Will Danoff: Succeeding at Scale
Fidelity Contrafund's longtime star manager on why he runs money, how his definition of "edge" has evolved, the best way to engage with analysts and company management, and more.
Our guest this week is Will Danoff. Will runs a number of Fidelity equity strategies, best known of which is Fidelity Contrafund, a mutual fund he has been managing since September 1990. During his nearly three-decade tenure at Contrafund, Will has trounced the market indexes and, even more remarkably, managed to maintain the fund's performance at scale. Indeed, Contrafund was recently home to more than $120 billion in assets and has ranked among the world's largest funds for many years. For his accomplishments, Morningstar named Will its Domestic-Stock Manager of the Year in 2007. Prior to becoming a portfolio manager, Will served as a retail analyst at Fidelity and for a time as assistant portfolio manager at Fidelity Magellan. He's a graduate of Harvard University and earned his MBA at the Wharton School of the University of Pennsylvania. We're thrilled to have him as our guest.
Meetings with Management
Circle of Competence
Investing in Private Firms
Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, director of manager research for Morningstar Research Services.
Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar, Inc.
Ptak: Our guest this week is Will Danoff. Will runs a number of Fidelity equity strategies, best known of which is Fidelity Contrafund, a mutual fund he has been managing since September 1990. During his nearly three-decade tenure at Contrafund, Will has trounced the market indexes and, even more remarkably, managed to maintain the fund's performance at scale. Indeed, Contrafund was recently home to more than $120 billion in assets and has ranked among the world's largest funds for many years. For his accomplishments, Morningstar named Will its Domestic-Stock Manager of the Year in 2007. Prior to becoming a portfolio manager, Will served as a retail analyst at Fidelity and for a time as assistant portfolio manager at Fidelity Magellan. He's a graduate of Harvard University and earned his MBA at the Wharton School of the University of Pennsylvania. We're thrilled to have him as our guest.
Will, welcome to The Long View.
William Danoff: Thanks, Jeff. Excited to be here.
Ptak: So, why don't we get things started. We'll widen the aperture, so to speak, and talk about sort of the general theme of “focus.” You're well known in investing circles. But you know, you're not necessarily part of the zeitgeist. You haven't appeared in commercials or written books or taken to Twitter, and you could do any of those things and gain a big following and greater notoriety. So, the question is, Why haven't you? Seems like, maybe that's a conscious choice you've made in how it is you're going to spend your time and focus as a portfolio manager. Maybe that's a good place for us to start. Why haven't you done those things?
Danoff: Well, Jeff, just to make sure that we're level set, I do believe that there is a Fidelity commercial about a letter that I received in 1993 from a new Contrafund investor. You can go to YouTube, I think, and search for me or the letter advertisement at Fidelity. And if you haven't seen it, it's a very good letter. And I think that probably partly explains why I haven't been as active on social media. I'm working for the shareholders. And this letter was written by the parents of a young child, 1 year old boy. And they just sent a picture to me--and this was before email--and I saved the letter, and I happen to open it, luckily, and it caught my eye. Go to YouTube and hear the story. But we're working for the shareholders here at Fidelity, and I take that quite seriously. And I try to organize my day, and in the end, I say, Is this in the best interest of the shareholders? And if it is, I tend to go to a meeting or two--probably go to more meetings--because I say maybe I'll learn something by going to a meeting.
And also, I think at Fidelity, we got a great team. And when you have a great team, it takes time to work with the team, make sure you're listening to your analysts and associates and other fund managers. And if you're out there, somebody, I think, famous once said, “You don't learn anything if you're talking all the time” and something about “You got one mouth and two ears, you should use them in that rough proportion,” but it's just who I am. I mean Fidelity is an unbelievable organization. I feel really lucky to be here. And I think Fidelity lets people be who they are. And as investors, we all need to play to our strengths and be who we are. This is sort of who I am. I like to call companies. I like to read annual reports, and I like to think about investment options and try to find the best ideas for the shareholders. But there's no question that if you put it in the lens of working for your shareholders and doing what's right for the fund shareholders, you're probably going to be working harder and hanging out in the zeitgeist a lot less.
On the other hand, you do have to find the right balance in life. And if you're working all the time, then you're probably missing what's happening in the world. And as you know, Jeff and Christine, the stock market is a reflection of what's really happening out there.
Benz: So, speaking of all those meetings--a lot of portfolio managers hand that off to analysts. They hand off responsibility for security research and talking to management. You're different. You've always been different in your approach. It sounds like that's personality-driven--that you like to dive into those details yourself. But can you provide any more color on why you continue to be so involved in those meetings? And in talking to company management--what do you think you get from that experience?
