The Best Fidelity Funds for a Growth-Led Market

Since I explained how Fidelity is betting big on a large-growth rebound, I've gotten lots of questions. "Why should I believe Fidelity that growth stocks are coming back? Haven't they  (and you) been saying this for years?" The believers, of course, want to know my picks among Fidelity's vast lineup of growth funds.

So far, large growth has held its own in 2007. But it's still too early to discern any trends. Here, I'll make the longer-term case for growth--again. I'll share some arguments gleaned from Fidelity and others for why you shouldn't be ignoring large growth in your portfolio right now. Then, I'll name my favorite Fidelity growth funds.

Is Growth Ever Coming Back?
Yes, Morningstar and others have been predicting a large-growth rebound for some time now. And yet value stocks have stayed on top. The moral of the story, to paraphrase Warren Buffett, is that it's harder to predict when something will happen than if it will happen.

But remember back to the late 1990s. Back then growth was king and value investors, including Buffett, were the fools who didn't "get" the new paradigm. Just as some investors were throwing up their arms and conceding that this time was different, the growth bubble burst.

We at Morningstar have seen yesterday's losers become tomorrow's winners too often to neglect beaten-down asset classes. And large growth has easily been the worst performer of the nine Morningstar Style Box-based categories since 2000. Sectors like tech hardware, health care, and media--traditional hunting grounds for growth investors--have been humbled by "Old Economy" sectors like energy, materials, and utilities. Just as it made sense to pay attention to value, small caps, and foreign stocks in the late 1990s, domestic large growth is worth your attention today.

But a "Buy the Unloved" strategy isn't the only reason to pay attention to large growth. Astute market observers have been pointing out for a couple of years now that stocks of companies growing much faster than the market are trading fairly cheap in relative terms. Judged by a variety of valuation metrics, the stocks in the Russell 1000 Growth Index aren't much more expensive than those in the Russell 1000 Value Index, despite the fact that they are growing their earnings, sales, and cash flows at a faster rate.

Then there's the top-down argument for large growth. When the economic tide is rising and interest rates are falling, all boats are lifted, which explains the surge in cyclicals and smaller caps over the past several years. Recent indicators show the economy slowing, and during such periods, the market tends to pay up for companies that can maintain growth. Also, sturdy blue chips tend to benefit from periods of uncertainty and unease. And if U.S. growth slows, global companies will hold up better because they earn revenues abroad.

Morningstar equity analysts now cover enough stocks that their bottom-up work can form big-picture views on the market. Going into the second quarter of 2007, they saw the market as a whole as fairly valued and found more bargains among the largest stocks than among smaller fry. I found it interesting that they found fewer undervalued opportunities in utilities and telecom than they did in media, health care, software, hardware, and media.

The same theme has been echoed by some of our favorite mutual fund managers. Frank Jennings, whose  Oppenheimer Global Opportunities owns the number-one long-term record in the world-stock category, recently told me that growth stocks are the only bargain in the market right now. You know the world has changed when savvy value funds such as  Dodge & Cox Stock and  Longleaf Partners own stocks like  eBay with above-average growth rates.

Fidelity on Growth
It's not nearly as surprising that Fidelity is betting on large growth. If you don't believe that the shop has a growth bias, consider that there are 27 Fidelity funds in the large-growth category. The biggest is  Fidelity Contrafund , whose manager, Will Danoff, has said that if he owned cyclical stocks, he would be selling them and upgrading to steady growers. He has also increased his tech stake. He bought data networking company  Cisco Systems in the second half of 2006, and his top 10 holdings as of March 31 included  Google ,  Genentech , and  Apple .

Then there's long-struggling  Fidelity Magellan , which we recently moved from blend to growth because of its newly aggressive orientation. Harry Lange, who took over as manager in October 2005, sees the stocks in his portfolio as unduly cheap given their growth potential. Magellan had more than double the hardware weighting of the S&P 500.

Whenever I speak to Lange, he tells me not to assume that the same stocks that dominated the last growth rally will lead the next one. That's why he sold blue chips such as  Intel and  Time Warner when he took over the portfolio, replacing them with what he sees to be emerging blue chips, such as  Allergan ,  Seagate Technology , and  Corning .

I can foresee a growth rebound that benefits both undervalued, steady blue chips--along the lines of Lange's discards and Dodge & Cox's fallen growth favorites--and the racier growth that Lange favors. So my Fidelity picks will cover both categories.

Top Fidelity Growth Picks
In the steady growth camp, I'm sticking with  Fidelity Dividend Growth   as my highest-conviction Fidelity fund and a great portfolio anchor. Manager Charles Mangum has struggled over the past several years, but his 10-year record is great. He is stashing 50% of portfolio assets in his top-10 holdings, which included such reasonably priced steady growers as  Johnson & Johnson and  Bank of America . I've been urging investors to be as patient with this fund as Mangum is with his picks (the fund's annual turnover rate is 30%).

And what about on the more aggressive growth side? If you own Contrafund, Magellan, or  Fidelity Growth Company , all of which are closed to new investors, I would hold. The former two are large funds, but their managers are good enough to stick with.

For new investors, I'd consider allocating a portion of your portfolio to one of the following two funds:  Fidelity Capital Appreciation or  Fidelity Growth Discovery . The former is run by Fergus Shiel, who is less a pure growth investor than an eclectic manager who tries to adapt to market conditions. That's a tricky game to play, but Shiel's record, going back to his days on  Fidelity Independence  , demonstrates his uncanny ability to win in different ways. The tiny Growth Discovery, which has seen a number of name and strategy changes over the years, is a purer growth play. Manager Jason Weiner is a Will Danoff protege who has put up great numbers on the handful of funds he has run before. Weiner, a classic Fidelity growth manager who invests according to broad themes, is running this fund as a clone of the much larger  Advisor Equity Growth . Both Shiel and Weiner are fond of trading, so don't expect either fund to be the most tax-efficient.

I list more favorite Fidelity funds, as well as Fidelity funds to avoid, in our monthly Fidelity Fund Family Report. Meanwhile, for funds outside of the Fidelity family that are poised to benefit from a large-growth resurgence, check out our Fund Analyst Picks in the large-growth category.