What would a shift out of a mutual fund and into an ETF look like up close?
Since exchange-traded funds have been eating mutual funds' lunch for years now, I imagine investors would like to think about how to make the switch to ETFs.
Fidelity's Contrafund is the largest actively managed U.S. equity mutual fund, so I challenged myself to find ETF replacements for Contrafund. Specifically, the goal was to match Contrafund's five-year returns and current portfolio.
A replacement could also be an improvement. Contrafund distributed 9.3 percent in capital gains over the 12 months to Feb. 7, 2014. At short-term rates, that translates to a 3.68 percent dead-weight loss. An ETF with similar pretax returns would be a long-term win for investors.
To get started, I decided to look at what Contrafund's website says the fund does. Here's the description:
Fidelity Contrafund is a diversified equity fund with a large-cap growth bias. Our investment approach seeks companies we believe are poised for durable multiyear earnings growth that is not accurately reflected in their current valuation. In particular, we emphasize companies with "best-of-breed" qualities, including those with a strong competitive position, high returns on capital, solid free cash flow generation and management teams that are stewards of shareholder capital.
Contrafund's published benchmark is the S&P 500 Index.
As of Dec. 31, 2013, Contrafund's portfolio was 88.42 percent U.S. equities and 9.35 percent developed-market equities, with the balance mostly in cash. Its top sector at that time was information technology, followed by consumer discretionary and its largest constituent is Google. Its style map shows it as a large growth fund, both currently and historically.
Finding The Right ETF To Match Contrafund
A near-90 percent allocation to U.S. equities suggests that the obvious place to start is with U.S. equity ETFs. The "large-cap growth bias" is not particularly useful, as definitions of both "large-cap" and "growth" can vary. Contrafund's style map consistency means a recent holdings-based analysis has a chance of leading me to a long-term match, barring future style drift.
My first step was to find Contrafund's market segment, by comparing its basic statistics with MSCI indexes covering a few parts of the U.S. market. Here's how I chose the comparison universe:
Contrafund's S&P 500 benchmark is a U.S. large-cap index, but many investors use it to represent the entire U.S. stock market. My test indexes were the MSCI USA Large Cap and the MSCI USA Investable Markets.
Again, Contrafund calls itself a large-cap growth fund. My test indexes: MSCI USA Large Cap Growth and MSCI USA Investible Markets Growth. (I threw in this last one for completeness.)
I found Contrafund's most recently published portfolio in Bloomberg's database. The portfolio has a weighted average market cap of $111 billion, and a trailing 12-month price/earnings multiple (P/E ratio) of 28.44.
Contrafund's $111 billion weighted average market cap and its 28.44 P/E ratio align it well with the MSCI USA Large Growth and the USA Investable Markets indexes.
Portfolio Statistics: Contrafund Vs. Four MSCI Indexes
|Benchmark Name/Fund Name||Weighted Average Market Cap||P/E Ratio|
|MSCI USA Large Cap||130,279,459,332||18.59|
|MSCI USA Large Growth||123,162,786,854||22.20|
|MSCI USA Investable Markets||94,334,928,254||21.03|
|MSCI USA Investable Markets Growth||86,321,253,037||25.38|