Walking in Peter Lynch's Shoes

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Imagine replacing Captain Kirk as captain of the U.S.S. Enterprise or taking the reins of the Millennium Falcon from Han Solo. You'd be filling a large pair of shoes in either case. Although farcical, these examples illustrate what one Fidelity manager might have felt like after first assuming the role once held by legendary investor Peter Lynch.

Harry Lange is the fourth manager to lead Fidelity's Magellan Fund since Lynch stepped down in 1990. Lange's immediate predecessor, Robert Stansky, probably alleviated some of the pressure on Lange after Stansky turned the storied fund into something that so closely resembled the S&P 500, it was dubbed a "closet index fund" -- and even underperformed that benchmark during Stansky's tenure.

Taking the wheel
As Magellan's current captain, Lange has had an opportunity over the past four years to restore the fund's reputation, and he's attempting to do so with a growth-based strategy that invests a fifth of assets in foreign holdings and bets big on technology stocks. In a recent Fidelity article, Lange identified the risk of future inflation as one of his primary concerns over the long run. Of the tools in his arsenal, he believes that among the most valuable will be gold stocks, investments in companies that benefit from increasing prices, and his sizable positions in international stocks.

Magellan Fund
Expense ratio	0.71%
Fund size	$23.1 billion
1-year return	71.7%
5-year annualized return	(0.9%)
10-year annualized return	(2.3%)

Source: Morningstar.

Top Five Holdings as of Sep. 30, 2009	Percent of Net Assets
Nokia (NYSE: NOK)	4.6%
Corning	4.6%
Applied Materials (Nasdaq: AMAT)	4.4%
Staples	3.8%
Medco Health Solutions (NYSE: MHS)	2.3%

Source: Fidelity.

Gold is CRUSHING the stock market!!!
You're probably sick of all those infomercials telling you to buy gold. But Lange advocates gold stocks to prepare for inflation. He says, "I like gold because it is not only an efficient hedge against inflation, but also a hedge against a falling stock market. The metal itself benefits from favorable supply and demand characteristics as middle-class consumers in many of the world's emerging markets put a lot of their assets into gold and jewelry. So it's a triple play for me."

Over the past year, it's hard to argue with the success of gold stocks. Magellan has more than 5% vested in the industry, and its investors have benefited handsomely from companies like Newmont Mining (NYSE: NEM), Goldcorp (NYSE: GG), and Rangold Resources, all of which have seen strong gains in the last 52 weeks.

Including the portfolio's gold stocks, materials stocks comprise 16% of Magellan, and while they've contributed significantly to the fund's overall returns this year, their weight pales in comparison to its stake in the technology sector.

Salvation through inflation
Lange has allocated more money into technology stocks than any other sector, and as you might expect, the sector has been a huge contributor this year to the fund's success. Since last November, technology positions like Corning, Apple (Nasdaq: AAPL), and Seagate Technology have added the biggest kick to the fund's overall returns, along with Applied Materials and Google (Nasdaq: GOOG).

Undeniably, technology stocks play a key role in the Magellan Fund. But how do technology stocks stand to gain in an inflationary environment? Lange believes that some inflation would manifest itself in higher home prices, which he thinks would decrease mortgage delinquencies and improve bank balance sheets; in turn, the broader economy should follow suit, and tech spending should rise.

As Lange puts it, "A little inflation can actually produce a favorable environment for growth. If prices are rising, there's an incentive to buy now. So, modest inflation can help generate better corporate sales and thereby boost overall economic activity."

Global focus
Lange has invested more than 20% of Magellan's assets in international stocks. High demand for commodities abroad along with trade and budget deficits in the U.S. support a weaker dollar. Since emerging markets are still growing, Lange hedges against the resulting inflationary pressure by investing in areas that he believes will have favorable currency movements in the face of a weakening dollar.

In other words, he's got his bases covered for a number of scenarios. And although he doesn't necessarily think it's a terrible thing, Lange definitely sees inflation looming on the horizon.