This Massive Fund Continues to Beat the Odds

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Fidelity Low-Priced Stock earns a Morningstar Analyst Rating of Silver for its veteran portfolio manager and disciplined investment process, both of which consistently prove their worth.

During his nearly 30 years at the helm, Joel Tillinghast has steadily built one of the finest track records of any fund in the small- or mid-cap Morningstar Categories. His cool-headedness has been key to his success. As a long-term investor, he looks for resilient companies with staying power and doesn't chase fads. He tries to avoid firms that lack an enduring competitive advantage, steers clear of those loaded up with too much debt, and scrutinizes their leadership's integrity and prowess.

The strategy stands out for its sprawling portfolio of 800-plus stocks drawn from across the globe and market-cap spectrum. Once solidly small-cap-focused, the strategy now orients toward mid-caps but distinguishes itself from that category by owning an above-average stake of large caps (35% of equity assets) and small caps (25%). Its generous helping of European and Japanese firms, which have tended to enhance the fund's risk-adjusted returns, also sticks out. Altogether, foreign stocks regularly soak up more than 35% of the portfolio, typically the highest share in the category. Tillinghast's partiality for high-quality fare reveals itself through the portfolio's average returns on equity, which are far higher than the Russell Midcap Value Index's, and its aggregate debt/capital ratio, which is consistently lower.

Tillinghast's risk-conscious approach doesn't have much of a thrill factor. The strategy's total returns are prone to lag competitors' during bull markets, such as the current one that began roughly a decade ago. Yet since March 2009, the fund's reliably below-average volatility has boosted its Sharpe ratio (a measure of risk-adjusted returns), which over that period beat 98% of funds in either the small- or mid-cap categories. The strategy's ability to maintain its edge, despite its massive asset base of more than $37 billion across all vehicles, underscores its advantages. Competitive fees make the fund's case even stronger.

Process Pillar: Positive | Robby Greengold 06/07/2019 This strategy earns a Positive Process rating for its sound, patient, and disciplined approach.

Manager Joel Tillinghast looks for sturdy, underpriced businesses. Stocks selling for less than $35 or with an earnings yield (12-month earnings per share/share price) at least as high the Russell 2000 Index's median are considered to be potential bargains. But his "low-priced" mandate isn't steered by stinginess. As a long-term investor, Tillinghast wants to own resilient companies with strong profitability, little debt, a defendable market niche, and capable leadership. He often finds what he thinks are excellent opportunities overseas but reserves serious consideration for foreign markets with democratic institutions and the rule of law.

The strategy owned more than 800 stocks at last count, with a large tail of tiny positions. Its huge asset base (more than $37 billion as of March 2019) makes breadth a necessity, as Tillinghast can't take big positions in the small- and mid-cap names he favors without exceeding ownership limits. In that regard, the strategy’s size is a constraint. Its average market cap is more than 4 times the Russell 2000 Index's but has remained squarely in mid-cap territory. In recent years, the fund landed in the mid-blend category but most recently moved to mid-value. This doesn't reflect a change in process but rather where the fund's holdings have skewed in recent years.

Despite a sprawling portfolio, the strategy has avoided becoming bland or benchmarklike. It has long distinguished itself through a sizable stake in foreign stocks: Its 36% stake as of April 2019 was well above its average mid-value peer's 2%. (The fund can't buy more non-U.S. stocks once the stake reaches 35%, but they can appreciate beyond that.) Joel Tillinghast works closely with a few analysts who source non-U.S. ideas, including one stationed in Japan, a country that recently took up 9% of assets.

The strategy has long favored the consumer discretionary sector, where Tillinghast is better able to find firms with compelling competitive advantages. Its roughly 14% financials stake is well below that of relevant benchmarks and peers, driven by Tillinghast's avoidance of complex banks with leveraged balance sheets. (Indeed, the fund's debt/capital ratio tends to stay relatively low.) The portfolio often holds 7%-10% of its assets in cash, which has acted as a drag on its total returns over the past decade.

Comanagers run 5% of assets, which usually include more than 100 unique names. Half of that stake is overseen by three sector-based managers, with the remainder split between a quantitatively driven subportfolio and a sleeve featuring global stocks. The crew manages its respective slices with discretion but always under Tillinghast's philosophical guidance.

