High Fidelity

After a topsy-turvy period marked by under performing funds and a reshuffling of its research staff, Fidelity Investments had a strong showing in 2007. However, analysts caution against flocking to a fund family based on one year's return.

When it comes to picking stocks, star Fidelity Investments fund manager William Danoff says he can't do it alone.

Danoff, head of Fidelity mutual funds including Contrafund, one of its largest, is coming off a powerful 2007 based on bold stock picks like search firm Google Inc. - lately Contra's single largest holding and one that rose 50 percent in 2007. Danoff says a lot of the credit belongs to stock analyst Kristina Salen, who joined Fidelity two years ago as part of a broader effort by the company to bulk up its research staff - which is now paying off.

"One of the unspoken advantages of having a stronger research department is that you bet bigger, earlier," Danoff said. When it comes to a complicated stock like Google, for instance, "Kristina's speaking with Google every week, she's out there every month, and she has a lot of contacts." With another analyst, he added, "Maybe it wouldn't have gone as smoothly."

Welcome to Fidelity's new stock-picking machine. After several so-so years, Fidelity's equity funds roared back in 2007, returning 11 percent against 7.8 percent for all other fund families, according to research firm Lipper. Fidelity's Contrafund helped lead the way with a return of 19.8 percent last year, and its flagship Magellan fund posted an 18.8 percent return, in a year when the overall market, as measured by the Standard & Poor's 500 index, returned 5.5 percent.

In all, 60 percent of Fidelity's diversified equity funds were on track to beat their category averages through Dec. 21, according to an analysis by Morningstar Inc., up from 48 percent in 2006.

Danoff and other Fidelity executives say the results reflect a broad reshuffling of its research staff begun in 2005, when the company started bringing in more experienced analysts and created a career track in which the positions weren't meant only as a steppingstone for individuals to become portfolio managers.

"When we started this game plan in '05, we knew it would take a few years," said Walter C. Donovan, Fidelity's head of equity investments. "Now that we're several years into it, we think it's starting to pay dividends."

Outside advisers who follow Fidelity caution that investors shouldn't pile into holdings just because of one good year, since three- and five-year returns are better measures. Many people seem to have gotten the message: For the 11 months ended Nov. 30, Fidelity funds pulled in $2 billion in new money from investors, according to the most recent figures from Financial Research Corp. of Boston, far behind competitors, led by Vanguard Group Inc. of Pennsylvania, which took in $70.6 billion. (The figures exclude flows to money-market funds, a Fidelity strong suit.)

Also, Morningstar's Dan Lefkovitz notes that Fidelity's bond funds haven't had as much success, misjudging risks in the housing markets. Still, Lefkovitz and several analysts say Fidelity deserves credit for sticking with the changes put in place by Fidelity chairman and chief executive Edward C. "Ned" Johnson III and by Fidelity's then-chief operating officer, Robert L. Reynolds.

"Really 2007 was the first calendar year we saw this bear fruit," said John Bonnanzio, editor of the Fidelity Insight newsletter. "The question is whether this persists or is just a function of Fidelity being in the right place at the right time."

Indeed, Fidelity and some of its competitors, such as American Funds, often face concern their products have a built-in bias that allows them to do well in years when large "growth" stocks go up - in other words, stocks in industries whose total earnings or revenue are increasing, such as technology firms. These companies make tempting purchases for big fund firms, which have so much money to invest there simply aren't enough smaller firms to satisfy them.

Donovan said he has heard this criticism before, but Fidelity is positioning itself "to make money for all our shareholders in all market environments." He said one sign Fidelity has done so is that all 10 of its sector funds - funds that focus on particular industries - beat their benchmarks last year and for the past three years, excluding fees.

That's also a sign, Donovan said, of Fidelity's growing research capabilities. As of July, Fidelity had 504 analysts, up from 314 in mid-2005. Traditionally, the company hired analysts straight out of business school, but in recent years it has brought in many with more experience. He mentioned John Dowd, who covers the energy sector and previously worked at Sanford Bernstein. At the same time, Donovan said, Fidelity still hires other analysts at a young age, such as Michael Valentine, a 2005 Amherst College graduate who follows the steel industry.

That traditional model "will still be the majority of analysts here, but that could change over time," Donovan said. "We've gotten a lot of traction with people from the outside."

Danoff says Donovan himself deserves credit for pressing his investment staff to take risks, changing compensation structures to reward high returns and pay less for mediocre records. Donovan also moved aside five analysts, Danoff said, and sent a message both to analysts and portfolio managers that he expected more.

"It's like when Bill Parcells took over the New England Patriots," Danoff said. "The guy is not accepting of mediocrity."

Fidelity's fund turnaround comes at a good time for the family-controlled firm, which faces an uncertain future with the 77-year-old Johnson at the helm and no clear successor. As the funds stumbled in recent years, Fidelity often has seemed to put as much emphasis on other areas such as 401(k) products and its electronic brokerage business.

Now the improved numbers are giving many more marketing options for Rodger Lawson, a longtime Johnson confidant named Fidelity's president over the summer, and for Johnson's daughter Abigail, who recently was given more responsibility for the firm's public image.

Lawson has said he plans to put more emphasis on individual Fidelity products in the firm's advertising, and James Lowell, editor of the Fidelity Investor newsletter, said he's already noticed a shift in Fidelity's ad content to emphasize particular funds, even smaller ones like Growth Discovery with $1.9 billion in total assets. And improved performance will enable stronger advertising, he said.

"Their performance has been nothing short of stellar," Lowell said. "But where you've really got to seek victory isn't just performance, but also inflow of assets. That's where Fidelity has to do a better job of broadcasting they were the ones who wrote the book on growth-fund investing."

Ross Kerber can be reached at kerber@globe.com.