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Mutual Funds: A Round Of Applause, But No Rave Reviews


Where to Invest in 1998 -- The Investment Spectrum: MUTUAL FUNDS

MUTUAL FUNDS: A ROUND OF APPLAUSE, BUT NO RAVE REVIEWS

Equity funds trailed the S&P 500 again. Many top performers were unknown mavericks

Only a few months ago, it looked as if mutual-fund managers might do in 1997 something they haven't done since 1993: beat the Standard & Poor's 500-stock index and the index funds that mimic it. But the October market turmoil and the December massacre in technology stocks put the funds back behind the index.

In real terms, funds had a great year. The average U.S. diversified equity fund earned 20.64% in all (through Dec. 12, including reinvestment of dividends and capital gains), says Morningstar Inc. The all-equity average, including battered international funds, was up 14.28%. But the S&P scored a 30.83% return, leaving the relative performance--how the funds did compared with the S&P--the worst since the bull market began. Even a small Santa Claus bounce probably won't change that. The S&P outdid all fund categories except funds specializing in financial services, which gained 42.84% (table, page 146). Financials soared on lower interest rates, higher earnings, and takeovers.

TARNISH. Technology funds, which have earned double-digit returns since 1991, lost 14 percentage points of return in the week of Dec. 8, winding up on Dec. 12 with a 2.29% gain for 1997. The slide in tech stocks undermined the broader fund averages, since funds average more tech holdings than the S&P 500.

Overseas funds flagged, their gains in Europe and Latin America offset by losses in the Far East. The average foreign fund mustered only a 3.18% return. World funds, which include U.S. stocks, fared better--up 7.96%. Funds specializing in Asia suffered devastating losses. Diversified Asian funds plunged 26.97%; those that exclude Japan were hurt even more--down 33.16%. By comparison, Japan funds did not look so bad. They're down 13.82%.

Precious-metals funds registered what was possibly the worst one-year performance of any fund category: They fell 46.82%. Gold funds were battered in the spring by Bre-X Minerals Ltd., whose supposedly record-breaking gold find turned out to be bogus. More recently, central banks started announcing they would sell large portions of their gold reserves. That sent prices down to $285 per ounce, an 18-year low. "At these prices, about one-third of the world's gold-mining companies--and 60% of South Africa's--are operating at a loss," says Kjeld R. Thygesen, whose Midas Fund is down 62.33%.

Whether the funds beat the S&P doesn't seem to matter to investors. Through November, they put $208 billion into equity funds, according to the Investment Company Institute (ICI). But the influx of cash has slowed from around $4 billion a week before the Oct. 27 minicrash to $1.6 billion now, says Robert Adler, whose company, AMG Data Services, tracks fund cash flows.

Part of the slowdown comes from volatile markets, but some is seasonal. Investors often hold off making investments at yearend to avoid taxable distributions. Adler expects a cash surge in January, as investors kick in bonuses and money for their new Roth IRAs.

Fund buyers also show renewed interest in bonds. ICI estimated that bond funds took in $8 billion in November, the strongest month in nearly four years. Adler says most of the new money is seeking high-yield or high-quality corporate bond funds. With long-term rates down 1.25 percentage points since April, most funds have made steady gains. Taxable funds earned, on average, 7.54% in all; tax-free funds, 7.56%.

Most of the largest equity funds scored above-average returns (table). The $61.8 billion Fidelity Magellan Fund, whose management closed it to new investors in the hope of improving performance, gained 23.87%. The Vanguard Index 500 fund, which matches the S&P, delivered the best return, and Washington Mutual Investors did nearly as well.

The top diversified equity funds feature names unfamiliar to fund buyers. One of them is Munder Micro-Cap Stock, the No.1 performer, with a 64.39% return. The $30 million fund blends growth and value stocks and has a median market cap of $105 million. Usually, such small funds make their mark with 30 or 40 stocks and a few big winners. But this fund has about 120 stocks, does not overweight sectors such as technology, and has no position larger than 1.5% of assets. "We buy stocks that are not widely followed and where management owns a large stake," says Carl Wilk, one of the fund's four managers at Munder Capital Management in Birmingham, Mich.

For Mark A. Coffelt of the Texas Capital Growth & Value Fund, quantitative screens work better than quizzing corporate executives. "Every time I've talked to management about a problem at a company, I've held on to the stock and eventually regretted it," says Coffelt, whose fund is in Austin, Tex. "Some people are good at sizing up management, but I'm not." The $27 million fund is up 40.87% so far this year.

FBR funds--part of Friedman, Billings, Ramsey & Co., an Arlington (Va.) investment bank specializing in financial institutions--opened for business at the start of the year, and had three funds in the top 50. It helps, of course, that two are financial services funds.

Some of the best returns came from those who challenge the conventional wisdom. Christian Felipe, who runs the MFS Massachusetts Investors Growth Stock and MFS Strategic Growth funds, was buying Oracle Corp. stock as the Street bailed out. "It's a great company at an outstanding price," says Felipe. "The core business is sound." Portfolio manager Saul J. Pannell, of the Hartford Capital Appreciation Fund, is a fan of unloved Waste Management Inc. "It's about to get its fourth CEO in less than a year," says Pannell. "It reminds me of AT&T. The company has great assets, and with good management, the stock could really run."

DUMPING. Thomas M. Maguire of Safeco Growth No Load Fund, up 45.08%, also bucks the trend. One of his favorites is Green Tree Financial Corp., even though Wall Street has been dumping it because of its accounting policies. But with a price-earnings ratio of 7, Maguire figures it's worth the risk. If the accounting gets more conservative, he says, near-term earnings would come down, but the stock benefits in the long run.

Among foreign funds, Lexington Troika Dialog Russia Fund, up 55%, is the standout. Impressive, yes--but that's less than half the year-to-date gain it had made by early October. Richard Hisey, the fund's co-manager, says Russia is different from Asia. In Asia, "economies are coming out of a long period of high growth, while the Russian economy has been contracting and is only now starting to grow," says Hisey. Most of the Moscow gains so far have been in telecommunications, energy, and utilities. "Longer term, there's an entire economy in development," he adds.

The emerging-markets melee ravaged some bond funds, too. Both Fidelity New Markets Income and T. Rowe Price Emerging Markets Bond Fund had been up more than 20% for the year before the crash. Returns have since been halved. John H. Carlson, who runs Fidelity New Markets Income Fund, says he is looking to buy from distressed sellers. "It's not the end of the world," he says. "But we've never had economies as large as Korea's in trouble either." Asian debt will be attractive, notes T. Rowe Price's Mike Conelius, "only when we're convinced reforms are forthcoming. Maybe that will be an opportunity next year."

The big winners among bond funds were four zero-coupon funds run by American Century Benham. Of these, the fund with the longest maturity gained 29%. Paying no current income, zeros are the most volatile of all bonds, gaining the most when rates fall and losing the most when rates rise. Just behind them are high-yield and convertible bond funds, which behave at least as much like stocks as like bonds.

Investors may buy bond funds to diversify, but there's no sign they've lost their zest for zippier equities.By Jeffrey M. Laderman in New YorkReturn to top


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