As company earnings improve next year, small-cap funds are likely to show positive returns, say the pros. A. Lanny Thorndike, fund manager of the $26 million Century Small Cap Select Fund, up 2%, expects single-digit earnings growth. "We're looking for steady Eddie," he says. Thorndike seeks companies with high recurring revenues that have earned at least 15% to 20% returns on equity annually for five years. He figures such stocks could double three years from now. His favorites include Portfolio Recovery Associates, a debt collection business; Medical Waste Disposal; and Stericycle (SRCL ), a medical-waste company.
Haven't heard of those companies? Managers destined to stay on top next year will likely gravitate toward unknown and unloved stocks of the high-quality variety. And should the stock market continue along its volatile trajectory, managers with flexible fund charters, allowing them to hold lots of cash, sell stocks short, or invest in bonds, may keep their competitive edge. Terry Coxon of the Permanent Fund, which has just such a go-anywhere strategy, has earned his investors 12.7% this year, earning his fund a No. 56 ranking in the industry. Lately, he has had a conservative mix of investments in Swiss francs, real estate investment trusts, bonds, and natural-resource stocks, such as ChevronTexaco (CVX ) and Burlington Resources Inc. (BR ) Other winning equity funds with similar strategies include the Comstock Capital Value Fund, up 31.7%, and, the Yacktman Focused Fund, up an annual 15% over the past three years.
High cash holdings have been a boon even for tech-fund managers. Zach Shafran, manager of the Waddell & Reed Advisors Science & Tech Fund, has lost 27%, vs. the industry's 39% average. He says tech stocks are still too expensive and has stashed 30% of the fund's assets in cash, up from his usual 10%. He has also relied on health-care companies, such as Alcon Inc. (ACL ), a global-ophthalmology company recently spun off from Nestlé. "Tech stocks have gone from extremely overpriced to just overpriced," echoes John L. Rutledge, of the $12 million Evergreen Technology Fund. He has stayed afloat by sticking to the information-technology services sector, with stocks such as First Data Corp. (FDC ) and Affiliated Computer Services (ACS ).
Bond fund managers have been reigning champions for three years. But the pros are preaching caution for next year. Their best advice: Stay short. Five- to 10-year bonds are the riskiest now because of the likelihood that interest rates will rise. Luckily, some corporate bonds now show promise. "What you find there are quality companies that are going through a period of transition," says Marc P. Seidner, senior fixed-income strategist at Standish Mellon Asset Management, which manages $40 billion, mostly in bond assets. "Their credit ratings and yield spreads do not fully reflect the improving business fundamentals."
The attraction is high yields averaging about 10%. But there's an important caveat: "The big mistake right now is for investors to chase yield," says Daniel J. Genter, president of RNC Capital Management LLC, a Los Angeles investment firm that manages $1.3 billion. Genter doubled his stake in corporate bonds in the fourth quarter--but there are risks of downgrades. "When you move away from Treasuries, cash flow and corporate issues affect these bonds, so be picky," he says.
International managers who take a conservative approach were also amply rewarded in 2002. The Commonwealth Australia/New Zealand Fund, No. 42 of all funds, is up 17.4% by favoring Old Economy stocks such as Williams & Kettle, an agricultural supplier, and Northland Port.
Emerging markets are also coming out of a deep slumber, says Mark Madden, manager of $1.2 billion in emerging-market assets for Pioneer Investments in Boston. His biggest sector weighting is in financials, at 17% of assets. His picks include Thailand's Bangkok Bank, one of the largest in the country, and Korea's Shinhan Bank. "We hit bottom two years ago," he says. "But the recovery in these companies was delayed by the slow economic global environment."
The pace of economic recovery isn't expected to pick up anytime soon, either in the U.S. or abroad. As long as it stays slow, a steady investment strategy will continue to win the race.
Copyright 2002, Bloomberg L.P.
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