Growth Funds Try to Mount Comeback

At the height of the bull market, mutual funds that focus on large-capitalization growth stocks were the center of the fund universe, the “must own” category for millions of Americans.

Many investors still own one or more of these funds. But the severe losses the category has suffered over the last 2 1/2 years have a lot of people questioning what went wrong--and whether they should stay put.

In the late 1990s, large-cap growth meant the biggest companies in the fastest-growing, most exciting industries. And nothing was more exciting to Wall Street in that period than technology.

As large-cap growth fund managers loaded up with tech shares, the average total return on the funds topped 25% in 1997, 1998 and 1999.

But since the tech stock bubble burst in March 2000, losses for the average large-cap growth fund have piled up at a 26.6% annualized rate, according to data tracker Morningstar Inc. That is far worse than the 16.6% annualized loss rate in that period for the Standard & Poor’s 500 index, the principal benchmark of the biggest U.S. stocks.

What’s more, the most popular large-cap growth funds at the market peak in March 2000 have been among the worst performers on the way down: 11 of the 15 biggest funds, by assets, at the market peak have lost more than the category average since then, Morningstar data show.

The annualized loss rate of the Janus Fund, for example, was 28.4% between March 31, 2000, and Aug. 23. The fund’s assets have slumped from $49.1 billion at the peak to $17.2 billion now.

Fidelity Aggressive Growth, the ninth-biggest large-cap growth fund in March 2000, has lost an annualized 48.6% since then, according to Morningstar. The Putnam New Opportunities fund’s loss rate has been an annualized 36.9%.

In part, large-cap growth funds were victims of their own success. As money poured in from investors dazzled by the sector’s high returns, the funds bid up prices of big-name growth stocks that already were arguably inflated.

“Large-cap growth got so big that the funds almost had to be in the most liquid stocks,” said Jonas Max Ferris, editor of the Web site Maxfunds.com, which covers the fund industry.

Unfortunately for the funds and their shareholders, the most liquid stocks of the era included not only technology titans such as Cisco Systems Inc. and Intel Corp., but also such subsequently scandal-tainted names as Enron Corp., WorldCom Inc. and Tyco International Ltd.

Too Much for Too Long

Though fund-industry analysts say large-cap growth managers can’t be blamed for their style of investing being out of favor since March 2000--since all investing styles have up and down cycles--it’s clear that many funds remained too concentrated in technology and telecom stocks for too long, analysts say.

“You wonder how hard these funds were even looking at what they were buying,” Ferris said.

The Denver-based Janus funds became closely associated with tech shares during the market boom, and paid the price when the sector busted.

“Some of the Janus funds took on a substantial amount of risk to earn such high returns in 1998 and ‘99, and the managers were not quick on the trigger in taking gains and selling out,” said Brian Portnoy, a Morningstar analyst who covers Janus.

Similarly, Steve Oristaglio, deputy head of investments at Boston-based Putnam Investments, said growth-stock funds at his firm became “highly focused on tech and telecom. We believed the build-out was going to be faster than what has transpired, and we thought the economy would be stronger.”

Scott Schoelzel, who manages the Janus Twenty fund, acknowledged that tech stakes hurt many of his firm’s growth funds, but he said it’s easy to second-guess managers after the fact.

“With the benefit of 20/20 hindsight today, it’s true that Janus and its shareholders would have benefited from diversification away from tech and telecom earlier in the cycle,” he said. “We, like most other fund families, would still be down but it may have mitigated some of the downturn.”

Some large-cap growth funds that took a more sober view of the valuations on tech stocks and other large-cap leaders in the late 1990s have recorded relatively modest losses since the market peak.

The American Funds group’s Growth Fund of America has lost 16.7%, annualized, since March 2000, according to Morningstar.

Individual investors who poured billions of dollars into large-cap growth funds in the late 1990s and much of 2000 bear part of the responsibility for what followed, said Phil Edwards, head of fund analysis at Standard & Poor’s in New York.

“People had a short-term perspective, thinking the bull market would go on forever,” Edwards said. “A lot of people didn’t really realize what they were buying. They were just chasing performance,” in turn pumping more air into the growth-stock bubble.

