Fidelity Contrafund: Fantastic Blue-Chip Fund

The Fidelity Contrafund (FCNTX) has delivered 12.1% annual returns since William Danoff took over the helm of the fund on September 17, 1990. This guy knows how to put together a blue-chip stock portfolio. Because the Fidelity Contrafund is so popular, it has seen its assets balloon to over $100 billion. That usually makes me nervous, as the universe of potential stock selections starts to diminish rapidly when you have over tens of billions of dollars to manage.

The great challenge for the Fidelity Contrafund is that it has the Warren Buffett problem–you are almost trapped by your own success because you have to try and beat the market by selecting among the universe of stocks that are the most highly covered, most liquid, and most likely to have efficient pricing out of all publicly traded stocks.

And yet, Danoff has been able to stuff the Fidelity Contrafund with some of the most exceptional large-caps in existence. The second largest holding is Berkshire Hathaway, which has grown earnings per share at 14% since becoming a top ten holding of the Fidelity Contrafund.

Really, the largest holding of the fund is Alphabet, because the A shares are the fourth largest holding and the C shares are the seventh largest holding. Those shares have compounded at 22.5% annually since Danoff added them to the Fidelity Contrafund.

He has also played financials well, adding arguably the two best large-cap stocks in the sector to his fund: He has made Wells Fargo the third largest holding of the Fidelity Contrafund, and he has also made Visa the eighth largest holding of the Fidelity Contrafund. Wells Fargo has compounded at 17% annually since its addition to the Fidelity Contrafund, and Visa has compounded at 18% during its time in the Contrafund.

And, rounding out the top ten, Starbucks and Nike are the ninth and tenth spot in the fund’s portfolio. They have compounded at an aggregate 16.8% annual rate since their inclusion in the Fidelity Contrafund. Even though I have, and do, argue that those stocks are currently overvalued, I do not blame Danoff for keeping them among the Fidelity Contrafund’s Top Ten Holdings. If he sells the appreciated stock, there may be a capital gain that causes an investor to pay 23.8%. This can be alleviated on a personal level by putting the Fidelity Contrafund in a tax-deferred account, but I can understand doesn’t want to take on the taxable gain for some of his investors unless he finds an alternative prospective investment that is sufficiently more attractive to overcome the 23.8% haircut from the appreciation.

My only criticism of the Fidelity Contrafund? The #1 holding is Facebook! It wasn’t #1 by design, but because the stock has appreciated by 73% annualized since 2013 and has catapulted to the top stop in the fund. So far, it has made the Fidelity Contrafund investors rich, but the historical track record for megacap firms trading at 78x earnings is terrible. It is almost certain that 1% or so of the net asset value will be lost either through a sale of the greatly appreciated Facebook stock or the inevitable P/E compression that will negatively affect Facebook’s stock price in the long term.

Advocates of focused investing base their argument on the claim that an investor’s absolute best idea ought to perform much better than an investor’s tenth, twentieth, or thirtieth idea. Although this theory doesn’t quite hold up in practice perfectly because some things exceed expectations and others disappoint, Danoff’s record at the Fidelity Contrafund is Exhibit A for that argument.

The top ten holdings of the Fidelity Contrafund have compounded at nearly 20% annually over the past five years, suggesting that Danoff at his best can hold up against Warren Buffett at his best. But here’s the catch. The top ten holdings only account for 30% of the Fidelity Contrafund’s assets, and the remainder stocks have a much lower compounding rate in the single digits. That’s why the five-year performance of the Fidelity Contrafund is only 12% annualized, despite the top ten holdings performing near 20% annualized (and part of the reason why they became top ten holdings is a product of this appreciation).

The industry average for fees is 1.16% for American large-cap funds, and the fee at the Fidelity Contrafund is only 0.64%. This means that, since Danoff tookover in 1990, the 12.1% returns that would have turned a $10,000 investment in the Fidelity Contrafund into $228,000 before fees would leave you with $198,000 net of fees for the past twenty-six years. It still puts you well ahead of the S&P 500 Index, which has compounded at 8.68% pre-fees over the past twenty-six years and turned $10,000 into $94,000.

Danoff is one of a few dozen managers in the United States that has a proven track record of beating the S&P over a 20+ year period. The holdings are generally exceptional, as the top holdings all have earnings per share growth well over 10% annually. The constraint of the Fidelity Contrafund is the $100 billion size of the fund, and I also think the Facebook holding will eventually impair the holders in some way, but other than that, Danoff is doing the best with what he’s got and has stuffed the Fidelity Contrafund with top stocks that are growing noticeably faster than the 6.5% rate of the S&P 500.

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