Tue, 4 Feb 2014
Investors need to be disciplined and selective in the search for underappreciated growth opportunities, says John Roth, a manager on three Fidelity Morningstar Medalist funds.
Greg Carlson: Hi, my name is Greg Carlson. I'm a fund analyst with Morningstar.
I'm joined today by John Roth of Fidelity Investments.
Thanks for joining me today, John.
John Roth: Thanks for having me, Greg.
Carlson: John, you've managed [Bronze-rated] Fidelity New Millennium since 2006, and [Bronze-rated] Fidelity Mid-Cap Stock since 2011. Millennium is a little bit more of an all-cap fund.
Roth: Yes, that's correct.
Carlson: And then, finally, you became a co-manager last year on [Silver-rated] Fidelity Advisor New Insights, which has been run for a long time by Will Danoff, who also manages Fidelity Contrafund.
Carlson: Could you talk a little bit about your philosophy and how that feeds into how the funds did last year?
Roth: In general, we have a fairly opportunistic approach in Fidelity New Millennium and also New Insights as well. It's looking across the market to see where there is opportunity, and we use fundamental analysis to figure out places where we have a different view than the market and try to concentrate on those opportunities.
The fund has flexibility in terms of cap, so it can go from small cap to large, and it has some flexibility in terms of how it's positioned, growth versus value. If you look at it today, it's been in large-cap growth stock for a while, but it's investing across the entire market to look for opportunities.
The last couple of years have been good for the market. One of the things that you've got to think about is, what drove the market performance. Two-thirds of the performance in the last couple of years has been multiple expansion, which means that expectations are moving up, versus earnings growth.
As I look at the landscape today, with an average valuation of 15.5 times, the S&P doesn't look expensive, but as you dig a little bit deeper, you find that growth stocks have moved up in price, and as you go down in cap, things will be getting more expensive as well.
We're trying to be opportunistic to look for areas where that's not all priced in, so you might see a little bit of a shift from faster growers to more value-like stocks, as we concentrate and say, these are the growth stocks that we really think are going to continue to make it as the ante has moved up across the space. I think you temper expectations a little bit for the next couple of years, because we've had such a good run over the last five.
Carlson: What worked particularly well, and what didn't work particularly well last year for you?
Roth: Last year, the technology stocks worked well. If you look at the attribution in the fund, the fund has owned Tesla, which is a very interesting company. I've owned it since 2011. And they were actually able to bring out and develop their first car, the Model S … or their second car, I should say, but their first pure electric vehicle that they designed from a blank piece of paper to production.
It's been successful, and they've actually started to make money earlier than people thought, and so the stock has done well. That helped.
Internet services has been strong. Software companies that are cloud-based have been strong; they've helped the fund's performance. Those are the big areas.
But again, we're being cautious around, how much is really left? And if we own a growth stock, it's because we still think that the market is underestimating the ultimate opportunity there. But as the ante gets raised across the market, you have to be more selective.
Carlson: Talk a little bit more about Tesla. It's a stock that generates some controversy from time-to-time.
Roth: At the end of the day, I sit back and say, which companies out there could be much bigger 10 years from now than they are today, and I would say Tesla is on that shortlist.
Part of the reason why is because it is a disruptive technology and it's a disruptive business model. The technology in electric vehicles is very efficient technology. There is much fewer parts. If you can get the battery right, which they've done, you can create a very good car. The Model S, which is their current production car, can go 0 to 60 in 4.4 seconds. It's a legitimate high-end luxury vehicle, and it has a range of around 300 miles. You don't have an issue with range.
The business model is very disruptive, too, because it's a non-unionized labor force, it's built out in California, and it doesn't have the traditional distribution systems that most automakers have. There is no franchise--it's all company-sold cars--and there is no inventory. You have to go in, you order your car, so we know exactly what you want. We are not trying to guess color and style and all the inefficiencies that are created with that. And the technology in the car, again, is really interesting in terms of how it communicates, how it checks on itself, and how repairs are done.
It's different and potentially disruptive with a lot of upside, so that's something that we spend a lot of time looking at.
Carlson: Can that ordering system work on a larger scale? Obviously, they've got big ambitions.
Roth: We'll see. The technology scales pretty well. It's not a simple industry. It's very competitive. There will be competitive responses. But promising technology, a very bright entrepreneurial leader in Elon Musk, who has a big vision--those are the things that we are looking for.
When we think about, in the last 10 years, what have been big companies. Look at Apple. Apple went from $6 billion in revenues to $180 billion. It's incredible what happened there. Google went from $3 billion to $50 billion. So the question is, what's the next one? I don't know if this is it, but it's something that we own, and we're going to keep track of.
Carlson: At the same time, we probably shouldn't expect to see this become a 5% position any time soon?