Investors plowed $224 billion into large-cap growth funds during 1999 and 2000, awarding the category 62% of total net stock fund inflows in that period, according to data tracker Financial Research Corp.

In the last year and a half, by contrast, investors have redeemed more from the funds than they’ve added.

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Looking for Recovery

How soon might large-cap growth funds stage a significant recovery?

Two factors will determine performance, analysts note: First is the broad issue of whether the next market advance will be led by big-name stocks (as opposed, say, to smaller stocks).

Second is the issue of industry sector leadership within large-cap growth, and how well portfolio managers pick winners and avoid laggards and losers.

The list of large-cap growth funds’ favorite stocks already has been altered dramatically compared with the favorites of March 2000.

Technology stocks comprised 15 of the 25 largest holdings of large-cap growth funds in March 2000, according to Morningstar.

Now, there are just six tech stocks on the top-25 list: Microsoft Corp., Intel, Cisco, AOL Time Warner Inc., Dell Computer Corp. and Applied Materials Inc.

Though tech may still be the single biggest sector weighting for many large-cap growth funds, managers have better diversified their portfolios, boosting their holdings of big-name stocks in such industries as health care, financial services, retail and consumer products.

At Putnam, Oristaglio said the funds’ managers in the late 1990s “had been focused too much on momentum factors and not enough on valuations. It’s a flaw we feel we’ve corrected.”

In June, Putnam hired Brian O’Toole from Citigroup Asset Management as its new chief of large-cap growth investing. O’Toole’s team oversees the firm’s Voyager, Growth Opportunities and New Opportunities funds.

O’Toole said he is emphasizing companies with steady earnings growth--the hallmark of growth companies--but is more careful about focusing on the true bottom line.

“Investors found out that, yes, earnings count. It’s not just cash flow,” he said.

Putnam also is emphasizing actual or “reported” earnings when evaluating companies and stocks, rather than “operating” earnings, which are results excluding so-called one-time charges, O’Toole said.

Reported earnings are less susceptible to manipulation, he said.

O’Toole said Microsoft, retailer Bed Bath & Beyond Inc. and financial services firm Northern Trust Co. exemplify the type of companies he likes. He believes that his criteria would have kept stocks such as Lucent Technologies Inc. and Tyco out of the portfolios before the shares got clocked.

At Janus, fund managers see better growth opportunities in health-care and insurance stocks such as Tenet Healthcare Corp., American International Group Inc. and Berkshire Hathaway Inc. All three are among Janus’ leading holdings firm-wide as of its latest portfolio reports.

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Solid Stock Pickers

For large-cap growth fund investors who are trying to decide whether to stick with a fund that has performed worse than the category average since the market peak, analysts suggest looking at what’s in the portfolio now, and at the manager’s longer-term record.

Alfred Harrison, who has drawn investor ire for betting on Enron and Tyco in his Alliance Premier Growth fund, is one manager who deserves investors’ faith, S&P;’s Edwards said.

“[Harrison] is a great manager with a good long-term record. He had a bad year but that doesn’t mean he had a frontal lobotomy,” Edwards said.

Some analysts also say that Fidelity OTC fund manager Jason Weiner and Fidelity Growth Company fund manager Steven Wymer also are solid stock pickers who should be given the benefit of the doubt, despite their funds’ recent results.

Van Kampen Emerging Growth fund, whose assets swelled to about $19 billion in spring 2000, probably got more “hot money” than manager Gary Lewis could deftly handle, said Morningstar analyst Robert Gynn.

Gynn said Lewis has had 13 years at the helm--most of them successful--and he said the fund is more nimble now at around $7 billion in assets. Despite the losses since March 2000, Lewis’ 10-year record is near the top of the large-growth-fund class, according to Morningstar.

Still, analysts say the urge to bolt a cold fund is understandable.

In the case of Vanguard U.S. Growth, which replaced longtime advisor Lincoln Capital with a team from Alliance Capital in June 2001, shareholders are in a tough spot, said Morningstar analyst Christopher Traulsen.

