| BUSINESSWEEK ONLINE : JUNE 14, 1999 ISSUE | |||||||||||||||||||||||||||
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| COVER STORY
Mutual Funds: Reversal of Fortunes As 1998's leaders limp along, some laggards are rising Last year, mutual funds that specialize in big, fast-growing companies left the competition in the dust. Then the bull market abruptly shifted gears and anointed new leaders. Through May 27, value funds have beaten their growth counterparts. Moreover, portfolio managers focusing on midsize companies have outdistanced those who favor the biggest stocks. The result: While many funds that invest in high-flying Internet and technology stocks are now on top, so are a number of last year's poorest performers. Laggards-turned-leaders include several emerging-market and energy funds, plus once-hot names that stumbled badly in recent years, such as manager Garrett Van Wagoner and the Vanguard Group's giant Windsor fund. ''There has been a rotation away from the nifty 50 stocks that led the market up last year,'' says Christine Benz, associate editor at Morningstar Inc., which prepares fund data for BUSINESS WEEK. ''Large growth has suffered.'' To be sure, most of the 25 largest stock funds, which by necessity focus on large-cap stocks, are faring better than the Standard & Poor's 500-stock index. Robert Stansky, manager of the nation's largest fund, Fidelity Magellan, continued to beat the S&P by a slight margin. Still, it was Vanguard's value-style Windsor fund that had the best return of the group, with a 13.9% gain. If the trend toward midsize and value equities continues, it is only a matter of time before more funds with stock pickers at their helms begin to outpace those that replicate the big-cap, growth-oriented S&P 500. The performance gap has already narrowed. Although the S&P rose 4.65% through the end of May, it ran only 0.84 percentage points ahead of the average U.S. diversified stock fund, vs. a 4 percentage-point lead in the same period last year. ''We've come through a few years where the S&P 500 funds were beating 90% or more of the managers, and that's simply not going to continue,'' says Sheldon Jacobs, editor of the No-Load Fund Investor, a fund newsletter. Behind the market's rotation is faster-than-expected global growth, which has helped the economically sensitive companies favored by value managers post surprisingly good earnings. ''The U.S. economy is strong, commodity markets are better, and Asia is improving. All these factors point to a sustainable value cycle,'' says value- fund manager Denis Laplaige. His MainStay Equity Income Fund has surged 23.1% this year, far surpassing the 4.71% average gain for value funds. MainStay Equity Income has benefited from snapbacks in basic materials, manufacturing, and energy stocks, including Texaco and USX. Despite some recent moderation in oil and other commodity prices, Laplaige says there is room for further improvement in his favorite stocks. He expects earnings in value sectors such as basic materials, energy, and transportation to rise an average of 20.7% this year and 31% in 2000, vs. gains of 20% and 19.4%, respectively, for growth industries such as consumer staples, technology, and health care. OIL STRIKE? Among funds that concentrate on specific industries, those that restrict themselves to natural resources are the hottest performers this year. After sinking 25.5% amid last year's global economic crisis, natural-resources funds have reversed course, rising 19.3% in the wake of this year's production cutback by OPEC. Lawrence Rakers, whose Fidelity Select Energy fund is up 41% this year after falling 14.7% in 1998, figures oil and gas stocks could climb an additional 15% to 35%, provided the price of a barrel of oil rises $1 to its average of $18 over the past 5 years. Higher oil prices also explain a good part of the Lexington Troika Dialog Russia Fund's blistering 65.9% gain this year. One of the most volatile funds, Lexington Troika fell 82.98% last year as the ruble collapsed and is down 31% since its 1996 debut. But because 35% of the fund's assets are invested in the Russian oil and gas industry, which is the nation's largest source of exports, it has benefited from the uptick in oil prices, says portfolio manager Mac Hisey. As a group, diversified emerging-markets stock funds are up 20.5% this year, after last year's 26.84% drop. Bond funds have experienced equally dramatic reversals. With