Danoff: That's a great question, Christine. Again, we're all a product of where we started in the business. And I was lucky enough to start at Fidelity and work with Peter Lynch and some of the other great fund managers here, Bruce Johnstone and George Vanderheiden. And the culture of Fidelity's research first, and everyone really started as an analyst in the research department and then continued to be an analyst even though their title might be a fund manager. So, I find that to really engage one as an investor, you need to engage with managements and then also to engage with analysts and other fund managers you have to be an analyst. So, I don't know that many great investors who aren't great analysts. But Fidelity gives us this great platform because we're one of the largest institutional investors. The management teams come to Fidelity or want to call Fidelity when they're embarking on a new strategic direction or after a big strategic move has been made, whether it's a merger and acquisition, or when they appoint a new executive to run the company. Often, that executive will figure out what they want to do for six months. And then they want to talk to the largest shareholders, the potential largest shareholders.
So, we have this great opportunity, virtually every day, I can meet with executives from five or six companies, maybe a few less on a quiet day. But there's a tremendous opportunity to learn and to monitor what's happening. I think as you all know--everybody can hear a story and say, “Wow, that sounds really good.” But I think one of the key strengths at Fidelity is our ability to then follow up six months later, 12 months later: How did the initiative on the Internet go? How did the initiative in India go? How did the growth initiative in China go? How did the new acquisition in Europe go? And to monitor what's happening. Life is such that clearly all the new growth initiatives won't meet expectations. But if they don't, what are we learning from that? What are we thinking about management? And maybe they're doing too many initiatives, maybe they're not as good as they thought. Maybe another competitor is doing a better job. So we can learn, but the monitoring of these companies takes a lot of time, but it can be very, very instructive as to the quality of the company that you're invested in or considering investing.
So that's the other reason why I spend a lot of time going to these meetings. But partly, it's just this opportunity. I think one of the huge competitive advantages Fidelity has is our access to managements and access at important inflection points. But the real key is not just to hear the story but to follow up. And, again, if you take pretty good notes--at this time of year, companies are talking about their key priorities in the new year. And then hopefully, in six or nine months, we'll be able to follow up and say, “How's it going?” or at the end of the year, say, “how did you do and what else are you going to change?”
That’s just the way life is--you got to keep moving forward, and do the best you can, but I personally like to interact with management teams, and I owe it to my own shareholders to say every day I'm coming to work, I'm looking for new ideas. I'm monitoring my existing ideas, and I'm across the table from decision-makers or other executives saying, “What are you doing to strengthen your franchise? What are you doing to grow your company's earnings per share? What are you doing to defend your competitive position?” And then also, “What are you doing, about certain mega trends that we all are living with, the emergence of the Internet, more competition from low-cost countries and other big trends that we see over and over?”
Ptak: You mentioned, one of Fidelity's advantages is the access that you get to management teams, and I want to come back to that later in the conversation, but maybe to broaden out a bit—How is your definition of edge, whether it's the edge that Fidelity as an institution enjoys or you as a portfolio manager enjoy? How has that changed in the last few decades in which you've been running money?
Danoff: Yeah, Jeff this business is really competitive. And I'd say that we have meetings with these managements just like the other large institutions.
Danoff: I think over time, maybe, you grow as an individual and you gain experience. So, I'd say my emotional coefficient has improved. I tend to try to empathize with the executives that we're working with and try to think about what they're thinking about and maybe ask good questions. I remember as a young analyst being told to go to a lunch, and I raced to the meeting--or I think it was maybe when I was a young fund manager in the early ‘90s. And I was going to as many meetings as I could and just wanting to learn as much as I could. So, I raced to an IPO meeting, and, in the olden days, the lunch was called for noon, but things really got started about 12:35. So I ran into at about 12:35, and there was an empty seat, and I sat down. And I introduced myself to the person to my left, who turned out to be the CEO of the company. And I only knew the name of the company. I hadn't really prepared, but I was just going to just learn about this new company. So, I said, “Well, what's your strategy to grow your company in the next three to five years?”
And I think that's a legitimate question to ask. But I can assure you nowadays, I would have at least skimmed the prospectus to know what the company did. And ideally you're asking good questions to learn as much as possible about an industry, about that particular company, and about that particular executive. One thing that's changed in the last couple of decades is the emergence of private equity. And there are all sorts of companies that have had multiple owners. You think about if you were an employee at a company like that. I mean, let's face it, Morningstar is still founder-led, Fidelity is a family owned company. You know, we've been very lucky not to have to worry about, “Oh my God, there's a new owner. What are they going to be doing? Are we going to get sold again to some conglomerate or to some private equity firm?”
So, I think, for me, one of the advantages over time is to be able to think long term and to try to think about what's on the minds of the executives on the other side of the table. And when these companies do come around to Boston, they presumably have an agenda. And sometimes it's just a matter of, “Hey, you know, you haven't been to Boston in a couple of years. Why are you here?” And often there is a story to be told, and they want to express it to potentially large shareholders, and sometimes there is a subtext, and you've got to try to anticipate what are the other person's objectives. And that can be subtle, and experience helps there. But you and your listeners--you're sophisticated investors. You can't always assume that managements going to do the right thing. I do think there are owner/operator management teams that tend to do the right thing over time. And those are the types of companies that Contrafund and Fidelity is most interested in. But there's something to be said for not going to any meetings.
