For Stock Fund Investors, It Was a Mixed Hand
Investing in stock mutual funds last year felt like crossing the Grand Canyon.
At the start of the year, the market was at dizzying heights. Then, with little warning, it dropped into the gorge in late summer, taking most stock funds with it. In the fourth quarter, stocks climbed sharply again, and most mutual funds managed to crawl out of a deep hole.
But did your fund make it back to the top?
The average U.S. stock fund was up 18.1% for the fourth quarter and 13.7% for the year, according to fund tracker Morningstar Inc. in Chicago.
While the 1998 gain looks impressive considering that the average domestic stock fund was losing money by the end of the third quarter, that 13.7% is still well below the 28.6% surge in the benchmark Standard & Poor’s 500 index of blue-chip stocks.
For a fifth consecutive year, then, the vast majority of U.S. stock funds fell short of the market benchmark.
Given that ever-lengthening stretch of underperformance by U.S. fund managers, “we might well see investors shift more of their investment funds to self-management,” opines Prudential Securities equity strategist Greg Smith.
To be fair, 1998 was an unusual year for stocks. More so than in recent memory, the market capitalization of the stocks a fund owned--in other words, their size--mattered.
“It mattered a lot,” said Greg Schultz, principal at Asset Allocation Advisors in Walnut Creek, Calif.
The bigger a fund’s stake in the largest Nasdaq 100 technology stocks and the largest S&P; 500 blue chips, the better chance it had of matching or beating the index.
“To beat the index, the largest piece of every dollar had to go into Microsoft,” argued Babson Value fund manager Nick Whitridge, noting that the largest 50 stocks in the S&P; propped up the entire index.
Not surprisingly, large growth stock funds thrived in this environment. The typical large growth fund was up 26.2% for the fourth quarter and 36.5% for the year.
Technology funds, which were also propelled by the Internet stock mania, did even better, leading all categories of stock funds for both the quarter and the year.
The average technology fund was up an impressive 41.7% and 53.4%, respectively. Technology stock funds are the hands-down best-performing category of mutual funds over the past decade, having delivered annualized returns of 23.7%--that’s 52% better than the performance of the average domestic stock fund over the past 10 years.
Some individual tech funds, especially those that invest in only the largest stocks on Nasdaq (like Microsoft, Intel, Dell Computer and Cisco Systems) nearly doubled their shareholders’ money in 1998.
By comparison, small-company stock funds lagged--yet again. To be sure, the average small growth fund did surge an impressive 23.9% in the fourth quarter. For the year, though, they eked out a gain of just 4.4%.
Small-cap value funds fared much worse, as did most funds that picked value-oriented stocks. (These are shares considered undervalued based on the underlying company’s earnings or assets.)
Small value funds gained 12.2% in the fourth quarter but lost 6.9% for the year.
Large-cap value stock funds were largely handcuffed in 1998. The popularity of the biggest stocks sent their valuations soaring, preventing these funds from investing in them. These funds were thus forced to rely on traditional standbys--the financial and energy sectors. But, thanks to the global financial crisis last year, these funds got hammered in the third quarter. And thanks to plummeting oil prices, a trend that worsened in the fourth quarter, the punishment continued through the end of the year.
The result: Large value funds advanced 13% for the year--about a third as much as large growth funds gained in 1998. Foreign funds, which rallied in the fourth quarter, ended 1998 about on par with large value funds, advancing 12.4% for the year.
Once again, though, Europe proved to be the big winner among international fund categories, with the average fund that invests in European stocks rising 15.1% in the fourth quarter and 20.1% for the year. Two trends fed investor optimism: continued corporate restructurings in the region, which would be expected to lead to earnings improvement, and the anticipation of the introduction of a single currency, the euro, which was officially launched Friday.
And the big loser? For yet another year, funds that invest in emerging markets. Despite an end-of-year surge, the average diversified emerging-markets stock fund lost 26.5% for 1998. Over the last five years now, investing in the emerging-markets sector has lost the average investor more than 10% a year.
The worst emerging-markets sector proved to be Latin America. One dollar invested in the typical Latin American stock fund at the beginning of 1998 had become 60 cents by year’s end.
