Related topics: mutual funds, 401k, savings, retirement, ETF
Harry Lange, the manager of Fidelity Magellan (FMAGX), has a prediction for investors wondering if he can turn around that floundering icon of the mutual-fund industry. Ensconced in a quiet 14th-floor conference room with sweeping views of Boston, the 59-year-old Lange says, "Six months from now, I'll look like I'm a star."
Those are bold words coming from a fund manager who trailed 95% of his large-cap growth-fund rivals for the three years ending in March.
Magellan, which helped popularize mutual funds by delivering 29% annualized returns from 1977 to 1990 under star stock picker Peter Lynch, has been leaking money for more than a decade.
From 2000 through last year, the fund had net withdrawals of more than $63 billion, topping every other mutual fund tracked by investment researcher Morningstar over that period. Magellan hit an ignominious low in 2008 when its Morningstar fund rating was dropped to one star on a five-star scale. Its assets now stand at roughly $23 billion.
Magellan is an extreme example of a change that has played out across mutual funds: The classic stock-picking genius who had an uncanny ability to snap up shares just before they soared is growing increasingly irrelevant. And the funds that such managers run, once the industry's bread and butter, are struggling to justify their existence.
That is partly because of the higher fees that actively managed funds charge, and partly because those funds tend to underperform: In the five years ending in December, 62% of U.S. large-cap funds trailed the Standard & Poor's 500 Index ($INX). Results were even worse for funds focused on smaller stocks, with 63% of small-cap and 78% of mid-cap funds lagging behind their benchmarks, according to S&P.
The days of star managers like Lynch raking in assets for fund firms are probably over, analysts say. Magellan, in that sense, "may be the poster child for a bygone industry," says Jim Lowell, the editor of Fidelity Investor, an independent newsletter.
"The jury's out as to whether active domestic management, especially large-cap, will have its day in the sun again," adds Geoff Bobroff, a fund-industry consultant.
Making money for fund firms
Even a historic market rally has not persuaded investors to favor stock-picking funds like Magellan over their cheaper index-tracking competitors. Although the S&P 500 doubled between early March 2009 and mid-February of this year, its fastest 100% gain since 1936, investors yanked more than $140 billion from actively managed U.S. stock funds in 2009 and 2010 -- while adding $67.3 billion to U.S. stock-index mutual funds and index-tracking exchange-traded funds.
What's more, even as U.S. stocks continued their climb this year, commodities, bonds and other assets have remained popular with investors. Taxable bond funds attracted roughly $41 billion in net new money in the first quarter, compared with about $25 billion for U.S. stock funds.
All told, investors pulled more than $325 billion out of actively managed U.S. stock funds from 2007 through the end of last year. They pulled more than $18 billion from Magellan during that period.
Stock-picking funds, of course, are still big moneymakers for fund firms. Actively managed U.S. stock mutual funds held about $2.75 trillion at the end of last year and charge average fees of 1.38%, while their index-tracking counterparts held just over $700 billion and charge 0.88% on average.
But most of the growth is in indexing and ETFs: Whereas the number of actively managed U.S. stock funds has fallen to 2,630, the lowest since 1998, the number of U.S. stock ETFs has rocketed from just a dozen in 1998 to well over 500 today.
Low-fee index funds are ascendant even at stock-picking shops like Fidelity. Its Fidelity Spartan 500 (FUSEX) fund, at about $43 billion, is now roughly twice the size of Magellan. Ratings firm Moody's Investors Service on April 1 lowered its rating outlook on bonds issued by Fidelity parent FMR to "negative" from "stable," citing poor stock-fund performance and a loss of mutual-fund market share.
Yet Lange, who started working at Fidelity on the inauspicious "Black Monday" of the 1987 stock market crash, does not seem worried. Asked about his game plan for turning around Magellan, he says, "I feel it has been turned around quite a lot."
If he is right, it would be quite a comeback. From the start of Lange's tenure at the end of October 2005 through March of this year, Magellan gained 2.6% annually, trailing the S&P 500 by 1.5 percentage points a year. It finished in the large-cap growth category's bottom quartile in 2010, according to Morningstar. And it landed in the bottom half of the category again in the first quarter of this year, gaining 5.4%, versus 5.9% for the S&P 500.
These are dismal results for a fund that was once legendary. Launched in 1963 and initially managed by current Fidelity Chairman Edward C. "Ned" Johnson III, Magellan became a household name during Lynch's tenure. It earned five stars when Morningstar introduced its rating system in 1985.
Successors never matched the star
Fidelity relentlessly touted the fund's results. Magellan had "the performance record no other fund can match," said an advertisement in the September 1991 issue of Kiplinger's Personal Finance magazine, adding that it was "the best performing stock fund in the nation for the 15-year period" that ended on June 30 of that year. In a footnote, the ad said the portfolio manager had changed on June 1, 1990 -- marking Lynch's departure from the fund.
That footnote turned out to be somewhat prophetic, since no subsequent manager has come close to measuring up to Lynch. Robert Stansky, who ran the fund from 1996 to 2005, made Magellan look much like the market benchmark, according to a study by Antti Petajisto, a visiting assistant finance professor at New York University's Stern School of Business. A Fidelity spokesman says "there are many ways in which the fund's investments regularly differed from the S&P 500" during Stansky's tenure.
Fidelity closed Magellan to new investors in 1997. Assets topped out at almost $110 billion in 2000. But investors pulled money out of the fund that year, and they haven't stopped since.
Investors and analysts had high hopes for a Magellan revival when Lange took the helm at the end of October 2005. He had delivered strong returns at his previous fund, Fidelity Capital Appreciation (FDCAX), where he was known for swooping into beaten-down tech stocks in 2002 and riding them to category-topping returns in 2003.
At Magellan, Lange immediately made the fund look far different from the index. The fund's "active share," which measures the percentage of fund assets that are invested differently from the index, climbed to 66% from 40% in the last few months of 2005, according to Petajisto's study.
But while looking different from the index should be a requirement for any active manager, Lange quickly demonstrated that it doesn't guarantee market-beating returns. Magellan gained about 7% in 2006, less than half the S&P 500's return. It quickly turned around and climbed nearly 19% in 2007, compared with a 5.5% gain for the S&P.
On the heels of that strong year, Fidelity in January 2008 reopened Magellan to new investors. But new shareholders arrived just in time to see Magellan lose 49% in 2008, far more than the S&P 500's 37% decline. The main problem: Lange loaded up on beaten-down financial stocks like American International Group (AIG, news) and Bank of America (BAC, news). Those turned out to be some of his biggest losers in his first five years at the fund, says Morningstar analyst Christopher Davis.
The 2008 performance was the final straw for some shareholders, including Pat Trainor, a sales engineer in Norwich, Conn. He first invested in Magellan in the mid-1990s, and kept rolling his 401k accounts into the fund as he went through a series of employers. By November 2008, he'd had enough.