You know, you think about the great Warren Buffett. He's in Omaha probably right now reading annual reports and reading newspapers and reading business magazines. So, I think partly every investor has to play to their strengths, and Fidelity and other big institutional investors have a huge opportunity because these management teams are willing to talk to us and visit us. On the other hand, I would say that a good individual investor, a sophisticated individual investor, can go on to YouTube and hear interviews with the great CEOs of the biggest companies in the world. I mean, you can see Tim Cook giving commencement addresses, you can see Mark Zuckerberg being interviewed, you can see Jeff Bezos being interviewed. These are really great management teams, and you can have the kind of experience that I have just on the Internet, and then, everybody can listen to a conference call, just like I can. Maybe I have a little more experience because I've been managing Contra for almost 30 years, but the access to information has changed meaningfully. I mean, when I was an analyst, I can remember calling companies after they reported and pleading with somebody in the CFO’s office to either read me the details of the income statement and balance sheet, or then to fax me the information quickly, but I do remember part of the job was to call the company and ask for a packet. And then two weeks later a packet would arrive.
So nowadays that can all be done electronically, immediately. So, I think you mentioned the word edge, I don't think about edge at all. I think about trying to understand the facts, trying to use my accumulated industry and company knowledge to anticipate the future. And often, it's really just, Is this company going to be bigger and better and stronger five years from now than it is today? And if I like the management team, and I'm confident that they're going to be able to grow, and I like what they're doing. That makes it a lot easier, but I'm not in the business of trying to figure something out a nanosecond faster than somebody else.
Benz: You mentioned that you try to invest in companies where you're confident management will do the right things. But how often, if ever, do you get involved with giving management your opinion about what you think they ought to do? Or do you just keep that to yourself?
Danoff: Yeah, that's a really good question, Christine. I remember being on a panel with Nelson Peltz, and Nelson, who does a great job at Trian, likes to write white papers on the company's business and then start telling management what to do, and I said, the only letter I ever wrote to management was thanking them for a great job and an update that I found particularly helpful. And again, it goes back to who you are, and maybe certain money managers have to justify their higher fees by being out there pressing management, but you know, it's a very good point, Christine. Again, I tend to want to invest with managements who I think are going to do the right thing over time, but there's a lot of trust there. And other investors may say, “I'd want to crack the whip and push management faster or harder.” That tends not to be what I do. If management asks once in a while about buybacks versus dividends, I will express a personal opinion. But historically, I have found that if you can identify people that you trust, that are extremely knowledgeable about their industry and enthusiastic about their company, and in some cases, ideally, are founders of the company—and, therefore, the company is an expression of who they are and what they are and they really want to grow the company--then that's the perfect situation, especially if it's a good business and they have a differentiated product offering and a great value proposition.
I mean, I was the retail analyst at Fidelity in the mid ‘80s. So, I remember the early days of companies like Costco, and management has experimented with new ideas, but generally speaking, they're close to their customers, they had a great value proposition. They made some mistakes and learned from their mistakes. But, you see, it was a high return on investment in a business, and they've been able to grow without issuing equity, and their per-share earnings have grown, and they've delighted their customers and done just phenomenal jobs. When you look back over a 20-year time horizon, you just see a pattern that you want to replicate going forward. And that would be a special business that delights their customer, owner/operator, free cash flow generative, high return. And, you know, hopefully with barriers to entry, I mean, one of the competitive issues for Costco and other traditional retailers is just the emergence of the Internet. And that often is hard for managements that have done so well. You think about your own life: If you're strong in one area, you don't necessarily want to change, and managements sometimes have difficulty changing because they've been so successful.
But that's what my business really is: trying to identify great management teams and great companies and then just let them do the hard work. But there's always controversy. There are always reasons to worry. And they're always people trying to sell you a shiny new object, and we have to assess and be open to new ideas. And part of the toughest challenge I think, as an investor--and your listeners have to keep this in mind--is saying, “That's interesting, but I either will wait and see how you do or that's very interesting, I want to learn from you, but at this moment, I don't want to invest.” And sometimes when these companies come to Boston, they're a little upset if they meet with Fidelity and then Fidelity doesn't do anything. I have to explain that I've become a little stodgy in my old age. And I like a lot of the companies I own, and I'm monitoring them, and I'm very excited about them. So, the bar has risen for the Contrafund. To make it into the starting lineup is not easy.
Ptak: And so does that tend to be a function of kind of how you would assess opportunity costs associated with entering into a new idea? You know, sort of like, basically the cost of that being whatever capital you'd have to divert from your next best idea, or does circle of competence, however you would define that, enter into it as well?
