Money: A fund worth $63bn? It was simple

An outstanding fund manager bought companies he thought looked good value at the time
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The Independent Online
The news that Fidelity's Magellan Fund, the largest mutual fund (unit trust) in the world, has decided to close its doors to new investors sent me scurrying off to read one of my favourite books on the subject of investment.

This is a book called Beating The Street, by Peter Lynch. He is the man who first rescued the Magellan Fund from obscurity and turned it into the most successful retail investment fund ever devised by man, before retiring seven years ago to spend more time with his family.

At the time, received wisdom was that he had quit his job because he knew the fund had simpy become too big to manage successfully. After 13 years, so they said, he had decided to quit while the going was good, and his exceptional performance record was still intact.

The fund then was valued at $14bn, and comfortably ahead of most of its rivals in size. Lynch himself denied that size had anything to with it: as he pointed out, the pundits first started saying the fund was too big to keep on growing when it reached the then unprecedented size of $1bn in 1980.

A 14-fold increase in the subsequent 10 years was pretty conclusive proof that the critics were wrong. Just as compelling has been the subsequent performance. At the time of Fidelity's announcement 10 days ago, despite Magellan's great contretemps two years ago, when the then manager put a large bet on bonds, the fund had reached a size of $63bn, something like four and a half times its size when Lynch switched off his market screen for the last time seven years ago.

This, to put it into perspective, means that Magellan Fund on its own is something like three times the market value of the largest single company quoted on the London Stock Exchange. (It is also nearly 20 times the size of the largest unit or investment trusts in this country, so if there is a problem with size, it is not one which is likely to appear here in the foreseeable future.)

These are big numbers, even in a country where stockpicking is a national pastime, and money has been flowing into mutual funds over the last few years like a torrent, driving the great bull market on. Inevitably, there has been much earnest discussion about whether Fidelity's decision to close the fund tells us anything about (1) how near we are to to the top of the bull market (answer - probably pretty close); and (2) yet again whether there is a point where actively managed funds do become simply too large to handle.

(I note with interest, given my comments last week about the tide running behind index-tracking funds, that Magellan is about to lose its top spot in the American mutual fund rankings to an index fund managed by the Vanguard group. One further advantage for index funds is that they are the only type of fund which automatically produces better results the bigger they become, since they enjoy clear economies of scale.)

While interesting, these questions seem to me to be of secondary importance to the question of how a single fund can have continued to grow and outperform its rivals for such a long period of time. Partly this is down to the marketing skills of the Fidelity organisation, which has not made itself the largest fund management group in the world simply by setting investment performance as its priority. These boys know how to sell their wares too.

What Fidelity has cashed in on, with Magellan and others in its stable of funds, is that the selling of retail investment products is a tough but lucrative game in which the bulk of the spoils go to a disproportionately small number of fund managers, usually those with the best recent performance track record. (Jupiter's success with its advertising campaign in the UK this year is a case in point.) No matter, as Lynch himself points out, that for most mutual funds, as with most unit trusts, historic performance is a poor guide to future success.

When you do have a genuinely outstanding fund manager such as Lynch in charge, however, and a track record which does persist, the commercial potential is simply huge. He himself is engagingly modest about his achievements, pointing out that when he took over Magellan for the first time in 1977, it was valued at just $8m. The market was still in the dumps and you could buy plenty of good companies on price/ earnings multiples of five. (Compare that with the average p/e for the FT All Share Index today of 19 times).

"When stocks in good companies are selling at 3-6 times earnings, the stockpicker can hardly lose," he concludes.

Lynch also admits now that throughout his career he never really had a single coherent stockpicking strategy. Magellan was, and is, a fund whose primary objective is capital appreciation, which was a suitably broad remit to allow him a lot of leeway in what he bought.

He simply bought companies which he thought had good prospects and which looked good value at the time. If small growth companies looked good value, he bought them, and if large companies appealed he bought them too.

If he found lots of companies he liked, he used to go out and buy them all (one thing which is easier when you have a fund the size Magellan became under his tenure). It was only after he had retired that he had the time to sit down for the first time and tried to work out what his investment style had been.

Another distinctive Lynch trait was to buy companies with simple businesses that he found easy to understand (for example, fast food chains) rather than exotic technology stocks whose activities he could never fathom.

Perhaps his best advice, however, is that investors should not waste time worrying about the state of the economy or the overall level of the market, which he, like every other professional investor, invariably tended to get wrong.

He would not, for example, waste any time in worrying about the subject of my chart, which shows the trend in volatility of world markets over many years. (Those of a gloomy disposition believe that the marked recent increase in the number of sharp daily rises and falls in the stock market is a classic indicator of an imminent market fall.)

It is no surprise, Lynch points out, that there are more one-day falls in the market on Mondays than on any other day in the week. lt is, after all, at the weekend that most people spend their time thinking about their investments. And when they start thinking about it, they start worrying about it too. As a result, they tend to sell their successful stocks too early, Better to cut losses on shares which have failed to perform, but hold on to the winners.

Such simple ideas helped to turn an $8m fund into something now worth more than the gross national product of several well known countries, so they have to be worth listening to.

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