Fidelity Contrafund (ticker symbol FCNTX) is a mutual fund with approx. $61.5 billion in net assets managed by William Danoff. Currently, Morningstar rates the fund Four Stars / Silver in the US OE Large Growth category. The latest Morningstar report on the fund, titled “Still a category leader” was published in January 2013. At present, this no-load fund has a total expense ratio of 0.74%. Let’s analyze the fund’s performance using the Alpholio™ methodology.

First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:

Cumulative Return of FCNTX and Reference Portfolio

The chart shows that from early 2005 to early 2009, performance of the fund was generally matched by that of its reference portfolio. From then on, the fund significantly underperformed.

This is further illustrated by the cumulative RealAlpha™ chart:

Cumulative RealAlpha™ for FCNTX

In the chart, the lag cumulative RealAlpha™ curve overlaps, for the most part, the regular RealAlpha™ curve from 2005 through 2008. Typically, this is an indication that the fund manager did not make any major directional bets that significantly departed from the fund’s holdings in the immediately preceding time window. From 2009 onwards, this approach changed; however, the net result was an undesirable downward trend of the cumulative RealAlpha™.

The overall statistics further underscore the unimpressive performance of the fund, esp. in the second part of the analysis period:

FCNTX Statistics

At about 15%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was slightly lower than that of the overall stock market. The volatility of the reference portfolio was just slightly higher than that of the fund. This typically indicates that the fund was well diversified and contained positions generally present in the reference exchange-traded products (ETPs). The discounted annualized RealAlpha™ of the fund was approx. negative 1%, which was mostly caused by a significant loss of alpha since 2009. At 0.89, the fund’s RealBeta™ was lower than that of the market, which was also reflected in the lower volatility.

The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:

Buy-Sell Signal for FCNTX (Smooth)

The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from its smoothed approximation, depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.

The signal would allow an investor to avoid the long period of the fund’s underperformance that began in late 2008 according to the smoothed RealAlpha™ measure.

The following chart shows the major investment “themes” of the fund over time:

Reference Weights for FCNTX

In the analysis period, the fund held equivalent equity positions in JKE (iShares Morningstar Large-Cap Growth ETF; average weight of 21.8%), QQQ (PowerShares QQQ™ ETF; 17.5%), JKH (iShares Morningstar Mid-Cap Growth ETF; 14.4%), PWC (PowerShares Dynamic Market Portfolio ETF; 9.2%), EEM (iShares MSCI Emerging Markets ETF; 7.2%), and VDC (Vanguard Consumer Staples ETF; 6.7%).

The fund’s equivalent cash position in SHY (iShares 1-3 Year Treasury Bond ETF) was at times as high as 17.8%. This indicates major market timing efforts in the fund an investor would reasonably expect to be predominantly invested in equities.

For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent position in IXJ (iShares Global Healthcare ETF; average weight of 4.6%). This position implies that the fund held equities with a significant exposure to the domestic and foreign healthcare sector.

While the Morningstar analyst report says that

“Despite its size, Fidelity Contrafund remains ahead of the game.”

this analysis clearly demonstrates that the strategy of the fund could easily be replicated using a relatively small number of exchange-traded products (ETPs), and with a better performance (higher return with comparable volatility). Investors could instead use the results of the ongoing Alpholio™ analysis to construct a substitute portfolio of liquid, low-cost instruments that provide an even higher diversification (as of the latest filing, the fund held about 375 securities).


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