Danoff: Yeah, no, it's a combination, Jeff. That's a really good point. I think the key to being a great investor is being open to new ideas, learning from new ideas, and finding that right balance between waiting for the right moment. But again, circle of competence to me means you know your companies well, but you also know certain sectors particularly well. One--you have to make sure that you understand the threats to your existing holdings, but also, there's usually a pivot point where a concept then turns into a profitable business. And this is always this debate I have when I think about biotech as a sector, and there are some very smart scientists who are pursuing important – on medical needs. There could be big economic opportunity if these biotech companies can solve some of these disease opportunities. But do you wait for good phase 2 data? Do you wait for good phase 3 data? Do you wait for FDA approval? Do you wait for, God forbid, revenue and profit? And this is always the great debate. But this is what we do, and we try to do the best we can. Mistakes are made, but I think that's the other advantage I have at Fidelity where we have a lot of young analysts and associates who are more open to new ideas. And they've grown up with a smartphone in their pocket and can help me understand the trends that are a little more difficult for an older fund manager to appreciate and understand.
But the ideas of delighting your customer don't go away, whether it's finding a new drug for a rare disease or developing a new software program, either for an enterprise or for a consumer. I just feel more comfortable with the idea of touching and feeling, interviewing management, trying ideally to go to as many company presentations or user conferences. For a long time, I was a little late to the software-as-a-service sector. And then I went to Dreamforce, which is Salesforce.com's user conference out in San Francisco. And I think 150,000 people went to the conference over a week in San Francisco, and I was just blown away by the enthusiasm of the employees and the customers, and that can be priceless in terms of your appreciation of the strength of a franchise.
Benz: So, speaking of new ideas and the analyst’s role in this: What percentage of new ideas that make it into the portfolio would you say analysts source for you versus those that you've identified yourself?
Danoff: I'm not sure of the percentage, Christine. I'd say a healthy research department is a joint effort. And the analysts ideally are coming to me with their best ideas. We're having a healthy debate and discussion about those ideas, and then I'm presenting ideas to them. Joel Tillinghast, who's the great manager of the Low-Priced Stock fund, and I have done very well here at Fidelity. And I think we've done very well because we're both large consumers of the Fidelity research department's ideas and efforts, but we also work closely to influence the research effort and what stocks the analysts are emphasizing.
So, I'd say it's a very healthy give-and-take and dialogue. And I would say, often because Joel and I and all the other fund managers started as Fidelity research analysts, when a new analyst arrives, they usually show up at my office with a list, and say “I'm the new railroad analyst. Here are my names, and I like XYZ railroad because the group's trading at 14 times earnings, and this ones trading at 11 times earnings.” And I might say, “Wow, that's interesting. Why is that one trading at such a discount to the group?” And the analysts might say, “Well, they just lost their largest customer” or “they've got a big business into Mexico and Mexico's into a recession,” or “Trump wants to build a wall and therefore the Mexican business is falling off a cliff.” And I usually say, “That's not the type of company I'm interested in. I'm interested in companies that are doing well, where the earnings outlook is positive, where earnings per share is growing. Maybe it's growing faster than people think. What do you have on your list that would fit that bill even if it's more expensive than the average company in your group?” So, it's that's sort of give-and-take. And I might encourage an analyst to reorient their priority list to help me look for stocks that fit my ideal pattern.
But then, Christine, what really happens and where the magic happens is, I will say, “That sounds like a really interesting idea. Let's call the company together, or let's go visit the company together.” Because, if you, Jeff, and I were working together, and I was just out at a conference and came back and said, “Oh, my gosh, ABC Company sounded awesome. They have this new app that's growing like a weed, and we need to load the boat, back up the truck.” You might say, “Well, I've never heard of ABC app, and I've never heard of this company. It's really hard for me to get excited about it like you. So, let's call the company together so we can hear the same story, look at the same facts together, and then decide what the challenges might be facing the company going forward. How high are expectations? How good is this management team?”
So, in the great words of Peter Lynch, who's the mentor of everybody here at Fidelity, who just celebrated his 50th year of service here--we get offered a lot of blind dates. And our real challenge or our job is to ask for a picture. We want to look before we leap. And so that's sort of what I do well, I think, is to try to ask for a call with the management team. So “Hey, that sounds really good. I respect you. I'm leveraging your industry expertise. If you think ABC Company is the best in your group, I'm willing to accept that. Let's then call the company together. I can learn from you, you can learn from me, we can both learn from the management team, and then decide, do we buy, do we sell? Do we decide to buy another company or one of their customers or one of their suppliers?” And if you do that every day, for 29 or 30 years over time you gain some expertise and hopefully you improve your batting average and add value to the shareholders.
