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Searching for the Next Fidelity Magellan Fund

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Mutual fund investors have their own version of the quest for the Holy Grail. It’s called the search for the next Fidelity Magellan.

This is the industry’s biggest fund and the best performer over the past 15 years. Peter Lynch, who stepped down from Magellan’s helm in April, 1990, set the standard for investment excellence. Many observers wonder whether any other manager will be able to duplicate his near-mythical performance of 25%-plus compounded annual gains over a 13-year stretch.

Time will tell, but there’s a good chance that, yes, the mutual fund realm will have another undisputed king someday. For a real champion to emerge, it will likely have to share certain characteristics with Magellan, and the fund manager may have to follow Lynch’s approach in several ways. If you hope to find the next stock-fund leader, experts suggest that you look for the following traits:

* A broad investment mandate. The next Fidelity Magellan probably won’t be a sector fund, limited to certain industries or types of stocks. “You want a diversified growth fund with wide parameters,” says Eric M. Kobren, editor of the Fidelity Insight newsletter in Wellesley Hills, Mass.

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In the early years, Lynch concentrated on smaller stocks when they were in vogue, then switched to bigger issues when they got hot, says Kurt Brouwer, a San Francisco money manager and author of a book on mutual funds. Lynch ran Magellan from 1977 through April, 1990, and, significantly, there wasn’t a single calendar year during that span in which both large stocks and small stocks lost ground.

And though Magellan isn’t classified as a global fund, Lynch enjoyed the ability to buy foreign stocks when he wanted, Kobren says. Many experts believe that the next Magellan will need to have a green light to invest in foreign companies, which account for a widening share of world commerce and investment opportunities.

* An ability to make big bets. For the next Fidelity Magellan to beat a broad index, such as the Standard & Poor’s 500, the manager will have to be able to focus his portfolio on the most promising corners of the market, Brouwer believes. “That might mean putting 15% to 20% of the fund’s assets in one industry,” he says. Otherwise, a passively managed index fund would be able to do just about as well as the S&P.;

* A fully invested posture. If the next Magellan is to score truly spectacular gains, it will probably have to keep close to a 100% weighting in equities all the time, without boosting its cash holdings during treacherous periods. “Lynch was always fully invested; he didn’t try to time the market,” Brouwer says.

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Of course, Lynch also benefited from a long bull run that pushed the Dow Jones industrials up from about 900 in 1977 to nearly 2,700 by the end of April, 1990. The manager of the next Magellan might not be so lucky, suggests Douglas Fabian, editor of the Telephone Switch Newsletter in Huntington Beach. “In a bear market, 90% of all stocks go down, and we’re overdue for a big bear market,” he says. “I think a manager who can take a large cash position will show superior long-term gains.”

On the other hand, trying to time the market by raising cash runs the risk of missing a big rally. Besides, the fully invested camp has an edge, in that the market does have a long-term upward bias: Stocks have appreciated in 54 of 61 five-year periods and 55 of 57 10-year periods dating to the mid-1920s, according to Ibbotson Associates of Chicago.

* One manager at the helm. Try to find a fund that has a single person calling the shots, Kobren advises. “Fidelity gave Lynch the ball and let him run with it.” Brouwer agrees, pointing out that the team or committee approach requires shared decisions, which may result in compromise or delays and thus mediocre results.

* Moderate size. Lynch confounded the doomsayers by continuing to beat the S&P; 500 after 1983, when the fund passed $1 billion in assets. Morris Smith, Lynch’s successor, is ahead of the market so far in 1991, his first full year at the helm.

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However, Magellan now counts $16.4 billion in assets--5% of all the money in stock mutual funds--and that’s probably too large to achieve exceptional returns. From 1987 on, Magellan has been beating the S&P; 500 by about 1.5 percentage points a year, compounded. While that’s impressive, Lynch crushed the index by nearly 26 percentage points a year from 1977 through 1983. More than anything, the fund’s huge size may have brought its returns down to Earth. “Trying to manage Magellan now is like maneuvering an aircraft carrier in the middle of a bathtub,” Kobren says.

Personal Finance, an investment newsletter in Alexandria, Va., also considers size to be crucial. In its own search for the next Magellan, the newsletter came up with a list of 10 possible successors, all with less than $100 million in assets and most with under $50 million.

* A manager, not an administrator. Lynch didn’t have to worry about running Fidelity, just Magellan. As such, he was able to devote his attention to finding attractive companies without getting distracted by bureaucratic duties, points out Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Hastings-on-Hudson, N.Y.

In this sense, Lynch differed from several other noted portfolio managers who must also juggle administrative chores, such as John Templeton, Mario Gabeli and Michael Price. Significantly, Kobren says, Lynch had the time to check out companies before he invested. “He was able to kick the tires, visit management and speak to competitors on a regular basis.”

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