Fidelity's Danoff ranks with fund giants

By Tim Middleton

Fidelity Investments has been deeply wounded by the bear market, but it retains one big edge over everybody else: Will Danoff.

Danoff is to the 21^st century Fidelity what Edward C. Johnson III and Peter Lynch were to the organization in the 20^th century: master portfolio managers, sui generis, brand names who showered riches on their investors.

Danoff's Fidelity Contrafund (FCNTX) shot up 17% in the year ended June 30, and that was less than its average return in each of the two prior years. Despite being the largest actively managed equity fund guided by a single individual, with $64.9 billion in assets, it behaves more like a sprite than a behemoth.

"Will Danoff is a tremendously talented manager with a very distinguished, long track record," says Greg Carlson, who studies the fund for Morningstar. "He's willing to own a pretty significant number of mid-cap names -- he doesn't just stick to the well-known stuff."

"He truly is, in spirit and in deed, a contrarian investor and a contrarian thinker," says Jim Lowell, editor of the Fidelity Investor newsletter. "He is somebody who has demonstrated for more than 15 years a clear and distinct ability to think against the grain."

Can you still get in?

Investors have flocked to Contrafund in such numbers that in April, Fidelity closed the fund to new investors. It remains open in 401(k) and other retirement plans, however, and together with another fund Danoff manages, attracted 46% of all the fresh money that flowed into Fidelity in the first six months of this year.

If you can get into Contrafund, do. Danoff is one of those extraordinarily rare individuals, like Warren Buffett and William Gross, who defy statistical odds and are nearly always right. If you can't, don't despair: I can recommend two other Fidelity portfolios that offer Contrafund-type opportunities.

He's not saying much

Through a spokeswoman, Danoff declined to be interviewed for this article, but that's just as well. I've read all of his published recent interviews and they are all blather. He speaks in platitudes that describe somebody who certainly isn't him.

Some examples:

• "I am not making sector bets, but identifying the best of breed." Investor's Business Daily, Oct. 4, 2002.

Hogwash. The fund's turnover is 60%, which implies an average holding period of 20 months. The best companies don't disappear in 20 months. And Danoff used to trade far more rapidly than that, until he was held back by sheer size.

"I think a large degree of his performance is from his themes more than his individual stock picks," says Jack Bowers, who has followed him for years as editor of the Fidelity Monitor newsletter. "His big bet over the last five years brought the fund up to 25.6% foreign (stocks). That was a stroke of genius."

• "I'm not a contrarian. … I wanted to change the name of the fund, but Fidelity feels that there's a lot of brand equity in it." Kiplinger's Personal Finance, December 2005.

Baloney. Another of Danoff's home runs was investing in gold as early as 1999. In this decade, he shunned the drug giants of big pharma before it became an albatross and embraced biotech before it began to sizzle.

Lately he has been selling some of his hoard of energy stocks, cutting that group to 11.4% of assets from 12.0% at the end of May, according to Fidelity's Web site.

• Q: Do you pay any attention to price, to valuation? A: "No. … Value investors say, 'You have to buy a stock right.' I want to buy something where I don't have to buy it right and I don't have to worry about selling it right. … It doesn't matter what you pay for a stock if the earnings growth is there." Kiplinger's.

Gimme a break. "In my opinion, he's a little more valuation sensitive than he's letting on in that statement," says Carlson. "He is mostly interested in earnings growth, but to him that doesn't mean he's going to own a lot of speculative companies. He knows when things are cheap."

It's the results that matter

A far more reliable way to judge Contrafund than logomachy is to examine the fund's results, and how it produced them.

What leaps immediately off the page is that, despite having so many assets, Contrafund's average holding has a market cap of $23.88 billion. That is one-half the $47.19 billion average cap of the S&P 500 Index ($INX). It is so low because 22% of Contrafund's assets are invested in small and mid-size companies.

As a result, Contrafund delivers the kind of supercharged returns associated with mid-cap stocks. The fund's r-squared, a measure of how similar it is to market benchmarks, is only 74% compared with the S&P 500, but it's 88% when judged against the S&P Midcap 400 Index ($MID.X).

The rap on midcaps is that they are subject to extreme price swings, but Contrafund is not. The fund has a standard deviation, or vulnerability to price extremes, of 10.19. The S&P 500's standard deviation is 13.60, and the average for mid-cap growth funds is 17.95. Lower is better, and Contrafund's standard deviation puts it in the same league as long-term Treasury bonds.

Then there are those foreign stocks. They've gotten a tailwind from a falling dollar in recent years, but the broad market has caught up with Danoff also in appreciating their earnings potential as other economies catch up with our own.

And consider this: While Danoff's top holdings begin with such high-flyers as Google (GOOG, news, msgs) and Genentech (DNA, news, msgs), No. 3 is Berkshire Hathaway (BRK.A, news, msgs), which has eked out a 2.6% advance over the past six months. I agree with Danoff that this is a premier high-growth company, but Wall Street certainly does not.

One more fund attribute I like: Danoff and his family are shareholders in Contrafund. It inspires confidence that a manager is putting his own money on the line.

Spread a bit thin

There are some negatives about Contrafund that bear watching. The first is that Danoff is spread pretty thin.

In addition to Contrafund, he manages Fidelity Advisor New Insights (FNIAX), which is also closed to investors outside of retirement plans. Between his funds and private accounts, Danoff manages about $83 billion. That is nearly one dollar of every nine Fidelity manages in long-term (i.e., non-money market) mutual funds.

The second is that he is mortal, and might decide to smell the roses. Peter Lynch was just as vital to Fidelity in his day, and Lynch quit when he was about as old as Danoff, who graduated from Harvard in 1982, is now. If Danoff were to retire, the lamentations coming out of Fidelity would be the loudest Boston has heard since the last time the Red Sox didn't win the World Series.

Fortunately, Danoff is not the only super-talented, go-anywhere investing savant in the marketplace. Right across the hall at Fidelity's headquarters sits Fergus Shiel, manager of Fidelity Capital Appreciation (FDCAX). Shiel racked up a distinguished record at Fidelity Independence (FDFFX) before leaving for the hedge-fund world, only to return last autumn. Lowell says that, like Danoff, he has a "similar ability to think against the grain."

And then there's Fidelity Value Discovery (FVDFX). Comparing it with Contrafund, Bowers says: "If you read their objectives, they're run pretty close. For those who can't get into Contrafund, I think it makes an excellent choice. I think it has the same potential Contrafund had a decade ago."

Fidelity has been badly wounded in recent years, tumbling to third-largest from first among mutual fund complexes (again, setting aside money fund assets). In temperament, this go-go growth shop is poorly suited to prosper in a lengthy bear market.

But it has a vast reservoir of talent, and managers like Danoff can withstand comparison to the very best the investment world has ever known. I wouldn't hire him as a public speaker, but I'm happy to count myself among his shareholders.

At the time of publication Timothy Middleton owned the following securities mentioned in this article: Fidelity Contrafund and Berkshire Hathaway. Middleton is the author of The Bond King: Investment Secrets of PIMCO's Bill Gross, and the former mutual funds columnist of The New York Times. He works from home in Short Hills, N.J.