“They endured a couple of brutal years of losses that were not Alliance’s fault, and now this must feel like salt in the wounds,” he said, noting that the fund is down 31.5% year to date. “But it’s far too early to pass judgment on Alliance,” he said.

Vanguard spokesman Brian Mattes said the fund’s new advisors deserve at least three years before their performance can be judged fairly.

In general, investors may regret giving up on large-cap growth funds at this point, some analysts say. The risk is that investors could be selling low after buying high if they came into the funds in 1998 or 1999.

With the funds’ more diversified portfolios, investors in large-cap growth now own a broader swath of the nation’s most successful companies, experts note.

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Time to Get Out?

However, in cases where fund losses can be pinned squarely on poor stock picking in recent years, some analysts say there’s reason for investors to consider jumping ship.

Robert Bertelson, manager of Fidelity Aggressive Growth, has been “a consistent underperformer” since taking over in early 2000, according to Jim Lowell, editor of the independent Fidelity Investor newsletter in Needham, Mass.

Although Fidelity measures the fund against mid-cap stock indexes, its assets ballooned under previous manager Erin Sullivan, and Morningstar labels it large-cap growth.

Regardless of the benchmark used, Bertelson has sustained deep losses each year at the helm.

Fidelity takes exception to the criticism Bertelson is getting.

“He took over this fund at the exact moment the market went into an unprecedented decline, and for 2 1/2 years he has faced tremendous challenges,” said Fidelity spokeswoman Anne Crowley in Boston. “It’s a very aggressive fund, by its own mandate, in a very conservative market.”

As for Janus funds, Morningstar’s Portnoy said the structure of Janus Twenty, which typically holds just 20 to 25 stocks, might make it tricky for manager Scott Schoelzel to steer a comeback. For instance, Portnoy said, selling large chunks of stock without depressing the market price is an “art form.”

But Portnoy said he would stick with the flagship Janus Fund, whose manager Blaine Rollins has done well over the longer term.

Schoelzel said he doesn’t think the Janus Twenty fund’s focused style will impair its performance, and he noted that the fund ranks in the top third of the Morningstar large-cap growth category year to date (the fund is down 21.2%).

One analyst said he is skeptical about active management overall when it comes to large-cap growth funds.

“It’s really a question of whether any manager can consistently outperform the large-cap indexes, which are made up of stocks that are so heavily covered on Wall Street,” said Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter in Potomac, Md.

Wiener said he opts for the Vanguard Growth Index fund, which tracks the growth segment of the S&P; 500--and has beaten three-fourths of its category peers over the last five years.

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Growth Fund Favorites, Then and Now Here are the 25 stocks that were the biggest holdings in large-cap growth stock mutual funds in March 2000--as the great bull market was peaking--and the stocks that are the biggest holdings now (measured at midyear). The lists show how technology stocks dominated the top 25 at the market peak. By contrast, tech shares are a minority on the top-25 list now. Stocks shown in boldface type are tech issues.

March 2000 Midyear 2002 Pctg. of Pctg. of large-cap large-cap

Stock growth assets Stock growth assets

Cisco Systems 4.2% Microsoft 3.4%

Microsoft 3.0 Pfizer 2.7

General Electric 2.2 General Electric 1.8

Intel 2.1 American Intl. Group 1.6

Time Warner 2.0 Citigroup 1.6

Nokia 2.0 Viacom class B 1.6

Oracle 1.7 Wal-Mart Stores 1.6

Sun Microsystems 1.6 Intel 1.5

EMC 1.6 Johnson & Johnson 1.5

Texas Instruments 1.5 Cisco Systems 1.3

Home Depot 1.5 Home Depot 1.3

Liberty Media 1.4 Philip Morris 1.2

America Online 1.3 AOL Time Warner 1.0

Applied Materials 1.1 Dell Computer 0.9

Qualcomm 1.0 UnitedHealth Group 0.9

Warner-Lambert 1.0 Tenet Healthcare 0.9

JDS Uniphase 1.0 PepsiCo 0.8

Amer. Intl. Grp 1.0 Kohl’s 0.8

Tyco Intl. 1.0 Coca-Cola 0.8

Dell Computer 0.9 Lowe’s 0.8

Citigroup 0.9 Medtronic 0.7

Motorola 0.9 Wyeth 0.7

Wal-Mart Stores 0.8 Freddie Mac 0.7

Pfizer 0.8 Applied Materials 0.7

Nortel Networks 0.7 Procter & Gamble 0.7

Enron 0.7 Amgen 0.7

Source: Morningstar Inc.

