion Fidelity Contrafund (FCNTX) is beating the S&P 500 over the trailing one-, three-, five-, 10- and 15-year trailing time periods as of Jan. 17, according to Morningstar Inc.
First, it has to be noted that for the past eleven years Morningstar classified FCNTX in the Large Growth category, while the S&P 500® index is traditionally considered a benchmark for Large Blend funds. Therefore, it may be more appropriate to compare the performance of FCNTX to that of an large-cap growth index fund, such as the Vanguard Growth Index Admiral (VIGAX). It turns out that in terms of returns, FCNTX beat VIGAX in each year from 2003 to 2008 but in no year afterward until 2013. This caused the annualized three- and five-year returns of FCNTX to be lower than VIGAX’s. However, FCNTX outperformed VIGAX in terms of the Sharpe Ratio over the three-, five-, ten- and fifteen-year periods.
The recent return shortfall can be attributed to a large size of the fund — over $111 billion in assets, trailing only one other actively-managed fund. The article quotes the FCNTX manager admitting that:
“Larger funds have a higher degree of difficulty,” Mr. Danoff said in a rare interview last summer. “For me, it’s the ability to make big bets — it’s harder. My denominator is so big that it’s not that easy to find really great stories at scale.”
Let’s again take a look at the fund’s cumulative RealAlpha™, updated through last December:
In 2013, there was no material change in risk-adjusted performance of the fund until the second half of the year. However, after peaking in October, the cumulative RealAlpha™ declined in the last two months. While for the year the fund managed to return 1.75% more than VIGAX, Alpholio’s longer-term assessment of FCNTX stayed the same. Even prior to 2009, the fund’s cumulative RealAlpha™ was roughly flat, and since then, the fund mostly failed to beat its reference portfolio of exchange-traded funds (ETFs). Since early 2005, the fund’s annualized RealAlpha™ was negative 1.35% with respect to a reference portfolio of comparable volatility.
The fund’s reference portfolio has not changed much since the last analysis, except the average historical weight of iShares MSCI Emerging Markets ETF (EEM) became smaller than that of the Vanguard Consumer Staples ETF (VDC):
In 2013, the reference portfolio continued to be dominated by the iShares Morningstar Large-Cap Growth ETF (JKE; average 12-month weight of 51.3%), iShares Morningstar Mid-Cap Growth ETF (JKH; 14.4%), Vanguard Health Care ETF (VHT; 10.0%), and PowerShares QQQ™ ETF (QQQ; 5.4%).
In sum, from Alpholio™’s perspective there does not appear to be any indication of a permanent change in the fund’s longer-term performance. Since 2005, investors would have achieved better results with a reference portfolio of ETFs and, in the last several years, higher returns with a comparable index fund.
To get more information about Fidelity Contrafund and other mutual funds, please register on our website.
October 23, 2013
Fidelity Investments is about to introduce a set of ten sector ETFs that will compete with similar products from State Street (Select Sector SPDR), BlackRock (iShares) and Vanguard (sector-specific ETFs).
The new ETFs will undoubtedly complement the current offering of 65 iShares ETFs that can be traded commission-free in Fidelity accounts if held for more than 30 days. The expense ratio of these ETFs will be 0.12%, lower than the average of 0.18% for SPDRs, 0.45% for iShares and 0.14% for most of Vanguard ETFs.
However, in addition to reported expense ratios, investors should also take into account trading costs, including bid/ask spreads and premium/discount to the net asset value (NAV) of each ETFs. With the highest trading volumes, SPDR ETFs are leaders in that respect.
The following table summarizes the existing U.S. sector ETFs from major issuers:
*The SPDR® S&P® Telecom ETF (XTL) is not part of the original Sector SPDRs; its expense ratio is 0.35%.
The new Fidelity sector ETFs will track MSCI IMI sector indices. In contrast, the nine SPDR ETFs track S&P sector indices that collectively represent all stocks in the S&P 500® index. iShares ETFs track the Dow Jones U.S. sector indices. As of February 2013, Vanguard ETFs track MSCI 25/50 indices that cap each fund’s exposure to stocks dominant in a given sector.
From Alpholio™’s perspective, these sector ETFs should benefit investors by expanding the pool of securities that can be used to build substitution portfolios for actively-managed mutual funds in a cost-effective manner (low expense ratio, commission-free trading).