fears of a worldwide economic downturn receding, investors who fled to the perceived safety of the U.S. Treasury market last fall are willing to ''embrace things that seemed too risky'' then, says Morningstar's Benz. That has helped emerging-markets bond funds gain 5.59% this year. And while rising U.S. interest rates have hammered Treasury bonds, the prospect of higher inflation has helped the debt-laden companies that issue high-yield bonds. That's because inflation erodes the value of debt, making it less onerous, says Roger E. King, whose Dreyfus(MEL) High Yield Securities Fund, up 16.5% this year, is first on the taxable bond-fund rankings after struggling last year. On average, taxable and municipal bond funds are down 0.63% and 0.19%, respectively. Long-term government bond funds have lost 5.6%. But high-yield funds are up 2.63%. Perhaps as a result, the flow of dollars into high-yield bond funds is still strong, even as equity funds suffered net redemptions for the two weeks ended May 26, according to mutual fund information company AMG Data Services. Only $47.4 billion has moved into equity mutual funds so far this year, down 40% compared with the same period last year, AMG says. One theory is that investors are souring on funds after several years of watching the S&P 500 trounce highly paid stock pickers. AMG President Robert Adler suspects that some investors are also shifting out of funds into stocks that they trade online. Even though big-cap funds have surrendered their leadership, many investors are still concentrating on large-cap index funds, primarily Vanguard's 500 Index Fund. Large-cap index funds have attracted $24 billion, up from $14 billion in the first five months of last year. The only other fund categories to receive more money this year than last are large-cap growth and technology funds. ''ABSOLUTELY LOONY.'' Although they have suffered lately, technology and Internet funds remain hot overall. This year's top-performer, Amerindo Technology fund, has plowed about 90% of its $139.17 million in assets into about a dozen Net-related stocks, including Inktomi(INKT), eBay(EBAY), and Amazon.com(AMZN). Through the end of May, it is up 98.9%. Money manager Van Wagoner, who trailed badly in 1997 and 1998, also used Net stocks to help four of his five funds claw their way into the top 11. But in April, he cut his exposure to the sector by half, to roughly 20% of the funds' assets. ''The valuations got absolutely loony,'' he says. Van Wagoner plans to buy more Net stocks if they get cheap enough. But now, he's investing his profits in health-care stocks, such as regional hospital chain Province Healthcare. The sector ''was beaten down this spring on fears of government regulation, which tend to be overblown,'' Van Wagoner says. That's a gutsy bet. Health-care funds fell 7.69% this year, making them the worst performers among funds that focus on specific industries. Besides the specter of government regulation, pharmaceutical stocks have been hit by concerns about high valuations and patent expirations, says John R. Schroer, manager of Invesco Health Sciences Fund, which is down 11.21%. Predictably, the list of this year's losers is dominated by bear funds, which bet that stocks will fall by selling borrowed shares in the hope of replacing them at a profit after prices decline. Among the biggest laggards: Prudent Bear, Potomac OTC/Short, and the ProFund's UltraShort OTC fund. Also hit hard were gold and small-cap funds, which have been depressed for some time. But now that investors have discovered value and mid-cap stocks, many are betting that small-cap funds will be the next to revive. They point to signs of cooling among Internet stocks, which have attracted money that might have gone into small-stock funds. ''Small- and mid-caps are undervalued. At some point that will be recognized,'' says George Henning, co-manager of Pacific Advisors Small Cap fund, which tumbled 13.61% this year despite a 0.66% gain for small-cap value funds as a whole. If that happens, 1999 will indeed be a year of surprises for mutual funds. BY ANNE TERGESEN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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 RELATED ITEMS Mutual Funds: Reversal of Fortunes TABLE: The Best Returns TABLE: The Worst Returns TABLE: How the Big Funds Fared TABLE: The Bond-Fund Leaders TABLE: How the Fund Groups Fared
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