Ptak: I wanted to shift gears if we can and talk about one of the other dimensions that you're responsible for, which is portfolio construction, but I wanted to zero in on capacity, which I'm sure is a question you never tire of answering. You do run a lot of money--I think over $100 billion in assets as of last year across the different strategies that you're responsible for, the largest of which is Contrafund. There are obviously trade-offs. Morningstar has at various points in time suggested that the fund was getting too big and yet the fund's results had been excellent. So, in your opinion, what do you think we got wrong?
Danoff: Jeff, just again, to make sure the facts are correct. I think the book of business is about $185 billion now, maybe a little higher. But mostly that's market appreciation. The market, as you know, has been unbelievably good. Honestly, Jeff, you have to play to your strengths. And being a very large fund has enabled me to have an unbelievably strong research department. So, Fidelity can monitor virtually every public company in the U.S. We can monitor every industry in the world. And we can also monitor all of these companies overseas. The world, in many ways, has gotten smaller, and what's happening in China is very important to the rest of the global economy. India is emerging as an important experimental ground for a lot of new technology as well. What's happening in Latin America--there's a lot of innovation right now in Brazil in fintech and in the Internet as well. So, having this global research department can, again, help me understand trends, help me appreciate which of my U.S. companies are executing well all over the world, which ones are open to new ideas, which ones are monitoring these ideas and responding and strengthening their businesses.
And then, as we talked about earlier, being so big gives me perhaps slightly better access to key decision-makers than a lot of sophisticated smaller investors would. You know, I've been a shareholder of Google, now Alphabet, since the IPO in 2004. So that's—whatever--coming up on 16 years, and I don't know, maybe 10 years ago, we decided that we needed to visit Mountain View more regularly and asked for visits with somebody other than just the CFO. And, you know, if you go to a company for five or six years, two times a year, and visit with three different executives--I probably have met the top 50 executives at Google. And that's one way to improve your understanding of important trends that important companies like Google are seeing and then assess the quality of the management below just the CFO or the CEO. I mean, it's great, and clearly, culture starts at the top, but when you have access to people who are making the decisions, who are actually out in the field seeing the competitive response or knowing the challenges of delighting the customer, that can really, really help, and I think larger funds like Contrafund have that advantage to do more in-depth research.
You know, if you think about it, Jeff, the larger companies in the S&P now are $1 trillion market caps. These are behemoth companies. And the name of this show is The Long View. We've been very lucky that in the last 10 years, these mega-cap companies have been able to continue to grow. But I would say capacity is one that I think a lot about. And so far, we've done well. I have told your colleagues--Katie's done a great job monitoring what I've done at Contra over many years--that if I didn't think I could beat the S&P 500 I would ask to close the fund. Managers here at Fidelity have asked me to close in the past, and I've decided for political reasons that I would agree with my managers, but then we've reopened. I have never gone to management and said, “I don't think I can beat the S&P 500.” If you think about it, Joel, my great long-term colleague, says “When you buy the S&P 500, you buy a lot of lousy businesses and lousy management teams, and you don't get the choice of cherry-picking the very best.” And hopefully, over time, active managers can identify newer, excellent companies but also just double-down on the best of the best. Clearly, there is survivor bias in the S&P 500, so it is hard to add value over time. But I think I can do it. And I've added value relative to the index. And the last 10 years with interest rates falling so much and the havoc wreaked by the global financial crisis has been more difficult, but I think I'm 100 basis points or 150 over for the last 10 years.
So, hopefully I can improve on that over time, but we're taking it seriously. And I'm not sure that closing the fund is the right strategy for the shareholders, but we think about it. But capacity--you know, I'm my degree of difficulty is harder than a smaller fund. But I have experience. I think it would be hard if I hadn't grown up with the fund. And I've been with the Contrafund for 29, almost 30 years. So, it's a little easier. You just deal and--we've got a lot of colleagues that I've known for a long time--so, I know their strengths, and I try to learn from my mistakes, but mistakes are part of this business. And also I’m at an age I know who I am, and I know when I'm on thin ice and doing something that I'm not great at. So, I try to stay within my own circle of competence.
And, you know, I would say this business is sort of like a poker game. I don't whip the fund around. Turnover is maybe 35%. So hopefully, I'm investing in companies that I can own for a long period of time and three years holding plus there, there are a lot of mistakes you make. It's like, oh my gosh, you know, XYZ is going to hurt this company. So, you sell a little and then you realize you overreacted. I am trying to reduce my turnover. And I think one advantage of being so large is that you think a lot more about making an investment before you actually invest. And, again, this is an iterative process. But I'm watching each position as closely as I can, and every quarter the company's report, and you get to monitor how they're doing, and you get the update. You know, what I tell the team is, “When in doubt, let's call the company.” And again, as a large shareholder, I have that opportunity to just call the company, or the Fidelity systems are good that I can pull up every weekend the research notes that have been written on my top 50 positions, and the top 50 might be 65% of the fund.