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Leaders Become Laggards

Here are the biggest large-cap growth-stock funds as of March 2000--when the bull market peaked--and how they have fared since then. The data show that the majority of the biggest funds lost more than the category average between March 31, 2000, and Aug. 23, 2002.

Annualized

Assets (in billions) total return,

Fund 3/31/00 8/23/02 3/31/00-8/23/02

Janus $49.1 $17.2 -28.35%

American Century Ultra Inv 46.7 20.8 -22.93

Putnam Voyager A 46.4 18.2 -27.06

Putnam New Opportunities A 39.2 10.5 -36.94

Janus Twenty 38.5 10.3 -34.46

American Funds: Growth 35.6 38.6 -16.66

Fidelity Growth Company 35.5 15.1 -30.85

Fidelity Blue Chip Growth 30.1 17.0 -21.20

Fidelity Aggressive Growth 23.1 4.1 -48.64

AIM Constellation A 22.3 8.2 -26.36

MFS Emerging Growth B 22.2 5.6 -35.66

Vanguard U.S. Growth 20.0 7.1 -34.10

Alliance Premier Growth B 19.7 7.3 -29.83

Van Kampen Emerging Growth A 18.8 7.4 -34.89

Janus Mercury 18.6 5.2 -35.44

Vanguard Growth Index 17.0 8.3 -22.98

Fidelity Advisor Equity Growth Instl 16.0 8.7 -24.36

Fidelity OTC 15.7 5.9 -33.50

Putnam Investors A 15.1 6.7 -26.47

MFS Mass. Investors Gr Stk A 14.9 10.2 -25.27

AIM Weingarten A 13.1 3.1 -36.18

Amer. Funds New Economy A 13.1 6.7 -25.29

Morgan Stanley Amer. Opp B 12.0 5.3 -23.06

American Century Growth Inv 10.9 4.6 -25.27

AXP Growth A 9.7 3.5 -32.07

Harbor Capital Appreciation 9.7 5.2 -27.54

Janus Growth & Income 9.4 5.6 -20.30

Fidelity Independence 9.2 4.4 -21.54

Janus Olympus 9.0 2.3 -33.96

Alliance Growth B 8.9 2.3 -28.12

American Century Select Inv 8.0 3.9 -20.27

American Funds Amcap A 7.7 7.8 -8.71

Prudential Jennison Growth A 7.5 3.2 -28.30

T. Rowe Price Blue Chip Growth 7.2 5.5 -17.38

Fidelity Destiny I 6.8 3.1 -20.93

T. Rowe Price Growth Stock 6.1 4.0 -14.90

AIM Blue Chip A 6.0 3.1 -23.70

Vanguard Morgan Growth 5.9 3.1 -21.03

Merrill Lynch Fund. Growth D 5.8 6.2 -23.26

One Group Large Cap Growth I 5.0 2.0 -28.06

IDEX Janus Growth A 4.5 1.3 -36.50

Van Kampen Enterprise A 4.2 1.8 -27.06

MainStay Capital App. B 4.2 1.7 -26.09

SEI Instl Mgd Large Cap Growth A 4.2 3.2 -30.96

Strong Growth Inv 4.1 1.8 -32.22

Fidelity Capital Appreciation 4.0 1.7 -19.96

Smith Barney Large Cap Growth B 4.0 3.0 -20.37

Oppenheimer Growth A 3.9 1.7 -27.44

Rydex OTC Inv 3.9 1.0 -46.93

Janus Aspen Growth Instl 3.8 1.7 -26.80

Average large-cap growth fund -26.60%

Source: Morningstar Inc.