My track record picking funds and forecasting markets.
By Dan Lefkovitz | 10-23-07 | 06:00 AM | Email Article

A version of this article appeared in the September 2007 issue ofMorningstar Fidelity Fund Family Report, our monthly newsletter dedicated to helping Fidelity investors find superior long-term investment opportunities. To review a risk-free trial issue of our Fidelity Fund Family Report, clickhere. Fund Family Reports on Vanguard and American Funds are also available.

Dan Lefkovitz is a content strategist for Morningstar's Indexes group.

I don't shy away from making calls in the Fidelity newsletter. I know that subscribers want Morningstar's view on Fidelity funds and markets in general, and I see my role as giving advice and predictions rooted in my contrarian investing philosophy.

On occasion, a subscriber will e-mail me and ask about my track record. It's a perfectly fair question. If you're taking advice from someone, you deserve to know if that person has any forecasting skill. My calls are generally long-term oriented, but I'll still tell you what's worked so far, what hasn't, and where I'm going from here.

Go Growth!
For the past few years, Morningstar has been calling for a rebound in large growth, the worst-performing corner of the market since 2000. We maintained our conviction even as smaller caps and value kept winning, urging investors to rebalance if their large-growth allocation had slipped. In April 2007, after a weak first quarter for large-growth, I laid out the case again. The piece also appeared here.

My timing was lucky. Large growth made up a lot of ground during the second quarter and hasn't looked back. Meanwhile, value funds, with their heavy allocations to financial-services stocks, have born the brunt of subprime worries and the credit crunch. Erstwhile superstar small value is the worst-performing style-box-based category in 2007.

The Best Fidelity Fund You've Never Heard of...and Other Picks
It's early in the game, but I'm especially pleased right now with my top pick for playing a large-growth rebound at Fidelity.  Fidelity Growth Discovery  is having a sensational year. When I first touted the fund, it had just $500 million in assets--piddling by Fidelity standards. But since it got a new name, a new benchmark, and a new manager, the fund has beaten the pants off of the broader market and the large-growth category. Jason Weiner has steered it to a 30% gain for the year to date through Oct. 17, 2007, ahead of 95% of its large-growth peers.

Another fund that I've recommended in the growth space is  Capital Appreciation . That fund has chalked up a 17.6% gain for the year. Though it may not be spectacular, that solid return is still far ahead of the fund's S&P 500 benchmark and in the large-growth category's top half. I like manager Fergus Shiel a lot and would stick with this pick.

I also consider  Magellan  a successful call. Morningstar got more bullish on that closed fund from the moment new manager Harry Lange took over, urging long-suffering investors to give him a chance. He has vindicated our stance in 2007.

 Dividend Growth  keeps making me look bad. For the year to date, it's behind the S&P 500, and it's in the large-blend category's bottom quartile for the year to date and the trailing three- and five-year periods. I maintain my conviction due to manager Charles Mangum's concentrated, low-turnover approach; his great record of preserving capital during the bear market; and his demonstrated stock-picking skill. Although portfolio holdings  AIG ,  Bank of America , and  Home Depot  have stunk it up in 2007, they remain great long-term buys, in the eyes of my equity analyst colleagues. If the economy heads south and markets waver, this fund will hold up well.

How about my pans?  OTC , which has been on my Fidelity Funds To Avoid list since that list's inception, has soundly beaten its large-growth peers in both 2006 and 2007. Still, I see the fund's focus on Nasdaq-listed companies as a structural flaw.  Aggressive Growth  and  Focused Stock  are also doing well, which is bound to happen. I just can't recommend funds in which I don't have the utmost confidence. So far, my decision to take  Blue Chip Growth  off the Best Buy list has turned out OK.

Bond Calls
I've said in almost every issue over the past couple of years that the bond market isn't too attractive and that you should stick to high-quality bonds. Unlike the large-growth call, this one hasn't exactly played out. After TIPS, the best bond category for 2007 is emerging markets. The other risky group, high yield, is in the middle of the pack.

Two of my highest-conviction picks among Fidelity bond funds-- Intermediate Bond  and  Total Bond --are underperforming due to subprime.  Municipal Income  is doing well in relative terms but not on an absolute basis. I don't regret telling you to consider money market funds or CDs. With rates around 5%, they continue to look like a pretty good deal. I wouldn't abandon an allocation to bonds, though. We've been hearing from many smart bond managers that the credit markets have thrown lots of good out with the bad.

Foreign
My message here has been three-fold. First, I've pushed you to reconsider your foreign allocation, challenging the conventional wisdom that a reasonable foreign allocation lies somewhere between 10% and 25% of assets. Second, I've steered you toward diversified foreign funds as opposed to niche funds, including those focused exclusively on foreign small caps and emerging markets. Third, I have recommended Fidelity's actively managed foreign funds over the  Spartan International Index Fund .

My first call is far too strategic and long-term oriented to judge over a short time frame. Still, I'll note that foreign funds continue to beat their domestic counterparts. Niche international funds continue to do well, for the most part. Emerging markets took a hit over the summer but have bounced back. I remind you that emerging markets have enjoyed a multiyear run and you have exposure to them through broader funds. As for my fund picks, I'm pretty satisfied. I recommend  Diversified International  (closed),  International Discovery , and  Overseas  above the index fund. All are ahead of the MSCI EAFE benchmark for the past couple of years.

Homebuilders. Ouch.
I recommended homebuilders for the first time in the summer of 2006. At that point, the group was getting crushed on fears of housing market weakness, and Morningstar equity analysts saw value. I recommended Fidelity Select Construction & Housing   as a contrarian bet, and I told you I preferred even purer plays on the builders, ETFs  iShares Dow Jones US Home Construction  and  SPDR Homebuilders .

Horrible call. Housing-related stocks did bounce back in the second half of 2006, but as you all know, nightmare scenarios have played out for real estate here in 2007. Essentially, we all underestimated how bad the housing market would get and relied on book value estimates that have been dramatically lowered as land values fall.

As for what to do now, I'm honestly conflicted. Morningstar has lowered fair value estimates for the builders and still concludes that the sell-off has gone too far. Smart portfolio managers, at Fidelity and beyond, have talked about undervalued opportunities among the group, which makes doubling down an attractive option. But with land prices falling, vacant homes for sale across the country, and mortgage financing drying up, who knows when a recovery will come? I'd hold on but wouldn't bet the ranch.

Finally, a general comment regarding the past few months and the road ahead. Equity markets fluctuate and for some scary summer weeks, they were fluctuating in the wrong direction. Times like these require intestinal fortitude, and, above all, a long-term focus. The subsequent equity market bounce-back that we've seen is a reminder of why abandoning the market based on doomsday headlines isn't a good idea.

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Dan Lefkovitz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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