So How Bad Was It? Pretty Bad

By PAUL J. LIM

Oct. 6, 1998 12 AM PT

TIMES STAFF WRITER

For U.S. stock mutual fund investors, the great 1990s bull market party was crashed by a tsunami from abroad in the third quarter.

And that wave quickly submerged virtually every type of stock fund.

Perhaps Sheldon Jacobs, editor of the No-Load Fund Investor newsletter, summed it up best: It was a quarter when “nothing worked” for most stock fund investors.

Of the 28 stock fund categories tracked by Morningstar Inc., 27 lost money in the quarter ended Sept. 30.

That marked the worst performance in eight years and a stunning reversal from the first quarter of 1998, when all but one category of stock funds made money.

The average U.S. diversified stock fund tumbled 15.2% during the third quarter, marking the second consecutive quarter of negative results, after a 2.3% second-quarter loss.

With a year-to-date loss of 4.5% through the third quarter, the typical U.S. stock fund is now poised to lose money on an annual basis for the first time since the modest market pullback of 1994.

“At the outset of the world financial crisis last year, it was Asia,” said Prudential Securities equity strategist Greg Smith. “This year it became Russia. By contagion, the rest of Eastern Europe was affected, which then put in motion a shift in confidence about Latin America.”

“The U.S. did not really have much exposure to Asia in terms of business dealings and profits,” Smith noted. “In Eastern Europe, the U.S. was not as exposed as Western Europe. But when it spread to Latin America, suddenly the U.S. started to look a little less insulated.”

Suffering Cut Across Sectors

As the shares of some prominent U.S.-based multinationals--like Coca-Cola and Gillette--plunged last quarter on news of deteriorating foreign earnings, so too did the performance of large-cap growth funds, which have been the standout performers of the last few years.

According to Morningstar, the typical large-cap growth fund fell 11.2% during the quarter--worse than the nearly 10% decline of the Standard & Poor’s 500 index. (All of these figures are “total returns,” which is price change plus any dividend income.)

Meanwhile, large-cap value funds, many of which invest heavily in financial stocks, fell 12.3% in the quarter as investors turned on the entire financial services sector, on fears of a global credit and financial crisis.

The fact that the S&P; index held up better than most U.S. stock fund categories is more salt in the wound for fund managers, most of whom have not beaten the index in the 1990s.

The S&P--still; up 6% year-to-date through Sept. 30--looks even better compared with the quarter’s biggest fund losers.

The typical Latin American stock fund plummeted 30.7% during the quarter on news of economic and currency erosion in that region, bringing their year-to-date losses to a stunning 43.4%.

Mutual funds that invest in Asian companies (minus Japan) fared better, but they still lost an additional 6.7% in the quarter, bringing their 12-month losses to 49.8%.

And with diversified emerging-market funds having fallen 23.8% during the quarter, these portfolios have now lost investors money, on average, over the last one, three and five years, and are barely positive over 10 years.

So much for “modern portfolio theory.” Notes Jim Owen, executive vice president of Husic Capital Management in San Francisco: “This recent decline does call into question our traditional notions of diversification.”

The fallout from emerging markets spread to developed Europe and mutual funds that invest in the region. Europe funds entered the quarter as one of the best performers thus far this year--advancing 19.8% in the first quarter and 2.3% in the second as excitement grew that the impending European Monetary Union would spur economic reform and growth.

In the third quarter, however, European stock funds retreated 18.2%, as excitement gave way to fear about the spreading global financial contagion.

Overall, foreign funds fell 16.3% during the quarter, erasing all of the gains they made in the first half of the year.

For U.S. funds, performance worsened with the size of the stocks owned--the typical pattern in a down market, as investors flee less-liquid smaller stocks.

The typical small-cap growth fund lost 27% more than the typical mid-cap growth fund, which lost 56% more than the typical large-cap growth portfolio.

If there was a silver lining in this storm cloud of a quarter, it was that some traditional “defensive” funds appeared to have done their job, though unspectacularly.

Over the last three years, for instance, precious-metal funds have been losers. But during the third quarter, the typical precious-metal fund sparkled, gaining 4.2%. That made it the only category of funds that finished above water.

Soft Landing for Utilities

Here’s how some other traditional hedges fared during the third quarter:

* Utility stock funds. The high-dividend-paying stocks found in utility portfolios provided the sector a soft landing during the tumultuous quarter. Utility funds fell just 0.9% in the quarter.

Over the last 12 months, utility funds have gained 17.5%, making them the best-performing stock funds in that period.

* Health-care stock funds. The typical health-care fund fell just 6.6% during the quarter, as investors recognized that the industry business will probably continue to advance whether the economy overall is healthy or sick.

Over the last 10 years, health funds have gained 20.7% a year, on average, the best performance for any fund category.

* Real estate stock funds. They are supposed to zig when the broader market zags, but that didn’t happen: The typical real estate fund fell 12.2%, roughly in line with large-cap stock funds, as investors feared that U.S. real estate markets may again be getting overbuilt.

What’s Inside

* Exclusive tables showing the best-per- forming funds over the last three years in each major stock and bond fund category, ranked and rated by fund tracker Morningstar Inc. Beginning on C12. And check your fund’s per- formance in A-to-Z ta- bles beginning on C16.

* Seven stock funds that have regularly performed better than peers in times of troubled markets. C5

* Where to look for fund bargains as mar- kets slump. C10. How bond funds fared. C11.

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Mutually Troubling

The average U.S. diversified stock mutual fund plunged 15.2% in the third quarter, the worst quarterly drop since the third quarter of 1990. The average fund was off 5.2% year-to-date through Sept. 30. Only a fourth-quarter market rally can keep the funds from experiencing their first down calendar year since 1994. Annual total returns, and the total return for the first three quarters of this year, for the average U.S. fund:

‘88: 16.0

‘89: 25.4

‘90: -5.9

‘91: 37.4

‘92: 9.9

‘93: 13.3

‘94: -1.3

‘95: 31.6

‘96: 19.9

‘97: 24.4

‘98: -5.2

Where It Hurt Most