How Some Mutuals Made Lemonade in Lemon of a Quarter
The best stock mutual funds in the first quarter owned either a huge chunk of the market or just a tiny sliver. The middle ground was a dull place to be.
The funds that own a broad array of smaller stocks, in particular, scored bigger gains than those that tried to pick the hottest small stocks. Diversification paid.
Meanwhile, some funds that buy only shares in individual industry groups also rose sharply. So specialization paid too--if you specialized in the groups the market suddenly wanted, such as banks, autos and real estate.
Overall, the average return of 882 general stock funds was a negative 0.17%, according to fund-tracker Lipper Analytical Services in New York. That followed gains of 7.3% and 8.3% in the third and fourth quarters of last year, respectively.
If the funds stay true to recent form, performance should improve this quarter. The trend since mid-1990 has been one down/two up: a losing quarter begets two back-to-back winners.
But because the first quarter was such a frustrating one for most stock fund managers--and because this quarter is off to a lousy start--betting on market gains in this quarter is risky business. Better just to make sure you’re comfortable with the funds you own, and start lining up the ones you’d like to buy if they get cheaper, experts advise.
Here’s a look at some of the first-quarter stock fund trends:
* The funds versus the indexes. You can argue that the average fund’s 0.17% first-quarter loss was much better than the broad market’s performance, or much worse. It depends on the index you use--another sign of how disjointed the market has become.
The Standard & Poor’s index of 500 major stocks fell 2.5%, including reinvested dividends. But the Dow Jones industrial average was up 2.8%, including dividends. The broadest measure of the market, the Wilshire 5,000 index, posted a loss of 1.3%.
The disparities tell you that the market is becoming much tougher to call, notes Michael Lipper at Lipper Analytical. Quoting an old but nonetheless appropriate line, he says: “It’s now a market of stocks rather than a stock market.”
* Small-stock funds versus the rest. Funds that own smaller stocks once again performed better than their big-stock brethren, a trend that began in the fall of 1990 and was only interrupted briefly in the second quarter of last year.
The average small-stock fund gained 2.4% in the first quarter, after soaring 51.6% last year.
But the surprise of the first quarter was that some of the best small-stock funds were the “index” funds, which don’t attempt to pick the best small stocks, but rather just own a vast number of them. These funds merely try to replicate the performance of some broad small-stock index rather than try to beat the market.
Colonial Small-Stock Index Trust in Boston, for example, owns the smallest 20% of the stocks traded on the New York Stock Exchange. The fund rocketed 17% for the quarter, far exceeding the 3% gain in the NASDAQ composite index, which is what most people think of as “small stocks.”
Stephen Lanzendorf, who oversees the Colonial fund, figures what happened in the first quarter was that investors jumped into many of the truly small stocks that were ignored during last year’s rally. Many investors bought only NASDAQ issues last year, but there are many companies just as small or even smaller on the NYSE’s bottom rung, he notes.
The rush to very small stocks also helped Ed Bernstein, who manages the $14.5-million Prudent Speculator Leveraged fund in Los Angeles. He scored a 14.1% quarterly gain by taking a page out of the indexers’ book: Bernstein owns more than 200 small stocks in his tiny fund.
Though he isn’t trying to copy a specific index of small stocks, Bernstein figures he can’t go wrong being more diversified. “I’m trying to reduce the downside volatility as much as I can,” he says.
* Value stocks versus high-growth stocks. Diversification helped small-stock index funds in another way: Because they’re forced to own all sorts of small stocks all the time, they benefited when the market focus abruptly shifted to “value” and away from “growth” during the quarter.
Value stocks, so-called because they often sell for low prices relative to earnings and asset value, rose sharply as investors began to perceive a turnaround in the economy. Many value stocks are industrial companies, which should do well when the recovery takes off.
In contrast, the growth stocks--fast-growing companies generally in consumer businesses--fell out of favor in the quarter after a stellar run last year. Because many small-stock and big-stock funds alike were heavy with growth stocks as the quarter began, they suffered as those stocks tumbled.
Meanwhile, the few small-stock funds that focus consistently on value stocks zoomed to the top. The Milwaukee-based Heartland Value fund, for example, shot up 20.1% for the quarter, the third-best performance of any stock fund.
Bill Nasgovitz, who manages the $40-million Heartland fund, says he was concentrated in such little-known stocks as auto-parts retailer Trak Auto, Badger Meter (a water-meter maker) and a host of small, regional banks and savings and loans that have survived the banking/S&L; shakeout with few if any problems.
From here, he figures that his kind of stocks have a far better chance of going on an extended run than do the growth stocks that have already soared for two to three years. But he also says patience remains a required trait for value investors: “A lot of these smaller issues--they take time” to blossom.
