Top Fidelity Fund's Manager: Patrick Venanzi

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P atrick Venanzi runs $1.7 billion Fidelity Small Cap Growth . That's the big Boston fund family's top-performing U.S. diversified stock fund this year through Sept. 30, according to Morningstar Inc.

Up 3.46% this year, the no-load mutual fund tops 98% of its peer-group of small-cap growth mutual funds tracked by Morningstar industrywide.

The fund's 12-month gain was 13.43%, which beat 98% of its direct rivals.

You can also invest in its load clone, Advisor Small Cap Growth , which is sold through advisors. Having earned 3.40% this year for investors , it is Fidelity's second-best.

The no-load mutual fund has a 0.99% annual expense ratio vs. 1.22% for its advisor-sold twin.

That puts Venanzi at the helm of one of the industry's most successful mutual funds .

From his Boston office, 36-year-old Venanzi talked with IBD about how he runs his portfolio, his two types of stock buckets, and how his approach differs from his predecessor's.

IBD: What's your strategy, and how does it differ from rivals'?

Venanzi: A lot of Fidelity's value managers sit near me. I'm looking for different things and for companies that are at a different point in their life cycles.

A lot of companies I own aren't making money today. But looking out two, three, five, 10 years, they will be making money and hopefully a lot of it.

That differentiates this fund from our other small-cap funds. Some have more of a value bent. Other growth funds, some ownGoogle ( GOOGL ) (recently renamed Alphabet) andFacebook ( FB ) and companies like that, which are just too big for this fund.

I focus on companies with between $100 million in market cap, up to about $6 billion -- that end is always sort of a moving target. The median market cap today is about $2.5 billion, so that's sort of the sweet spot -- between $1 billion and $3 billion.

IBD: Tell me how your two types of growth stocks differ from each other.

Venanzi: Yes, the fund is a blend of stable growers that are profitable and emerging companies. The stable growers are about 60% to 65% of the fund.

A lot of the emerging growers lose money. Many value managers would struggle to justify buying a company that is losing money this year, last year and maybe next year. But I am trying to look five years out and think about whether a company will be profitable, maybe wildly profitable.

Can we buy it today before other folks who look at just this year and next year get interested?

IBD: Do some holdings fall into both of your buckets?

Venanzi: Some do. My top position, 2U ( TWOU ), isn't making money. But it has a track record of steady 20% to 30% (quarterly) revenue growth. Is it a steady or emerging stock? It's both for me.

IBD: Why were you comparing your portfolio to value funds?

Venanzi: This is definitely not a value fund. It's definitely growth.

But especially in this universe, you win in small-cap growth by thinking about valuation more than my competitors do.

Most growth funds are a sort of momentum strategy, and valuation is an afterthought. For me, I don't buy stocks that I think are overvalued just because they will have a good three- to four-quarter run.

Growing up (as a manager) at Fidelity, for 15 years being around managers like Joel Tillinghast (Low-Priced Stock Fund , Chuck Myers (Small Cap Discovery and Small Cap Value and Jamie Harmon (Advisor Small Cap , our small-cap team has a legacy of value and sort of GARP-y fund managers. Valuation is important no matter what universe you're in.

So this is a growth fund, but valuation is a key part of my process.

IBD: What's the hardest part about being a small-cap growth manager?

Venanzi: The temptation in small-cap growth is to focus on emerging growth and have too much exposure to them. If that's all you own, history works against you. So I try to be super-selective. Only two or three out of 10 emerging-growth stocks work. But if you buy those that are growing, six out of 10 outperform over a longer time.

So this fund is a mix of stable and emerging growers, and we are highly selective on emerging growers.

IBD: How have you changed this fund since taking the helm in November 2011?

Venanzi: My predecessor, Lionel Harris, was a good steward. He manages Small Cap Stock Fund . Lionel skewed this fund toward steady growers. That bucket is Lionel's bread and butter. He's less willing to dive into emerging growers than I am.

IBD: How important is water heater makerA.O. Smith's ( AOS ) global exposure?

Venanzi: Seventy-five percent of their business is in the U.S. The rest is overseas, including China. These guys have a strong brand name, which they're able to leverage overseas, especially in China and India.

People worry about China (growth slowing). But I'm told by folks who spend more time there than I do that water heaters are something that people there show off. Apartments and houses are smaller than in the U.S., and people have their water heater on display in the living room. They show off their A.O. Smith water heater. The brand seems to resonate.

Back at home we've owned it in the past because of the residential and nonresidential construction recovery. Finding companies with a strong competitive position is paramount to my process. And these guys have a strong competitive position.

IBD: What made you add to your stake inCadence Design ( CDNS ) as of your latest disclosure -- which is the time frame for all of my questions?

Venanzi: I covered semiconductors as an analyst. It's tough to maintain a competitive position in semiconductors because product cycles are short and prices go down 10% to 20% each year. You're on a treadmill.

But Cadence sells software to semiconductor companies to help them design chips. That business does not have the same price-decline curve as their customers do.

