Fidelity’s Christopher Lin was on the team that ran one the very best mutual funds when he was handed the helm to run it on his own about a year ago. Fidelity OTC Portfolio (FOCPX) is still one of the top performing funds.

The $21.2 billion fund ranks No. 2 among all U.S. diversified stock funds over the 15 years through Jan. 31.

That makes it Fidelity’s top U.S. diversified stock mutual fund in that span. And better than all but one other rival industrywide.

The fund racked up a 39.22% advance in 2019 vs. 31.49% for the S&P 500. That positions the fund for a repeat appearance on IBD’s upcoming, annual Best Mutual Funds Award lists. The Award goes to funds that beat the broad-market bogey in the latest calendar as well as in the three, five and 10 years prior.

Lin has been alone at the helm since Jan. 1 of last year. He served as lead manager, working with co-manager Sonu Kalra since Oct. 1, 2018.

Since taking sole charge, one of Lin’s key jobs is to keep this mutual fund on a roll and among the best mutual funds. He’s done that.

The fund’s average annual gain since he took the tiller has been a red-hot 38.85% through Jan. 31 vs. 28.70% for the S&P 500.

Keeping ahead of the S&P 500 has required certain changes.

Lin, 38 years old, described those changes and his strategy overall — including spelling out the first thing he looks for in a stock, and the stocks he says have the “best business model on the planet” — in a conversation with IBD from his office in Boston.

Best Mutual Funds: Refining The Fund’s Approach

IBD: Given this fund’s prominence, a lot of people wonder whether you will run this portfolio exactly as it has been run. Or will you fine tune anything?

Christopher Lin: The number of holdings is down a little.

IBD: You had 223 stocks as of your last disclosure. How much smaller have you made the fund?

Lin: When I first picked it up, it was about 300 stocks, so it’s down about 25%.

Lin’s Biggest Changes In OTC

IBD: Why have you dropped the number of holdings?

Lin: It’s not that I cater to a specific number of holdings. For me, this is the right size for the level of risk I want and the performance I can get out of it.

IBD: Why such a big reduction, 25%?

Lin: Looking at the assets ($21.2 billion), that is the kind of number of holdings that sort of naturally emerges. I thought about how much I want on average.

IBD: Morningstar says you’ve got 29 “other” holdings too. What are those?

Lin: We hold only equities. Those others are positions in private companies.

IBD: What’s the biggest change since you took sole control?

Lin: Focusing less on really fast growers and more on durable growers. Something that grows really fast is interesting to me, but not if it won’t last a long time. The fund has gotten more valuation sensitive as a result.

The First Question Lin Asks

IBD: Your technology sector weighting is high. Why do you expect to find so many opportunities there?

Lin: This is the key. That’s where I see lots of mispricing based on durability of earnings growth. I like to think I can recognize when that’s happening in a stock, and play the pricing game my way.

I focus on how long earnings growth will last. If earnings growth is durable, I will pay for it.

IBD: Do you look for durability in all stocks?

Lin: It’s the first question I ask about individual companies — does their product or service have durable growth?

Can Lululemon Athletica Help This Portfolio Remain Among The Best Mutual Funds?

IBD: What’s your thesis for Lululemon Athletica (LULU). It wants to double menswear and digital sales and quadruple international sales.

Lin: They understand how to maintain a powerful brand. And the product is excellent. They maintain a highly differentiated product, and their customers are willing to pay a premium.

When you look back three years, they had a bit of a PR misstep that cost the company and hurt them. Also, e-commerce for the U.S. took off, but Lululemon had a brittle, unstable website. It would go down. Customers were not able to buy products.

They’ve rebuilt that. Now menswear revenues were up 38% year over year in the third quarter. And international could have a huge impact. There’s a ton of runway left.

How Intuitive Surgical Makes OTC One Of The Best Mutual Funds

IBD: Intuitive Surgical’s (ISRG) robotic systems make surgery easier on the surgeon physically, not just the patient, right?

Lin: Surgery is hard on the surgeon’s body. The surgeon must stand over a table, hold himself still and with precise muscle coordination. Quick surgery can take 90 minutes. But long surgery can last many hours.

And, yes, outcomes for patients are better. On average you can go home 24 hours earlier. They have 25% lower readmittance rates in certain surgeries.

Adobe’s Key Acquisitions

IBD: Adobe (ADBE) products enable digital marketers to work creatively. And the company’s shift to a cloud-based subscription service makes distribution more efficient and lower cost, right?

Lin: They are the market leader in creative software tools. Mostly everyone in that field (standardizes their skills) on the Adobe suite. If you want to work with others, your common language is Adobe.

Adobe has three businesses: creative cloud, document cloud and marketing cloud, whose name was changed to “experience cloud.”

Their marketing business made two big acquisitions: Magento and Marketo. The jury is still out on how successful they’ll be for Adobe. But their creative cloud has not skipped a beat.

The stock has performed well because of the transition from selling shrink-wrapped, off-the-shelf software to internet subscription sales.

Their subscription-based model provides individuals access to the entire collection of creative services and apps. And Adobe automatically adds new services or updated services to the individual that he or she must pay for in the subscription fee.

The Best Business Model On The Planet

IBD: Which do you like more, Mastercard (MA) or Visa (V)?

Lin: They may be the best business models on this planet. They are the railroad for the payments industry. They’re the rails. These companies connect all merchants and issuing banks and ultimately consumers, and they issue credit or debit cards. That is such a wide moat, and it is extraordinarily durable.

And the shift to electronic payments is a secular-shift driver.

How Nvidia’s Chips Differ From Rivals’

IBD: Is Nvidia (NVDA) being driven by growing demand for more advanced computer chips?

Lin: CPUs are chips that are pretty good at a lot of things. They’re programmable, flexible. GPUs, or graphics processing units, are more focused, less generalized. It’s a higher end, more expensive piece of silicon.

Computer graphics require performing a lot of math, very fast. Video games need that. Cryptocurrency mining needed that. Now machine learning and deep learning need GPUs. And Nvidia makes GPUs.

What One Of The Best Mutual Funds Thinks Of Apple

IBD: Many investors have doubts about Apple (AAPL). But it was your No. 1 holding, at a nearly 11% weighting, as of Dec. 31. What do you like?

Lin: We felt the market was undervaluing this stock. Some people felt this was Nokia (NOK) or the old Motorola Mobility handset company that got sold to Google (then to Lenovo (LNVGY)), trading at an unfair multiple, when we felt the business was more durable.

I was an Apple analyst for four or five years. We believed its margins would be more sustainable than others believed, and that turned out to be right. We were optimistic about their services business, and that continues to be part of my thesis now.

Around two years ago they said their goal was to get to around $50 billion in services revenue by 2020. People laughed. After several years of 20% annual growth, people aren’t laughing.

Is Costco Fully Priced?

IBD: How does Costco Wholesale (COST) fit into the portfolio?

Lin: This is apple pie. It is a better mouse trap. They bring low prices to consumers.

The pushback is that it is fully priced. But is it? Their online penetration is still very low. They sell goods at razor-thin margins, pass savings to customers and monetize their annual subscription fees. We thought this would be durable.

Others have tried that. Sam’s Club (a subsidiary of Walmart (WMT)) is still around. But Costco has taken share. BJ’s (BJ) caters to a different, lower-income demographic. We think Costco has potential to last a long time.

Author: Paul Katzeff

Source: Investors: How Fidelity’s No. 1 U.S. Diversified Stock Mutual Fund Hunts Stocks

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