Roth: No, no. As these technologies emerge, there are always going to be ups and downs. You have to manage the risk in the fund, and you don't want to be greedy. You need to balance it.
So, as it does well, if it gets ahead of itself, we'll trim some. And if expectations turn the other way and people start to give up, maybe we'll buy some more. We'll just manage that process.
Carlson: Talk about the other opportunities that you're seeing now. You still have some interest in financial services?
Roth: Financials are still interesting. They were the epicenter of the last crisis, and they have recovered, balance sheets are repaired, credit has gotten better, the economy is starting to grow again. But all that being said, we still see some upside in terms of fundamental performance, and some valuation upside as well. Expectations are still a little bit low. They are still in the headlines, they're still being regulated, they're still cutting checks for the last crisis. You need all that to clear before people can get excited again. So, I think there's still some opportunity there.
Carlson: Here, we are talking about both big banks, but also mortgage insurers…?
Roth: Yes, big banks. New Millennium and Mid-Cap own mortgage insurers. They were the epicenter of the crisis, and they have survived. Radian has been a big stock in the fund for a while, and they fixed their balance sheet, and they are continuing to write good business, and the competitive dynamics are still pretty good.
One area of the U.S. economy that still looks like it's improving is housing. We can debate the pace--it's usually not just straight up--but there is still upside there.
Carlson: Is it a similar picture for regional banks? I know you've owned some of those in the Mid-Cap Stock fund?
Roth: It becomes more bank specific at that point. Credit is getting better, [but] loan growth has been anemic. I think people would have thought that would have been faster at this point in the cycle. There is still hopefully some opportunity there. In many cases, some of the larger banks have retrenched and pulled out of areas and focused, and that's created opportunities for the regionals and some of the smaller banks. We look at that on a region-by-region basis and a stock-by-stock basis.
Carlson: Any other particular areas you would highlight as being so promising now?
Roth: If we think long-term, there is a lot happening in technology. Internet service and software from a long-term perspective is very interesting. We have to be careful about valuations because, again, expectations have moved up. So, we are being more selective there. But there is a lot of long-term exponential-like growth possible in that area.
And then consumer is always a great spot for new business concepts and products that resonate with people. … Lululemon is a great example. It came out of nowhere, and it's been a good stock. Those things happen over time. There is tons of opportunity in consumer normally, and that can be global as well. So, we look outside the U.S.
Carlson: Touch, if you would, on your new role at Advisor New Insights.
Roth: Yes, I get to work with Will Danoff more closely. I've been in his group since I became a diversified [portfolio manager] about seven years ago. We co-manage the fund. It's the smaller of the two funds he runs--it's about $26 billion--and it's a very opportunistic fund. We can do a lot with it, and I work more closely with him. We're just scouring the investment universe for ideas to put in the fund. We leverage all the companies that come through Fidelity, and what our analysts are saying, and we're just trying to find good stocks. It's a lot of fun to work with him.
Carlson: Finally, can you talk a little bit about what we were touching on earlier: Graduating, if you will, moving up and running some bigger funds. New Millennium was first, which was $2 billion. Mid-Cap Stock is a significantly bigger fund. And Advisor New Insights is a lot bigger than that one.
Roth: I've been managing mutual funds for 15 years. You start out with these smaller specialized funds, and then graduate to diversified [funds].
I think as you move up in assets, it forces a longer-term discipline, which I think is good for shareholders and probably good for investors. One of the advantages we have is that the assets don't come and go every day; they are there. So, I can take a longer-term view, and if the market is becoming more myopic or it becomes very volatile or gets scared about something that I view as short-term, I can use the fund's assets to buy. And conversely when things get really frothy, we can sell into it and redeploy the assets.
But having that long-term view and having that scale allows you do it very methodically. You almost can't be whipsawed, because there is so much assets, you can't just change your mind day in and day out. It forces more of a discipline, which is good psychologically, and it's good for investors. It's one of the advantages that we are trying to press.
Carlson: Can you talk a little bit more, though, about the challenge in that size, because you are dealing in some smaller [companies], small- and mid-cap stocks?
Roth: The math is the math: The more assets you have, the longer it takes to buy it and the longer it takes to exit. But it forces more discipline around that decision, which is a good thing. You don't want to get into a very illiquid security all of a sudden and then change your mind. So the bar is little bit higher--although it's pretty high anyway.
There are some disadvantages. The $26 billion fund can't go as low as the $3 billion fund can in terms of cap. It's hard to buy a $700 million cap in a $25 billion fund. But I can do it with the New Millennium Fund. So, there's a little bit of a limit there. But there is a lot of opportunity in that mega-cap range, and that's what New Insights is really focused on.
Carlson: Thanks a lot for your time.
Roth: Thanks for having me.