Fidelity Magellan Reopens

Fund investors can now do something with their money that they haven't been able to do for a decade, except through select retirement plans. They can now buy a stake in Fidelity Magellan fund.

On January 15 the fund (symbol FMAGX) reopened to new investors. Should you bite? Those who do will be buying into a storied, but spotty history.

Magellan was the poster child of the Great Bull Market of the 1980s. Run by the legendary Fidelity manager Peter Lynch, who had achieved a string of fantastic returns in the late 1970s, it had been closed to new investors for 16 years until Fidelity reopened it in 1981 -- just in time to be swept up by euphoria when the stock market broke free of a 20-year holding pattern and began a breathtaking ascent.

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Under Lynch, from 1977 through 1990, Magellan racked up an annualized return of 29%, according to Fidelity Investor. Hoping to cash in on Lynch's homespun "buy-what-you-know" philosophy, investors flooded the fund with money. Assets grew steadily, reaching about $14 billion in 1990, when Lynch abruptly retired, saying he wanted to do other things with his life.

A string of successors tried but could never duplicate Lynch's hot hand. Morris Smith earned an annualized 13% from 1990 to 1992 then quit the business entirely to pursue religious study.

Jeffrey Vinik earned 17% annualized but is now often remembered for moving out of tech stocks and into bonds in 1995 -- about five years too early, thereby missing a huge chunk of one of the biggest bull runs in history.

Still, the money poured in, and Magellan became so unwieldy that Fidelity again closed it to new investors, in 1997. Assets peaked at more than $110 billion in 2000. But soon after, Magellan lost the mantle it had held for years as the world's largest stock fund.

Then, the encroaching bear market dampened investors' enthusiasm for stocks overall. Even as stocks recovered, Magellan's returns struggled to keep pace with the market.

Unable to feed on investments by new shareholders and battered by withdrawals of disillusioned ones, Magellan began a long decline in assets. Microsoft dropped the fund from its 401(k) plan in 2005, and Ford Motor followed suit the next year.

Today, the biggest U.S. stock fund, American Funds' Growth Fund of America (AGTHX), with $193 billion in assets, dwarfs Magellan, with $45 billion.

The outlook for Magellan is starting to improve, however. In October 2005, Harry Lange replaced Robert Stansky -- often accused of being a closet indexer -- as manager. Lange brought with him the reputation of being a hot stock picker, earned over nine years at the helm of Fidelity Capital Appreciation (FDCAX). During his tenure there, Lange notched an annualized return of nearly 10%, compared with 8% for Standard & Poor's 500-stock index and 7% for Stansky during roughly the same period at Magellan.

Lange wasted no time making Magellan over in his own image, lightening up on financials, boosting tech holdings, thumbing his nose at benchmarks and generally making it known that Magellan was now a "go-anywhere" fund. And, after a sluggish 2006, Magellan's fortunes started to turn.

Jim Lowell, editor of Fidelity Investor newsletter, is a fan. "Lange is no weak kitten in the litter," he says. "There's no question he has done two things well: He's managed returns and he's managed the outflow [of investment funds] that still attends Magellan."

Lange is a bottom-up investor, which means he picks stocks on their own merits as opposed to making big-picture judgments on the economy and the overall market. But he adjusts the size of his positions based on his view of where the economy and the stock market overall are headed.

"I want to see a competitive edge and a management strategy that will lead to above-average earnings growth for a few years," he explains. Lange sells when earnings growth deteriorates, or occasionally, when price-earnings ratios become stretched. "In 2007, I cut back on some materials and infrastructure stocks where it appeared that earnings growth would slow," says Lange. "I also sold some Chinese stocks after they had risen 500% or more."

His instincts, clearly, were on target. Last year, the fund performed better than more than two-thirds of similar funds, returning nearly 19%, compared with just 6% for the S&P 500. In 2006, the fund returned 7%, on par with its peer group but trailing the S&P 500 by nearly nine percentage points points.

True to his word, Lange's 262 stock positions include mostly large-company stocks, but more than 20% of assets are invested in mid-cap stocks and there are even some small-caps, too. About one-fourth of assets are in foreign stocks, including the fund's biggest holding, Finnish cell phone giant Nokia (NOK). Bumped-up weightings in gold and oil stocks goosed returns last year.

The market is just now approaching the sweet spot for the kind of earnings-growth oriented investing that Lange specializes in, after years of rewarding stocks selling at bargain prices.

"Certainly, growth stocks have had a tough time since 2000, in spite of a lot of good earnings growth," says Lange. "I think growth stocks look attractive over the next few years. The valuations of growth stocks versus value stocks certainly didn't catch up in just one year."

Lange says his large-cap bias should also pay off in a weaker U.S. economy because large companies often have more international exposure, which cushions U.S. weakness.

"Domestic vs. international stocks is a tougher call in my view," Lange adds. "Foreign stocks have had a good run, but their economies also still look stronger, so for now, I'm maintaining a significant foreign stock exposure."

Proving that he's got a nose for bargains, too, Lange confesses to adding a small amount of beaten-down financials last year. "I will keep a very close eye on the sector in 2008," he assures me. A legion of analysts will help -- 400-plus, which is more than twice the number that supported Magellan when it closed back in '97.

So, will reopening the fund help or hinder this turnaround artist? Lange has complained about redemptions cramping his style. "The fund has been in steady redemptions since I took over," says Lange. "There's only been one day of net inflows that I remember. That means in big down drafts I haven't been able to buy anything, I've just had to sell."

Improved performance notwithstanding, Magellan will have to contend with redemptions for years to come. Some 85% of the fund's assets are earmarked for retirement, and the vast army of Baby-Boomers is starting to tap those dollars. Says Lange, "Reopening helps because it gives me an opportunity to put new cash to use."

In other words, it's a good time to reopen the fund. And not a bad time for investors to buy in, either. Magellan is not the only high-caliber growth fund out there. The fund's 0.54% expense ratio is well below average, and the minimum investment is a modest $2,500.

And investors -- I'm one of them -- who hung in there with Magellan in their retirement plans haven't been disappointed. As long as Fidelity, now that the floodgates are open, keeps Magellan's asset growth under control, we think investors have a good shot at experiencing at least a little bit of this famous fund's former glory.