Sizing Up Growth-Stock Fund Laggards

For growth-stock mutual fund investors, enduring the pain of the last 12 months’ losses is bad enough.

But what if your growth fund not only fell more than its peers in 2000 and the first quarter of this year but also lagged behind its peers during the growth-stock surge of 1999?

As a rule of thumb, some financial planners say any fund that trails its peers for two straight calendar years should be closely reviewed.

The Times asked Morningstar Inc. for a list of growth funds that performed worse than their average peers in 1999, 2000 and the first quarter of 2001. About 70 funds emerged. Those that fared worst in the first quarter relative to their category average are shown in the accompanying chart. The list includes several prominent names such as Vanguard U.S. Growth, which has $30 billion in assets, and Invesco Blue Chip Growth, with $1.6 billion.

“Any time a fund underperforms its peers for two straight years, we put it on our watch list,” said Roy Diliberto, a Philadelphia-area financial planner.

“Vanguard U.S. Growth is a good example,” added Diliberto. “We’re not selling that fund. We always look at a lot of factors. But we’re not buying any more of it.”

Still, many financial advisors say that any fund deserves at least three, and perhaps five, years to prove its mettle. They note that many funds have bounced back in a big way after extended slumps.

One thing advisors agree on is that relative performance is just one factor to consider in evaluating any fund. A fund may lag its peers but still meet your goals.

Some of the managers whose growth funds popped up on our screen said it’s unfair or misleading to say they’ve lagged behind, pointing to the flaws inherent in comparing funds that supposedly fall within the same category--in this case, as grouped by Morningstar.

Many growth-fund managers explain laggard results over the last year, at least, by arguing that they’re remaining true to their stated investment style--while other growth funds are buying “value” stocks.

Valerie Malter, whose Kemper Growth fund has about $1.7 billion in assets, said she is proud of her record since taking over the fund in early 1999.

“If you look at the top-quartile large-cap growth funds over the past 12 months, those funds are more ‘value’ and smaller-cap than I am,” Malter said. “It has nothing to do with my ability as a [growth] portfolio manager.”

Although Kemper Growth’s returns of plus 36.9% in 1999 and minus 19.7% in 2000 trailed the Morningstar large-cap growth averages, Malter points out that the fund beat the Russell 1,000 growth stock index by several percentage points both years.

“That’s the benchmark I’m paid to beat,” she said. “Our shareholders want us to be a true growth fund. The last thing I’m going to do is try to outperform a peer universe that’s roaming all over the place.”

She said she has continued buying classic growth stocks with higher earnings growth rates, higher price-to-earnings ratios and higher price-to-book-value ratios, while some managers whose funds are labeled “growth” have shifted toward more-stable but slower-growing “value” names such as Citigroup, Exxon Mobil and General Motors. Kemper Growth lost 21.5% in the first quarter.

In 1998 and ‘99, Malter said, manager David Dreman of the Kemper-Dreman High Return Equity fund was considered to be a category laggard because he stuck with classic large-cap value stocks.

“Dreman is not stupid, he’s brilliant,” Malter said. “Everyone saw that in 2000 when he stayed true to his style” and value stocks resurged.

Jeff New, whose Van Kampen Enterprise fund has $2 billion in assets, said his fund was affected by Morningstar’s decision in early 1999 to change the way it calculates fund category data. The fund tracker now looks at price-to-earnings and price-to-book-value ratios separately for a fund’s small-cap, mid-cap and large-cap holdings, rather than looking at those ratios for the portfolio en masse.

“We were ‘large blend’ [by Morningstar category] but then, not because of anything we did, all of a sudden the next day we were categorized as ‘large growth,’ ” New said. “We thought about taking portfolio action to push us back into large blend. We care a lot about style consistency and we didn’t want to jump around. But in mid-’99 we decided, ‘OK, let’s keep it large growth,’ especially since our firm did not have another offering in the category.”

To compete with a different peer group, New said, he boosted the fund’s tech stock weighting, a move that now may look ill-timed, “with perfect hindsight,” he said.

Van Kampen Enterprise rose 26.5% in 1999, lost 15% last year and slid 21.5% in the first quarter.

David Fowler, manager of Vanguard U.S. Growth, said his fund, like many others, has been dragged down by the tech stock wreck over the last year. Its underperformance in 1999, meanwhile, reflected a relatively low tech weighting compared with other growth funds.

“In 1999 we were a little slow to recognize the scope and power of the tech phenomenon, but eventually we did,” Fowler said.