So, you know, I can monitor what's happening and review what's happening regularly. But, Jeff, we have a lot of great fund managers at Fidelity that have smaller funds. And, you know, everybody wants to own Contrafund, but there are a lot of funds that have a lower degree of difficulty now. The managers are less experienced, but everyone has to hustle. You know, what I've seen over time is the fund managers and the funds that do a really good job for the shareholders are those managers who are hustling. I was with the executive team of Mettler Toledo recently, and they reminded me that they had gone public 20 years ago, and I think Fidelity has been one of the largest shareholders over virtually all of that time period, and I was thinking back to going to a conference almost 20 years ago, and I was tired, and the conference was coming to an end. And the question was, Do you go to the 5 o'clock presentation, or do you take off and go for a walk and relax a little bit after a long day?
And I said, “I have to go to this presentation. I've never heard of this company, and it looked like they were growing.” And another 45-minute presentation had to be done. So, I went, and I was really excited about the story. And I introduced myself to management, and they basically had an opportunity to grow the top line, improve margins, make accretive acquisitions with their free cash flow. And they were a relatively small player with a differentiated product and mostly selling balances to labs. And they've just kept executing. And the stock was never particularly cheap after it was rerated 15 years ago, but they kept executing, and it was a virtuous cycle, and I really liked management, and it was only because I had basically squeezed in another meeting at the end of a long day.
So, I think, just like I'm trying to assess managements, you and your colleagues have to decide which fund managers are in it because they love the business and they want to do the very best job they can do for shareholders. But capacity is what it is--that was a decision that I didn't make. I do feel, honestly, Christine and Jeff, that a large fund can only do so well and that smaller funds may do better than I do. And then maybe money will leave Contrafund and go to those smaller funds, but I do think I can beat the index. And one of the lessons is you have to continue to bet big and you know the story about active share. So, I'm trying to bet big with the bigger companies. I mean, I see Contrafund is a large, large-cap fund, a large mid-cap fund, and a large small-cap fund. And there's no question that it's important even though I'm such a large fund to continue to plant seeds in the small-cap space with management teams and with companies that I think can grow into bigger, bigger companies and make a difference over time.
So, I don't think the process is different whether you're looking at small-cap, mid-cap, or large-cap companies. There are large-cap companies that are in a growth mindset that, even though they're large, can continue to generate a lot of shareholder value. And it's just a matter of finding those companies. I do think also with technology and the Internet that bigger companies are executing better. It's harder for smaller-cap companies in certain industries to gain traction because the larger companies have just very strong winner-take-most type competitive positions. That has been a change over the last couple of years. But in every industry, there are new emerging themes, and hopefully, the Fidelity research department and I can identify those themes and find companies that are going to benefit from those themes. And hopefully small mid-cap companies can grow into bigger companies.
Benz: So, you've mentioned circle of competence a couple of times. Do you have kind of a “too hard” pile--either types of companies or maybe industries that you just say, “This has not historically worked out well for me. I'm going to not spend my time there”?
Danoff: That's a really good question, Christine. Do you attempt to improve what you're not good at? Or do you play to your strengths and just put all your energies into what you're good at? And I think as human beings, it's a lot easier to do the latter. I'd say part of the wisdom of experience is to know where your circle of competence begins and ends. And I think that all experienced investors have made mistakes and are more aware of when they're approaching thin ice. Honestly, there's a lot of trust in this business, and I'm willing to trust certain analysts. In the biotech area--I took biology 40 years ago--so, I am way out of date. The older mind is not as nimble as the younger mind. So therefore, you are trusting management teams and experts in certain industries to guide you, and hopefully I'll understand the financial ramifications if the company is successful, and I can make an assessment if I think the scientists or the technologists are going to be able to execute on their plan, and every industry is a little cyclical. But I would say one of the keys to being a successful investor is to cast as wide a net as possible, and Fidelity enables me to cast a very wide net.
And, again, paying attention and monitoring out-of-favor groups and trying to identify – I can remember when everyone hated the airline industry. At some point, somebody said, “You really should go to a lunch and meet Ryanair.” And I said, “Really?” And they're the low-cost operator in Europe. And I went to a lunch in the mid to early 90s. And it was again, it was a Friday afternoon, maybe in the summer, and there weren't that many people there. And the executive said, “You know, we're not really competing with the airlines. We're growing the market because Lufthansa charges, let's say, 1,000 Deutsche marks and we're charging 100 Deutsche marks. And I was like, “Wow, how do you do that?” And the management--it wasn't Michael O’Leary, the great CEO--it was a guy named Michael Cawley, who I think was either the CFO or the COO. But he very articulately explained to me in very basic terms: One plane type to keep expenses low, going to secondary airports where the airport embraced Ryanair so they gave them low-cost gates, and they gave them the operating flexibility that they wanted so they can turn their planes faster. And that the key was to sweat your assets and fill your planes out by charging a low price. And, as you know, there were constraints on when you can book and only one class and no free food and all that stuff. And they have basically gone from a startup airline in Europe to I think--they're like 25% of all passengers now flying in Europe fly on Ryanair, and they've done a great, great job. But at the time, people weren't paying attention to airlines and Europe was sort of a no growth, low growth space. But when it comes to some of the tech and the biotech, I'm treading more lightly.