An interesting twist on the value-versus-growth debate: The $20-million Loomis Sayles Small Cap fund in Boston. Its portfolio is always split half-and-half between value and growth small stocks, says Barbara Friedman, who manages the growth side. The fund rose 9.7% in the quarter.
* Specialty funds: If you knew how to pick ‘em, you made a small fortune. The quarter’s top fund was the Fidelity Select Automotive fund, which produced a 24.6% return as auto and auto-related stocks soared, beneficiaries of economic recovery talk.
Among specific fund categories tracked by Lipper Analytical, the handful of funds that concentrate on financial-services stocks (banks, S&Ls;, etc.) turned in the best average return, up 6.3%.
Another winning group: Funds that targeted stocks in Latin American markets.
The problem with specialty investing, though, is that if you’re wrong you can be very wrong. Funds that own only Japanese stocks, for example, dominated the quarter’s losers list as Tokyo’s market plunged. Likewise, the biotech funds that were last year’s stars fell dramatically in the quarter, big casualties of the shift away from growth stocks.
While some of the first quarter’s losers might have become bargains, many fund experts warn that it’s probably too early to bargain-hunt among the downtrodden.
If the market’s change of heart toward growth stocks is real, chances are it will go on for a lot longer than one quarter, experts say. “Trends tend to go too far in both directions,” notes Don Phillips, editor of Mutual Fund Values newsletter in Chicago.
First Quarter Stock Fund Performance
Here are average total returns for 17 categories of stock mutual funds in the first quarter, the past 12 months and the past five years. Also listed are two benchmarks: performance of the average general stock fund and the Standard & Poor’s 500-stock index.
Category (No. of funds) 1st Qtr. 12 months 5 years Financial services (11) +6.31% +37.51% +67.67% Specialty/miscellaneous (29) +2.48 +16.80 +48.43 Small-company growth (122) +2.39 +22.75 +61.30 Real estate ( 6) +1.84 +11.24 +40.46 Science & technology (21) +0.51 +16.13 +49.32 Capital appreciation (131) +0.43 +16.37 +52.49 Equity income (72) -0.42 +12.83 +45.52 Growth and income (250) -0.48 +12.38 +53.33 Growth (307) -1.11 +14.38 +55.06 European region (27) -1.58 +1.22 +21.99 Global: U.S. and foreign stocks (56) -1.86 +7.24 +33.10 International: foreign stocks only (94) -2.53 +1.46 +29.42 Natural resources (21) -3.11 -4.03 +15.79 Utilities (28) -3.71 +11.10 +53.01 Pacific region (22) -6.46 -5.82 +34.66 Gold (35) -7.25 -5.04 -31.27 Health/biotechnology (11) -9.51 +18.44 +134.36 General stock fund average -0.17 +15.04 +54.22 S&P; 500 index, including dividends -2.52 +11.01 +64.25
Source: Lipper Analytical Services Inc.
Top Funds, 1st Quarter
Fund Return Fidelity Select Automotive +24.59% Sherman, Dean Fund +22.17% Heartland Value +20.05% GT Global Latin America +19.65% Merrill Phoenix A +19.50% Merrill Phoenix B +19.23% Pioneer Capital Growth +18.40% American Heritage +17.65% Colonial Small Stock Index +17.00% Merrill Latin America A +16.20% Average stock fund -0.17%
Source: Lipper Analytical Services
Worst Funds, 1st Quarter
Fund Return Capstone Nikko Japan -22.93% Strategic Gold/Minerals -21.94% Lexington Strategic Invsts. -21.94% Vanguard Intl. Pacific -18.79% DFA Japan Small Co. -18.42% GT Global Japan -16.85% Fidelity Select Biotech -16.39% Japan Fund -15.15% DFA Large Cap. Intl. -13.58% Oppenheimer Global Biotech -13.53% Average stock fund -0.17%
Source: Lipper Analytical Services
Biggest Funds, 1st Quarter
Fund Return Fidelity Magellan -0.70% Invest. Co. America -2.01% Washington Mutual -1.26% Vanguard Windsor +4.27% Fidelity Puritan +3.17% 20th Century Select -7.34% Fidelity Equity-Income +2.66% Vanguard Index 500 -2.57% American Mutual -1.43% Templeton World -0.42% Average stock fund -0.17%
Source: Lipper Analytical Services
Stock Funds Take a Rest The average stock mutual fund fell slightly in the first quarter, after two quarters of sharp gains. Meanwhile, funds that specialize in small stocks again outperformed the average fund. How the two categories stack up since late-1990:
Source: Lipper Analytical Services