Stock funds that invest in Asia didn’t have it nearly as bad. The average diversified Pacific/Asia fund rose 20.8% in the fourth quarter to finish the year down just 2.2%. Japan funds led the way in the region, gaining 20.5% in the quarter and 10.2% for all of 1998.
Of the 29 stock fund categories tracked by Morningstar (including funds that invest in convertible shares), 27 gained ground in the fourth quarter, a testament to the global market’s strong and broad recovery in the last three months of the year.
Yet only 20 ended the year in positive territory. Health-care funds got a shot in the arm, advancing nearly 26% for the year on the strength of large U.S. drug company stocks, such as Pfizer (the maker of the popular impotence drug Viagra), Merck, and Bristol-Myers Squibb.
Utilities funds, traditionally seen as a defensive play, went on the offensive in 1998, powering to gains of 17.6% for the year. Financial stocks got back into the black in the fourth quarter, advancing 17% and ending the year up 5.9%.
On the other hand, contrarian plays, such as real estate and gold funds, lost money for investors in 1998. They were down 15.9% and 12.9%, respectively, for the year.
Natural resources funds suffered with the worldwide oil glut, falling 24.4% on the year.
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Paul J. Lim can be reached at paul.lim@latimes.com.
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Weaker Returns
Despite stellar gains in a handful of blue-chip shares and technology issuees, many stocks struggled in 1998, a fact reflected in a far lower return for the average diversified U.S. stock fund than in the previous three years. Annual total returns for the average fund since 1988:
‘98: +13.7%
Source: Morningstar Inc.
Stock Fund Performance by Morningstar Category
Here are average total returns for equity mutual fund categories tracked by Morningstar, through Dec. 31. Total return is principal change plus dividend or interest income, if any. Figures for periods longer than one year are annualized average returns. Category descriptions, and Morningstar’s top-rated picks in each category, appear in the tables on the next few pages.
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Tot.% Return Annualized Category Obj 4thQ 1998 3-yr 5-yr 10-yr Technology ST 41.7 53.4 24.3 26.5 23.7 Communications SC 34.4 44.7 25.4 18.4 20.5 Pacific/Asia ex Japan PJ 27.5 -10.1 -15.0 -12.6 0.3 Large growth LG 26.2 36.5 26.6 21.2 19.1 Mid-cap growth MG 26.2 18.1 15.9 15.2 15.9 Small growth SG 23.9 4.4 11.4 13.5 16.0 Misc.-specialty SS 22.9 15.6 19.8 15.2 16.9 Div. Pacific/Asia DP 20.8 -2.2 -8.4 -7.0 1.3 Japan JS 20.5 10.2 -8.1 -3.5 0.1 Large blend LB 20.4 22.8 23.7 20.2 16.7 Mid-cap blend MB 20.4 9.5 18.2 16.2 15.3 Health SH 17.8 25.5 19.2 20.6 21.7 World WS 17.2 13.1 13.9 11.0 11.2 Financial SF 17.0 5.9 26.1 23.4 21.7 Large valuelv 16.6 13.0 20.1 18.2 15.8 Foreign FS 16.1 12.4 10.2 7.7 9.3 Small blend SB 16.0 -5.1 13.6 12.3 13.3 Div. emerging mkts. EM 15.3 -26.5 -8.7 -10.1 2.3 Europe ES 15.1 20.1 20.5 15.7 10.6 Mid-cap value MV 13.6 1.4 16.0 14.7 14.1 Small value SV 12.2 -6.9 14.3 12.8 12.8 Convertibles CV 10.5 3.5 12.7 10.6 12.0 Domestic hybrid DH 10.4 12.6 14.9 13.4 12.6 Utilities SU 10.4 17.6 17.7 13.9 14.4 International IH 9.6 9.3 9.7 8.3 5.0 Latin America LS 7.8 -39.6 -0.8 -7.7 NA Real estate SR 0.1 -15.9 11.0 8.0 9.9 Natural resources SN -5.3 -24.4 2.6 5.7 8.6 Precious metals SP -5.6 -12.9 -18.2 -12.7 -2.9 Avg. domestic stock 18.1 13.7 18.2 16.3 15.6 Avg. international stock 16.0 6.2 6.3 4.4 6.6 S & P 500 index 14.9 28.6 28.1 24.0 19.2
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