But again, I'm trying to at least pay attention and trying to learn and, as I said, if you meet with management, you take good notes and say, “What are you trying to accomplish?” And then you go back after a year and say, “What have you accomplished? How have your priorities changed?” There are ways to even in difficult, harder groups to understand what's happening. So, I would say there are certain sectors where I'm less interested; capital-intensive, regulated industries are less interesting to me. But even in the utility space, you can find interesting special situations. Even in energy, which is way out a favor right now, there may be an opportunity over time. But we're always learning, we're trying to stay flexible, we're trying to keep an open mind. And, in addition to casting a wide net, for me, the common language is earnings per share and earnings per share growth.
So, again, when the only part of the company that's growing is the number of shares outstanding, that's a concern, or you know, when losses are growing, that is almost a “I don't have time for that” we're finding. But when per-share earnings, per share free cash flow is growing, then I've got a lot of time. And there are a lot of really good companies out there, but what I'm trying to do, as we talked about earlier, is find the exceptional companies and trying to bet bigger on the exceptional ones. But again, it’s personality in what you do, and Peter Lynch talks about the notion of a poker game. And that it's really hard to know that you're going to win the hand when everybody only has two cards. And maybe you have a king showing, and the other players have low card, so you can bet. But it's when you get a second king that you want to bet more. And it's an iterative game. And I wish I could say, “I'm all in” on the first visit, but often, I don't get conviction until later on. I tend not to do well in what I call v bottom industries, like in semiconductors, where things are really bad and then all of a sudden the light changes and all of a sudden things are really good and things have bottomed and are getting better. I tend not to do well when we have to make a quick pivot. I prefer improving stories where I can double down if things get even better.
Ptak: If I may, I wanted to ask quickly about portfolio construction--a couple of aspects of it. The first is, I was just curious how you think about the path to outperformance, whether you're conscious of the need to produce a few, call them supercompounders. And whether that informs the way you manage the portfolio. Are you content to really to try to hit for average, come what may? And then my second question is how you size positions. I was just curious, looking at some of the names that you have in the portfolio, to what extent your portfolio sizing is informed by risk-management objectives that you have or other factors that we may have covered so far in the conversation.
Danoff: That's a really good question, Jeff. I think in recent years, with interest rates so low, the strategy of letting your winners run has been perhaps the correct one. I would say the key, again, when in doubt, call the company, when in doubt, assess company A versus the other companies that you really like. There are some tricks to the trade that I implement. But everybody worries about everything. And I'd say try and stay optimistic. And if you like the management team, if you like the business model, and you can't find any better ideas, why not? People ask a lot about when do you sell a stock--and you sell a stock when the earnings growth slows, often due to intensified competition. Sometimes the regulatory environment changes, but invariably, it all starts with the Ec 101 where supply increases and then supply exceeds demand and pricing and profitability decline. Or there's a better mousetrap that comes out of the competitive set that hurts you a lot.
But I would say the real key to finding when to sell is when you're looking for new ideas and when you find a better idea. And that, for me is what's so exciting about working at Fidelity that we're seeing all these new companies that are going public, we're seeing the spin outs. We're seeing the new management teams when they come to Boston to tell us how excited they are to take over the company, and finding new ideas then raises the bar for your existing positions.
So, in terms of portfolio construction, in the last 30 years, I've taken bigger bets. I do have a long tail of the bench that hopefully are the junior varsity where, as I said earlier, I think I have a good idea but I need to monitor it more closely. And I don't want it to fall by the wayside. I want to make sure the research department knows I care about the stock. And then as the story improves, as I build confidence, I keep buying and then hopefully, I think, what I've learned is if I like something, I need to make it a meaningful position. And that's one of the challenges--we talked earlier about size--that it's harder for me to make a new idea a meaningful bet. Let's say, a 50-basis-point or 100-basis-point bet immediately. I mean, 100 basis points on $185 billion is $1.8 billion investment--that's hard to do quickly if you think about it. You can't necessarily call your trader and say buy $1 billion worth of company XYZ. You can do it, but that's going to take some time. So, I look at the fund. I'm aware of my positions. Contrafund currently is heavily invested in technology. I mean, if you think about it, Jeff and Christine and listeners, maybe 10 years ago, you had one smartphone-type device. And now people have two devices. They've got their EarPods, they've got an iPad, they've got a computer. Technology has become a bigger and bigger part of everybody's life. So, I don't think it's bad that I've increased my weighting in technology and the business models of some of these larger technology companies. I mean, Apple is the largest company in the world; they're very profitable. They're low capital intensity because they outsource their manufacturing. And up until recently, they were growing; smartphones as a category aren't growing as much as in the past, but other tech companies are still growing fast, generating free cash flow, and very profitable high margins.
