Mark Schmehl launched his Fidelity Special Situations Fund in April 2007. A year later it had a 42.3% return. The fund has continued to do well with a five-year return of 23%, while consistently outperforming its benchmark.
How does he do it? By looking at the unique aspects of sectors and individual stocks that other managers might shy away from. There’s research that goes into his investment decisions, and it comes from a wide variety of sources, including some 230 periodicals and magazines he subscribes to every month.
How do you choose your investments?
We have a huge network of research analysts and managers around the world. In addition, I do a lot of my own research looking for industry trends and companies with great growth potential. This includes reading a wide spectrum of monthly magazines that can provide leads for retail companies and trends. I subscribe to everything from Wired and The Economist, to Vogue and Elle.
As a result of insights from these retail publications, I’ve successfully owned a lot of luxury names. For example, one of my holdings is Brunello Cucinelli, a very high-end men’s wear fashion house in Italy. [Editor’s note: the Wall Street Journal reports Cucinelli’s 2013
preliminary revenue stands at $438.2 million, up 15.4% from the previous year.]
What are your criteria for stock picking?
My rule is if I find a stock that has multiple ways to win, it becomes a huge position in my portfolio. For example, when I launched my fund, 30% of it was in agriculture. With bio-fuels gaining popularity and the price of corn and fertilizers rising at that time, there were many ways to win in agriculture. This includes:
- high energy prices;
- scarcity in the market;
- cheap stocks on earnings;
- inflation; and
- very low Bay Street estimates.
Similarly, I put 15% of the portfolio in lumber stocks three years ago. They were huge for about a year and a half because:
- nobody liked the group;
- stocks were cheap;
- housing was getting better; and
- China was consuming more and more lumber.
I started selling before they turned down. The first year of the fund, I was up 42.3%.
You can replicate this thesis with individual stocks as well. One I’ve done well with is LinkedIn. It was ignored by investors even though it levered to social media, which was growing. I saw potential because it was a new concept that changed the way we do business.
Many investors are conditioned to shun expensive stocks. But stocks that may be ignored are a great place to look for new ideas. I buy an expensive stock when I feel it will grow faster than it has in previous years because it’s trending. And I hedge my bets on companies whose fundamentals are getting better.
How do you evaluate asset classes?
I look for improving industries because it means some stocks within the sector will likewise be improving.
For instance, the resource sector has been one to be out of for the past couple of years. I don’t own any energy, gold or materials because things have been a bit downhill due to increase in supply, flattening demand and the U.S. dollar gaining strength. So I won’t to go back and look at the sector until some of these things change.
Meanwhile, one market that is changing is the U.S. The economy is picking up, there’s massive monetary stimulus, many companies have put their debt issues behind them and housing is getting better.
And the best sector within the U.S. is technology because there’s innovation. I own a lot of technology stocks such as Splunk and Tableau Software at the moment. Some of my big winners in 2013 included electric car manufacturer Tesla, and LinkedIn.
How have you performed throughout a complete market cycle?
When I started the fund in 2007, we had a great year through early ’08. I went down with everybody else and then brought it all back in 2009. I was able to do this because I’m a growth manager, not a value investor. I have never been able to make money out of cheap stocks. I buy small companies with good earnings growth, many of which no one has ever heard of.
On the downside, I tell clients I will not be worse than the index. If the market goes down 20%, the odds are I’ll probably be down 20%. But on the upside, I tend to do much better than the markets. Since launch, my fund has captured 80% of the market downside and approximately 140% of the upside.
To capture the upside of a market you have to take on risk, which can also work against you if the market turns down. The key is knowing when to get out so that it doesn’t hurt your returns.
For instance, in 2007, I sold almost all of my resource stocks. I bought some defensive stocks, which went down like everything else. But when the market bottomed in 2009, I invested in some of the worst companies—bad balance sheets that were barely existing. Those companies were where the new growth could come from because they were the most levered to improving fundamentals. For example, I bought a mall REIT in bankruptcy and I bought every regional bank in the U.S. When you’re at the bottom of the market, you want to own beta. It was just a question of buying the right names.
When was the last time your investment process failed?
I had a terrible 2011 because I thought the market would get better. But as the year progressed, the signs changed and I thought I’d have to invest defensively. Europe and China were declining, and there were signs the U.S. was planning to pull back on stimulus. However, these things didn’t play out the way I expected. Two months later, things started getting better. The next time something like this happens, I’ll have more patience, stick with my original thesis and ride out the swings.
What’s your short-term global or sector outlook?
With the economy improving and interest rates starting to rise, the market is going to get tougher to beat. As business gets more competitive, weaker companies will also start to fall by the wayside. As a result, the winning portfolios will get more concentrated into the best names, which will take outsized returns. Globally, I see the cleanest growth in the U.S. I’m investing in technology and consumer stocks, such as Trip Advisor. I also own a lot more healthcare because I want to capitalize on the innovations cycle in biotechnology.
What circumstances would drive you to go to cash?
I tend to run very little cash balance—0% and 5% at all times. Whenever I’ve gotten to about 20% cash, it’s usually been at the bottom of the market. The two big tail risks that might push me to even more cash, say 50%, would be deflation or an unforeseen increase in long-term interest rates. At the moment, neither seems likely.
Kanupriya Vashisht is a Toronto-based financial writer.
Originally published in Advisor's Edge Report
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