For U.S. stock funds, a modest advance for ’07
You were more likely than not to make money in U.S. stock mutual funds in 2007.
But some investors may wonder if it was worth the risk.
The average domestic stock fund scored a total return of 6.4% last year, according to investment research firm Morningstar Inc. That was the weakest calendar-year gain since the bull market began late in 2002, and was down from the 12.6% average return in 2006.
By contrast, money market mutual funds generated an average yield of 4.7% for the year, based on preliminary calculations from IMoneyNet Inc.
So U.S. stock funds, on balance, beat the relatively low-risk money fund return by less than two percentage points -- arguably not much of a reward for the trouble.
But underneath average performance figures, of course, there’s usually a lot going on. And that was the case in 2007.
As the housing market’s woes triggered deep concerns about the health of the American economy in the latter part of the year, many investors sought the perceived safety of large-company U.S. stocks. The result was a momentous shift in market leadership, away from the small-company shares that had long led the current bull market.
Many funds that focus on small-capitalization “value” stocks, for example, were in the red for the year. The average fund in the category sank 6%, according to Morningstar.
Fund returns include price appreciation or depreciation plus any dividend or interest income.
As smaller stocks struggled, the resurgence of big-name stocks was best exemplified by a sharp turnabout in the fortunes of the Fidelity Magellan fund, which scored an 18.8% advance for the year.
At the same time, U.S. investors refused to turn away from other sectors that had made them a boatload of money for the last five years and that continued to perform well in 2007.
At the top of that list: most foreign stock markets. The average foreign stock fund gained 15.7% for the year, according to Morningstar. It marked the sixth consecutive year that foreign funds outperformed U.S. funds.
Foreign markets benefited from strong economic growth abroad and from the dollar’s continuing slide, which made overseas investments worth more when translated from stronger foreign currencies into the weaker dollar.
Natural resources funds, many of which focus heavily on energy stocks, also had another bang-up year, gaining 37.2% on average. After stalling out in 2006, the price of crude oil set a series of record highs in 2007 and flirted with $100 a barrel in recent days, before pulling back Monday.
Energy stocks including ConocoPhillips and Devon Energy Corp. helped the Excelsior Value and Restructuring fund post a 10.4% return last year, buoying its performance as some other bets flagged.
Manager David Williams said he was drawn to energy because he believed the stocks’ prices didn’t accurately reflect the run-up in oil in recent years.
“I thought you could buy oil cheaper on the New York Stock Exchange [via the companies’ shares] than going out and finding it,” he said. “I feel the same right now.”
On the downside last year, many investors fled the financial and real estate-related stocks that were the primary victims of housing’s troubles.
The average real estate-oriented fund, most of which own real estate investment trusts, sank 14.8% for the year, including a 12.2% plunge in the fourth quarter alone, Morningstar said.
Financial services funds, which own mostly bank and brokerage shares, dived 11.9% for the year, on average, amid soaring losses on mortgage-related securities at many financial firms.
As 2008 kicks off and stock fund investors mull over whether to make changes in their portfolios, here are three key questions worth considering:
* Can “growth” stocks keep their lead over “value” stocks? Growth stocks are shares of companies whose earnings are expected to grow at an above-average pace over time. Value stocks are issues that appear cheap based on the company’s underlying earnings or other measures.
Growth had ruled the roost in the late 1990s, then crashed in 2000, led by technology shares. In this decade, value stocks had mostly had the lead -- until 2007.
Last year, the average large-capitalization growth stock fund gained 13.4% on average. The average large-cap value fund edged up just 1.4%.
Many growth-fund managers have contended for the last few years that growth was overdue for a bounce. It happened in 2007 thanks in large part to a comeback for the tech sector.
The Los Angeles-based Payden U.S. Growth Leaders fund, with $128 million in assets, rose 22.3% last year, paced by strong gains in tech shares including Apple Inc. and Google Inc.
Christopher Orndorff, the fund’s manager, says he’s betting that global spending on computers and other tech equipment will defy slower growth in other sectors of the economy.
The need to upgrade tech systems, particularly for video downloads, means “everything needs to get bigger in terms of capacity,” Orndorff said.
Will Danoff, who manages the $81-billion Fidelity Contrafund in Boston, can invest in growth or value issues, or both. He’s favoring growth stocks now, and that helped his fund gain 19.8% last year. Danoff thinks many tech stocks, in particular, boast strong fundamentals -- the equivalent of a tail wind.
Over time, he said, “I’ve done well investing with a tail wind rather than a head wind.”
* Can foreign stocks keep their lead over U.S. stocks? The obvious risk facing still highflying foreign markets is that a U.S. economic slowdown, or recession, could drag down the global economy. Likewise, if China’s hot economy slows, many other foreign economies could be hurt.
Also, if the dollar were to rally instead of slide further, that would cut into U.S. investors’ returns on foreign stocks.
Although many financial advisors say they can’t argue with the risks, the long-term appeal of the foreign-growth story also remains powerful.
Norman Boone, who manages $400 million for clients at Mosaic Financial Partners in San Francisco, said foreign stocks comprise about 40% of his average client’s equity holdings, with the balance in U.S. shares.
“I suspect that in 2008 we will be shifting foreign to 50%,” Boone said, citing his faith in foreign economies’ growth prospects over the next few decades.
William Fries, who manages the Santa Fe, N.M.-based Thornburg Value stock fund (which rose 6.1% last year, better than most peer funds), had about 12% of the portfolio in foreign issues, including China Mobile Ltd., a major cellular telecom company.
Although the stock has been zooming for five years, “We still see the company’s growth rate well above anything else we can identify,” Fries said.
* Is it time to look at beaten-up financial issues? Many fund managers believe that financial stocks will become screaming bargains at some point in 2008, if they aren’t already.
Thornburg’s Fries said he sold the fund’s holdings in mortgage finance giant Freddie Mac in the fourth quarter, but then moved back into the stock when it fell as low as $25 in November, its lowest in more than a decade.
At that point, he said, “I thought it was attractive.”
But Danoff said it might still be too soon to jump into financial shares. “A lot of people are watching” the stocks, he said. “My experience is that the best value ideas appear when fewer people are watching.”
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