Glass Is Half Full--or Half Empty--as Best-Worst Performer Gap Grows

You’ve got more opportunities this year to find stock mutual funds that are blowing the doors off their category averages.

You’ve also got a better chance of investing in a fund that’s doing worse than its category average.

In most domestic stock fund categories, the difference in returns between the best-performing portfolio and the worst-performing portfolio has been wider over the last 12 months than in 1998 or 1997, according to Standard & Poor’s Fund Services.

Take funds that invest in large value stocks. Over the last 12 months, the best-performing large value fund has rocketed 59.1%, while the worst performer lost 4%. The average large value fund is up 12.8%.

In 1998, the best performer in the large value category gained 35%, while the worst lost 6%. The average gain was 11.6%.

What we’ve got here is a classic stock picker’s market: The performance of stocks within specific market sectors is all over the map.

On one hand, this is great news. This year, unlike last year, there is more of an opportunity for fund managers to show just how savvy they can be as stock pickers. “Clearly, this is better for active fund managers,” says Bill Dougherty, a fund analyst with Kanon Bloch Carre in Boston.

That’s the glass-is-half-full view of things. The glass-is-half-empty viewpoint is that, in a stock-picker’s market, some fund managers are going to pick much more poorly than others.

Perhaps the best evidence of how the tide has shifted in favor of stock pickers is in the performance of funds that aren’t limited to small stocks or large ones, but instead are allowed to invest in companies of all sizes. In theory, if stock pickers can truly distinguish themselves, this is the arena in which they would most excel.

The gap between the best-performing “multi-cap” stock fund and the worst performer over the last 12 months is nearly 64 percentage points. That’s more than 20 percentage points greater than the gap between the best and worst in calendar year 1998.

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Last year also was a stock-picker’s market, but only in the narrowest sense of the term: If you weren’t in a handful of big-name stocks, you would have found it tough to show spectacular gains.

“There were [about] 20 large growth stocks that were leading the market,” notes Dougherty. “To be competitive, you or your mutual fund had to own those stocks.”

Indeed, 14 of the biggest growth stocks in the Standard & Poor’s 500 index of blue chips accounted for 99% of the benchmark index’s gains last year, according to Morgan Stanley Dean Witter equity strategist Leah Modigliani.

Just five stocks accounted for half the S&P;’s gains. And incredibly, Microsoft and Dell Computer alone accounted for a third of the market’s move.

But this year, the market has broadened substantially. Value stocks are beating growth stocks. And smaller stocks went on a hot streak in spring.

For fund investors whose managers have picked well within their specific sectors, the opportunity for outsize gains is terrific. But if your manager doesn’t have one of those hot hands, you may well find your fund trailing the category average--even though the fund may actually be doing better than most of its peers.

Consider: In 1998, the median gains of funds in the growth, growth-and-income and equity-income categories all were higher than the average fund gains in those categories, according to fund tracker Lipper Inc.

Median return is the midway point, meaning that exactly half of funds did better than that figure and half did worse.

Average returns, by contrast, can be skewed by a few very big winners or very big losers. But average returns are what are typically reported in looking at performance of fund categories--such as in the Lipper fund category chart on C15 today.

If the median gain is higher than the average gain, it means your chances of investing in a fund that performed better than average were, well, better than average.

So far this year, the tables have turned. The median fund returns for growth, growth-and-income and equity-income funds are all lower than their respective category’s average returns. Which means you’ve got a higher probability of being invested in a stock fund that is performing worse than the average.

A good example of this can be found in the micro-cap sector--funds that invest in stocks with market capitalization (stock price times total shares outstanding) of less than $300 million. According to Chicago fund tracker Morningstar, the average micro-cap stock fund has gained 18.8% over the last 12 months.

Now, suppose you set out 12 months ago to pick a micro-cap fund. You might have figured that the odds of picking a better-than-average fund for the following year was about 50-50.

As it turns out, the odds of beating the average were much lower. Only 20 out of 69 micro-cap funds tracked by Morningstar, or 29%, have posted average or better-than-average total returns over the last year.

What happened in micro-cap is what has happened in other categories: A few big fund winners are skewing the category average returns.

Wasatch Micro-Cap, for example, has returned about a quarter less than the category average. But it still did better than most micro-cap funds: It ranks 30th out of 69 micro-cap funds in performance overall.

What all of this means for investors is that to truly judge how well your fund is doing, you need to consider both a fund category’s median and average returns.

The easiest way to do that is to go to Morningstar’s Web site (https://www.morningstar.com) and plug in your fund’s name or ticker symbol in the section titled Quotes & Reports. Once you do that, Morningstar will show you where the fund ranks overall--how many of its peers it is beating and how many it is lagging.

To compare performance to the average category return, you can go into a section of Morningstar’s site called Fund Selector.

Do you have ideas for mutual fund and 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.