Large caps run, but Fidelity's large funds lag Stock, sector and country bets fail to pay off for Magellan and Contrafund. By Penelope Wang, Money Magazine senior writer October 11 2006: 2:20 PM EDT NEW YORK (Money) -- With the Dow Jones Industrial Average hitting new highs, and the S&P 500 up nearly 10 percent so far this year, you would think that would mean good things for shareholders in Fidelity's two largest funds - $45 billion Magellan and $65 billion Contrafund. You would be wrong. More from Money Magazine Put Santa's elves on a budget Squandering a minor's trust fund Weaker dollar, stronger returns Best Places to Live Current Issue Subscribe to Money Mutual Fund Screener Domestic Stock Funds Select to Activate Large Growth Large Blend Large Value Mid-Cap Growth Mid-Cap Blend Mid-Cap Value Small Growth Small Blend Small Value Bear Market Search the full range of fund types Return of at Least: Any 3% 5% 7% 10% 15% 20% Over the Past: All 1 Year 3 Years 5 Years 10 Years Expense ratio less than: Category Average 2% 1.5% 1% .5% More Tools Millionaire calculator Rate of return calculator Asset Allocator

For the year through Oct. 4, Fidelity Magellan (FMAGX (Charts)) has gained only 2.7 percent. That performance lags seven percentage points behind the Standard & Poor's 500 index and places the fund in the bottom 3 percent of its large-blend peer group.

Fidelity Contrafund (FCNTX (Charts)) lags the S&P by 4.4 percentage points, with a 5.3 percent return. And although Contrafund still ranks in the top 20 percent of large-growth funds year to date, it plummeted to the bottom 20 percent of its category in the third quarter of this year.

Both funds are closed to new investors, but they are still available to millions of 401(k) plan participants.

This sagging performance is especially disappointing for long-suffering Magellan investors. After all, they were hoping for a turnaround when new manager Harry Lange came on board nearly one year ago from top-performing Fidelity Capital Appreciation.

Lange quickly jettisoned many of the stodgy mega-cap holdings favored by former manager Robert Stansky, who had persistently lagged the S&P 500, and replaced them with fast-growing technology, health care and energy stocks. He also put nearly 30 percent of the fund into foreign companies, with a large stake in Japanese stocks.

The strategy worked well at first. And then it didn't. Among Lange's top holdings, United Healthcare (Charts) is down 20.2 percent, Genentech (Charts) is down 11 percent and Peabody Energy (Charts) is down 12 percent.

Lange's Japan stake didn't help either - the MSCI Japan index is down .2 percent, compared with a 6.7 percent gain for the MSCI EAFE index, which tracks the markets in Europe, Asia and the Far East.

Says John Bonnanzio, group editor of Fidelity Insight newsletter, "The bets that Lange made turned on him."

A growth investing approach also hurt recent returns at Contrafund, a fund that has delivered great long-term performance despite its huge size.

Manager William Danoff began loading up on growth stocks, including technology and energy, back in 2004. And top holdings, such as Google, helped the fund soar 16 percent last year.

But in the third quarter many of the fund's largest stakes imploded, including Marvell Technology (Charts) (down 41 percent), Genentech (11 percent) and Newmont Mining (Charts) (down 23 percent).

Fidelity spokesperson Vincent Loporchio says there is no reason to be concerned by a few months of poor returns. "We take a long-term view of performance, as do our shareholders," says Loporchio. "And we have confidence in the abilities of these portfolio managers, who have proven track records of performance."

Certainly investors should not overreact to a few months of short-term returns. Markets can turnaround quickly - and many investing experts are predicting an eventual rebound in the large growth stocks that these managers favor. So if you already own these funds, then it makes sense to hang on for now.

But if you are just signing up for a 401(k), you may want to consider your other fund options first.

"Will Danoff is a great stock picker," says Greg Carlson, mutual fund analyst at Morningstar. "But with such a large asset base it will be more difficult for him to deliver outstanding returns in the future."

As for Fidelity Magellan, Carlson says, "The jury is still out on whether Lange can reproduce his performance at Fidelity Capital Appreciation in a much larger fund."

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