Cadence,Mentor Graphics (MENT),Synopsys (SNPS) -- their market has consolidated over the past 10 to 15 years. There used to be 15 companies. Now there's just three (main ones), so all have stronger competitive positions. Their pricing is more stable.

And Cadence has a new product cycle coming up. It has a big refresh every three or four years, and it's been three or four years since they had a new tool, so I wouldn't be surprised to see one in the next year or so.

IBD: Why have you slightly trimmed your stake inGlobal Payments (GPN) in recent quarters?

Venanzi: I'm always managing position size. Any time a stock outperforms by as much as Global Payments has, you ask yourself if this is still the right position size. And from time to time I take chips off the table, and I add when the company comes back.

Global resells or leases equipment made by companies likeVerifone (PAY). This business has recurring revenues, good returns, and underlying market growth as the world continues to move from cash to plastic payment. Global's main differentiators are their global footprint and a one-stop shop that makes it easy for merchants to accept any form of card payment and to easily keep up with industry changes like the chip-and-PIN. They also have software tailored to niche markets like gaming and dentists.

Global uses a lot of middlemen to sell. Those middlemen put pressure on. Global had to cut price to gain share. The last couple of years, a new CEO led their charge to decommoditize their business. They did a couple of acquisitions to give them more differentiation, allow them to sell more software around their core product.

That's started to reverse a margin decline.

IBD:'s (STMP) earnings per share growth has accelerated. Why have you trimmed?

Venanzi: Stamps was still a significant position as of our last report. But all of those comments about managing position size when stocks have a big run apply.

Stamps sells software that helps small businesses or people working out of their homes get their boxes out the door (heading to customers).

They were one of only three businesses that had licenses that let them put labels on packages for shipping through the U.S. Postal Service.

They have a great record of capital management. They invest at the right time. They step back when marketing channels get expensive, when key words (like "shipping software" that they pay online search engines for) get too expensive. So at times their revenue growth decelerates. But when their stock pulls back, they buy their stock.

Over the past year, they used their cash to make acquisitions, ShipStation and ShipWorks. They're similar to, but they use multiple channels. So Stamps now is more diversified. It has a stronger offering.

IBD: Did you trimG-III Apparel (GIII) because it has done well?

Venanzi: This is another where the stock's done well and we took chips off the table as of our last holding period.

They started as licensing, doing outerwear, making raincoats forRalph Lauren (RL). That's a notoriously difficult category.

But now "G3" owns more brand names, which gives them more control.

It's tough to figure a company's terminal value (in the future) if all they have is a business that can go away when their current contract expires. But if they own their own brand, that won't go away.

IBD: How isDominos Pizza (DPZ) making its earnings per share growth accelerate?

Venanzi: The issue for a lot of consumer companies is what does "online" mean. Retailers have (challenges). But pizza is one thing you can't get online. But you can order pizza online, which helps Dominos.

IBD: ICU Medical's (ICUI) earnings per share grew 89% and 90% the past two quarters, but you've trimmed. Is this another position management move?

Venanzi: You're probably sensing a theme. This was trading around 60 a year and a half ago. Now it's (above 110). Any time a stock has that kind of move you must revisit it and ask if the position size is right.

They make inexpensive plastic tubing and valves used in hospitals. They got too dependent on one customer, Hospira, which went through some regulatory challenges.

ICU got a new CEO a year or two ago, who figured out ways to regenerate growth, and Hospira has fixed their regulatory issues.

IBD: Why have you cut back your position inService Corp. (SCI)?

Venanzi: Position management.

But this company fits the theme of strong competitive position. They're in an industry, death care, that will stick around. The company is very cash generative. They've done a good job putting cash to work through acquisitions and buybacks. And in the past few years, they've pushed to sell services pre-need, trying to hit baby boomers to take care of their burial needs before they die so their kids don't have to deal with it. They fit my steady grower bucket.

IBD: Do you have a case of puppy love forVCA (WOOF)?

Venanzi: They run animal hospitals and a lab. They have a strong competitive position.

I think the thing there is that they went through a period when growth stalled, especially (during the recession from) 2008 through 2010. People spend less on pets when they don't have a job or they're worried about losing their job.

But as unemployment went down, people resumed spending on their pets. And VCA management are good capital managers.

IBD: Which of your baskets isAthenahealth (ATHN) in?

Venanzi: Over the past five years they've graduated from emerging growth to steady growth.

They're not afraid to try new things. That's led to a lot of innovation that's served shareholders well.

They do revenue-cycle management for doctors, doctors' practices. They help doctors collect money they're owed, and do it faster with lower loss rates. And each time (they collect), they take a little cut. It's rare for doctors to switch away, so they're building a sustainable business. It's a good business model when revenues are growing.

IBD: IsPacific Premier Bancorp (PPBI) a play on the prospect for an interest rate hike?

Venanzi: You're on target, but that's not my leading line. If rates go up, Pacific should benefit. In addition, Pacific is small, based in California, growing 15% to 25%, generating above-average returns on equity. The CEO is a take-no-prisoners guy who doesn't like losing money, so their credit is pristine. Their valuation is trading at a historically low multiple.

So when you can buy above-average growth for a below-average multiple, that is nirvana.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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