So that idea and global markets that enable continued growth--so that's a very sweet combination for shareholders: low capital intensity, high margins, and growth. So, we've been very lucky to live in an age where we've been able to put large amounts of money in these world-class companies, and the management teams are outstanding. You know, these are very, very smart executives. I think they're managing their size very, very well. So, you know, I do have a lot in technology. I'm aware of that. And I'm constantly looking for better ideas. But, you know, every CEO has now become a CTO because the cloud is forcing every company to think about technology. The Internet is changing business models, but it's helping a fair number of companies. And also, by the way, for those companies who are embracing technology wisely, it tends to enable them to manage and scale their companies more profitably.
So, margins for the S&P 500--both operating margins and free cash flow margins--have improved nicely in the last 15 years. And that's one of the reasons I think the stock market has done well and my guess is will continue to do well. And we talked about the long view. The long view has to be that equities are going to perform better than bonds for the foreseeable future. Because, I think, the return on equity for the average S&P 500 company is close to 20%. And you get 2% in the long bond, and the long bond isn't growing their "payout," and presumably, the U.S. equity companies are going to grow their dividends at a GDP-plus rate.
So, anyway, I would say again, for me, it's sort of like the chef tasting the soup, Jeff. I'm tasting the soup in the kitchen every day and tweaking it, but generally, I like the taste and I'm aware of the taste profile that I have. And I'm aware of the risks of that profile, but at the moment, I think that's the best-selling taste.
Benz: We were hoping you could touch briefly on the role of private firms in the portfolio, perhaps talk about what percentage of time you spend researching private firms--you reference them earlier in the conversation, that they’re maybe a bigger part of your thought process than they were years ago. So, what percentage of your time do you spend on researching them? And do you expect that to ramp up further in the future?
Danoff: That's a really good question, Christine. And that certainly has been a modest change in the life of a mutual fund manager and a change in the mutual fund industry in the last decade or so. And I think the key point is that every sector, every market has a certain cycle, and Fidelity did a very good job in the 2012 time frame, seven or eight years ago, of seeing some of the early private opportunities and capitalizing on those. And the thought process was, “Well, we have industry expertise, we have company expertise. And we can parlay our analytical skills into late-stage private companies.” And as you know, the ‘40 Act allows mutual funds to invest up to 5% of assets in illiquid securities. And that's where the privates are.
So, seven or eight years ago, there were a lot of very good opportunities. The private market has grown and, one could argue, became very overheated, let's say, in the 2017-2018 time horizon. So, we're seeing a lot of companies come to Fidelity as private entities, and I'm listening and learning. I'm investing less. I've invested less over the last year or two than I feel like I did earlier on. I would say I probably see two or three private companies a week. And I'm seeing 25 or more companies a week. So maybe 10% of my time. And again, private companies are an opportunity to learn and, if they're the right private company, an opportunity to invest. But, you know, what we've all learned is we want to make sure that the management team is particularly special. And the entrepreneur and founder is able to build a team, and I think before it's all over, maybe it will be wise to wait until the company is public. I mean, when Facebook went public, they were--and Google, they were--both nicely profitable, growing companies.
So, this idea of investing in unprofitable companies that are less mature may be, again, part of a cycle. And again, I referenced low interest rates. Low interest rates have created certain distortions in valuation. And so, one has to be very careful. And again, experience plays a role here. But privates are, again--if you pick the right entrepreneur and you pick the right opportunity, and you have the expertise-- But they tend to be more time intensive, the companies tend to be less mature, management teams tend to be a little less mature. So I would say they're higher risk. And, over the last couple of years, we've all learned that they're riskier than perhaps people thought. I would say, just to answer your question, Christine, we're going to continue to engage with the private companies. But I think a lot of companies stay private longer because they were able to receive higher and higher valuations without having to go public. And, if I had to guess, I think that trend might slow down. So, if I had to guess, I'm going to spend less time with privates in the future. But that's just speculation. A lot depends on how the markets go.
Ptak: Well, I think that we could talk to you and ask questions of you for hours. We so appreciate the time and insights you've shared with us and our listeners today. Thank you again, so much, for joining us on The Long View.
Danoff: Yeah, Jeff and Christine. This has been a lot of fun. Thanks so much. And I hope everybody has a great year.
Benz: Thank you so much, Will.
Ptak: Thanks again Will.
Ptak: Bye. Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcast.
Benz: You can follow us on Twitter @Christine_Benz.
Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)