Then, in the first half of 2000, the fund made a significant transition, he said, dumping personal computer-oriented holdings such as Microsoft and Intel in favor of data storage and networking stocks such as Cisco Systems, Juniper Networks and EMC.

“That worked brilliantly through October of last year, and even after that, when the stocks were getting hit, the company fundamentals were holding up,” he said. “But in January and February everything hit a wall. We’ve been surprised by the magnitude of the weakness in the tech industry. I’ve had 29 years in this business, and the last six months seems like another 29 years in itself.”

Though higher-growth, high-P/E stocks have been hurt more than mundane tech stocks, Fowler said he still thinks data storage and networking stocks in general have strong long-term potential.

“Now that we’ve absorbed that body blow, we’re not going to panic,” he said. “We try to be extremely consistent to our style mandate.”

Trent May, manager of Invesco Blue Chip Growth, also argued that his fund has been hurt over the last year, at least, by staying true to its growth mandate. “We’ve been hit with our networking stocks like Cisco and Corning, along with some of the other tech holdings like Palm. It’s been painful,” he said.

But an emphasis on pure growth stocks outside the tech realm also has been costly, May said. “In the retail area we tend to favor [stocks] like Wal-Mart and Home Depot, but they’re getting trounced these days by the likes of Kmart and J.C. Penney,” he said. “We don’t buy second-tier stocks and we don’t buy turnaround stories.”

May said he’ll stick with firms with robust revenue growth and rising earnings--and wait for the market to appreciate them again.

“Philip Morris, Coca-Cola and Procter & Gamble don’t meet our definition of true growth. We’re not going to change our stripes and move away from what we do best.”

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Two (and a Quarter) Strikes Against Them?

These growth stock funds are among the 70 that lagged behind their average category peer in 1999, 2000 and in this year’s first quarter, according to Morningstar Inc. The funds shown performed worst relative to their category average in the first quarter, though their under-performance in 1999 and 2000 may not have been the worst of the laggards.

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Large-Cap Growth

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-----Total return----- 1999 2000 Q1 ’01 Invesco Blue Chip Growth +38.5% -23.9% -40.2% HighMark Growth +22.1 -24.2 -31.4 Vanguard U.S. Growth +22.3 -20.2 -31.0 John Hancock Large Cap Growth +20.5 -30.7 -30.7 Phoenix-Engemann Nifty Fifty +32.5 -18.8 -30.7 Phoenix-Engemann Capital Growth +29.0 -18.1 -28.5 Gartmore Growth +16.6 -30.3 -28.0 Aim Weingarten +34.9 -20.4 -27.7 BlackRock Large Cap Growth +36.5 -25.4 -27.4 Harris Bretall Sullivan Growth Eq. +35.1 -21.8 -26.0 Category average +40.5 -13.8 -19.7

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Mid-Cap Growth

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-----Total return----- 1999 2000 Q1 ’01 Monetta Mid-Cap Equity +53.4% -12.7% -41.0% Riverfront Small Company Select +47.1 -21.1 -38.7 North American Mid Cap Growth +32.2 -13.0 -30.8 John Hancock Mid Cap Growth +58.2 -13.5 -30.2 John Hancock Medium Cap Growth +60.2 -13.1 -29.6 Neuberger Berman Manhattan +50.8 -11.4 -28.9 Warburg Pincus Emerging Growth +41.8 -12.0 -27.8 Alger Small Capitalization +32.1 -29.5 -27.4 Undiscovered Managers Behav. Gro. +65.7 -26.8 -27.0 Scudder Development +35.0 -15.9 -26.8 Category average +65.9 -6.7 -22.5

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Small-Cap Growth

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-----Total return----- 1999 2000 Q1 ’01 PBHG Emerging Growth +48.4% -25.2% -32.8% Navellier Aggressive Small Cap +28.3 -29.5 -32.5 Kemper Small Capitalization Equity +33.6 -10.6 -29.1 Eaton Vance Tax-Managed Em. Growth +46.4 -10.9 -27.4 Eaton Vance Special Equities +42.3 -9.0 -27.3 Preferred Small Cap -10.6 -16.8 -27.2 Atlas Emerging Growth +42.7 -22.8 -26.4 Jundt U.S. Emerging Growth +49.0 -27.2 -25.9 Advantus Enterprise +45.5 -13.5 -25.5 Evergreen Select Small Cap Growth +58.8 -10.7 -25.3 Category average +61.3 -5.8 -17.9

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Note: Data are based on the oldest share class for each fund. Some funds may have better-performing share classes that charge lower expenses.

Source: Morningstar Inc.