Performance Pillar: Positive | Robby Greengold 06/07/2019 A stellar long-term track record supports the fund's Positive Performance rating.

From its 1989 inception through May 2019, the fund gained 13.0% annualized, which is the best showing of any surviving fund in the mid- or small-cap categories. Across those nearly three decades, the fund beat its prospectus benchmark, the Russell 2000 Index, by 3.8 percentage points annualized and the Russell Midcap Value Index (to which it's more correlated) by 2.0 percentage points. It exhibited lower volatility than relevant benchmarks and the average mid-value and mid-blend fund (its current and former category, respectively) despite an above-average foreign-equity stake. The fund has also consistently offered downside protection. For example, during the late-2018 market correction (Sep. 21-Dec. 24), the fund dropped 17.6% versus the average loss of 21.1% for the mid-value category.

The strategy’s girth does make outperformance more difficult than in the early years; Joel Tillinghast cannot invest as easily in the small- and mid-cap fare that he favors. He's had to manage through outflows in recent years, which he's funded through cash and trimming liquid large-cap positions. He's done better at his smaller, more nimble fund used exclusively in Fidelity's target-date series.

People Pillar: Positive | Robby Greengold 06/07/2019 Manager Joel Tillinghast joined Fidelity in 1986 and started this fund in late 1989. He's posted one of the industry's best long-term records during his tenure, with the strategy's Positive People rating based on his insights and experience. The strategy's performance is all the more impressive considering its $37 billion asset base--a huge sum, particularly for a strategy that features small- and mid-cap stocks.

Five comanagers run discrete sleeves that combined amount to 5% of the strategy’s assets. Some of these members ran the fund when Tillinghast took a short sabbatical in late 2011, including John Mirshekari and Shadman Riaz. Mirshekari exclusively picks financials stocks for his sleeve, while Riaz concentrates on energy, materials, and utilities. Comanager Morgen Peck, who covers tech and telecom, replaced Rayna Lesser in 2016. Jamie Harmon, who ran a diversified sleeve, moved off the fund in April 2017. His sleeve now consists of a global component run by Peck and Sam Chamovitz and a quantitative portion led by Salim Hart. Veteran comanager Kathy Buck, who since 2011 had run a small slice of the fund, retired in March 2018. Tillinghast now manages those assets.

The comanagement structure helps feed ideas to Tillinghast. He also has access to Fidelity's 100-plus global analyst team, which includes teams stationed in the United Kingdom and Japan--important markets for this strategy.

Parent Pillar: Positive | 07/06/2018 Fidelity isn't without challenges but remains well positioned enough to compete in a changing industry. It earns a Positive Parent rating. The firm's diversified asset mix has shielded it from steady outflows from its active U.S. equity funds, with its taxable bond, international equity, and low-priced index offerings attracting assets. Its revamped target-date offerings have improved, and in 2018 the firm plans to launch an additional series combining active and passive funds to better compete in an area where investor interest has grown.

Attracting and retaining talented investment professionals is more important than ever. The equity division came under fire in 2017 amid reports of sexual harassment and a hostile work environment, leading to portfolio manager dismissals and a change in leadership. While Fidelity addressed the personnel issues and is working to improve collaboration through weekly team meetings, more-open floor plans, and improved feedback systems, it remains to be seen how the division may incorporate team-based elements into the legacy star-manager system. Meanwhile, the fixed-income division remains in steady hands following the retirement of a longtime CIO. While the bond analyst and manager ranks have seen more change than usual lately, the team-oriented structure of its investment-grade and municipal offerings helps minimize the impact of departures.

Price Pillar: Positive | Robby Greengold 06/07/2019 This fund's expense ratio changes based on how its three-year returns look relative to the Russell 2000 Index. (For every percentage point of out- or underperformance, the expense ratio is adjusted by 0.02%, up to a maximum of 0.20%.) Without considering the performance adjustment, the no-load and K share classes have baseline expense ratios that rank among the lowest quintiles of their similarly sold peers. That competitiveness earns the fund a Positive Price rating.