Finance: Mutual Funds
Mutual Funds: "There's Been a Sobering Up"
The average equity fund rose just 0.4% in the third quarter as New Economy darlings took a licking
When they rang in the 21st century, investors in growth funds were intoxicated by the soaring returns of technology stocks and mutual funds that invest in them. Since then, the stock market has acted more like a glass of stale champagne: flat, with no bubbles. Now, in the third quarter, few are in party mood.
Those toasting these days are back-to-basics value-fund investors. Their third quarter was the second in a row in which they beat their growth-fund rivals. "There's been a slow turn away from speculation to reality," says Robert Olstein, fund manager of the Olstein Financial Alert Fund, a mid-cap value fund, up 4% in the third quarter through Sept. 25. "If you don't understand company fundamentals or valuations, you're going the way of the dinosaur."CLASSIC ROTATION. Olstein's performance is solid considering that, for the third quarter, the average equity fund was up a scant 0.4%--dragged down by the Nasdaq Composite's turbulent year, including a 6% loss in the quarter (table, page 196). For the most part, U.S. diversified equity funds beat the market, but not by much: Third-quarter gains of 2.23% only skimmed past the Standard & Poor's 500-stock index' loss of 2.06%. Mutual-fund data are prepared for BUSINESS WEEK by Standard & Poor's Corp.
In a classic market rotation, mutual funds investing in such standard-issue defensive sectors as real estate, pharmaceuticals, and energy surged ahead. Funds whose managers favor value investing were winners, too: Small-cap value funds, up 4.57%, beat small-cap growth, up 1.45%. Large-cap value, up 3.67%, edged out large-cap growth, up 0.21%. Mid-cap value funds, up 5.37%, beat mid-cap growth, up 4.68%.
Jeanne Mockard, whose $1.3 billion Putnam Utility Growth & Income Fund rose 7.81% in the third quarter, couldn't get investors' attention last year though the sector's stocks, such as Montana Power Co., Enron Corp., and Calpine Corp., were up as much as five-fold. With deregulation, these traditional companies have gotten a bigger stock boost, trading power worldwide and maximizing fiber-optic assets. "Suddenly, the possibility of a 15% total return sounds good relative to being down 30%," says Mockard. "We're back on the map."
The performance of high-tech and Internet mutual funds was dramatically turned on its head. These New Economy darlings were trounced by Old Economy stalwarts in the third quarter. Financial services funds, aided by a flurry of brokerage and investment banking mergers and the uptick in insurance stocks, gained 19.17%, leading the pack of sector funds. Meanwhile, real estate funds, which were posting losses last year, gained 6.04%, and natural resource funds were up 4.77%. By comparison, technology funds rose just 0.5%, while communications funds lost 7.27% in the quarter. Nasdaq's roil has pummeled funds such as the Pilgrim Global Technology Fund, down 16.22%, and Fidelity's Select Telecommunications Fund, which lost 14.93%. The one bright spot in growth investing was health-care funds. Powered by white-hot biotech stocks they averaged an 11.5% rise, the second strongest sector performance. "Each time there's been a tech rally, somebody takes the punch bowl away again," says Mark Fuller, fund manager of the $36 million William Blair Small Cap Growth Fund, which made its debut on New Year's Eve. "There's been a sobering up." Fuller's tiny fund was up a healthy 59.96% this year, and 9.25% in the third quarter, thanks to its small asset base and successful hefty bets in the risky new issues market.MARKET ODDITIES. Even diehard growth managers have been forced to dabble in oil and energy stocks to get an extra pop. Dan Becker, manager of Waddell & Reed's Vanguard Fund, a $3.1 billion large-cap growth fund, doubled oil-services stocks to 12% of assets. "We usually ignore it," Becker says. "Once in a blue moon you get growth characteristics out of the basic materials sector," Becker says. The fund, which still has a 50% stake in tech, lost 1.25% for the quarter, but is up 15.11% for the year.
The market's oddities don't stop there. A year ago plain-vanilla index funds were winners. Now, investors have been cashing out of both the Vanguard Total Stock Market Index Fund, which tracks the Wilshire 5000 index, and its flagship Vanguard 500 Fund. The reason: lackluster performance with third-quarter returns of 0.21% and a loss of 0.78%, respectively. "It's pretty unique when you see money flowing out of these funds," says Daniel P. Wiener, editor of the Independent Adviser for Vanguard Investors newsletter and Fidelity Investments' mutual funds. "Indexing isn't working; those who jumped on the indexing bandwagon late last year may have gotten the raw end of the stick."
All told, investor demand for equity funds has cooled sharply. Mutual-fund inflows sank to $39.9 billion in the third quarter, about $10 billion less than the second, and two-thirds less than the third quarter of 1999, says Bob Adler of AMG Data Services, an Arcata (Calif.) firm that tracks fund flows. At the same time, investors are becoming less inclined to ditch bond funds, taking less out of them than they were before: $9.9 billion at the start of the year to $4.7 billion in the latest quarter.
The torrent of cash pouring into money-market funds is yet more evidence of investors' nervousness. Inflows averaged $7.7 billion a week for most of the third quarter--more than double the amount going into equities. "People are beginning to reallocate their risk to fixed income," says Adler who has collected flow data since January, 1992, adding, "I haven't seen this dynamic as clearly as it is here.""TAKE YOUR HITS." Mutual-fund investors remain edgy. By mid-September, as the Nasdaq slid 11%, cash inflows to retail funds dipped dramatically, to $527 million a week. Some investors, viewing this as an opportunity to buy cheap stocks, reversed their exodus just one week later, Adler reports. The result: a choppy market. "It's `let's go sit someplace away from where the bombs are dropping,"' says Jeffrey S. Van Harte, manager of the Transamerica Premier Equity Fund. "That's the easiest thing to do; the hardest is to hold on and take your hits." Standing his ground helped Van Harte's tech-heavy fund last year, but the fund lost 3% in the latest quarter.
It's not as if bond funds provided much shelter in the third quarter, either--even if some outdid equity funds. The average tax-free bond fund had a total return of 2.17%, while taxable funds were up 1.42%. However, some convertible-bond funds, such as the Ariston Convertible Securities Fund and the Harris Insight Convertible Securities Fund, beat the averages handily with 14.05% and 6.89% gains, respectively.HITTING THE SKIDS. International markets, more and more globally connected, have been no refuge. Foreign equity funds were down 7.18%, and world funds, which include U.S. stocks, were down 3.36%. Overseas managers explain that the U.S. tech rout has left little standing. "If tech doesn't do well, you really don't have much to choose from in the service sector or consumer industry," says Eric J. Ritter, who runs the $30 million Driehaus Asia Pacific Growth Fund. Rather than a tech rally to pull Asia from its doldrums, he is counting on more government reforms and deregulation.
Even European funds, which were up an encouraging 2.85% in the second quarter, were hit, mainly because of the falling euro, and lost 6.54% in the third quarter. Latin American funds shed 2.75%. Japanese funds, which earned triple-digit returns in 1999 after a decade-long bear market, hit the skids again, losing 9.24%.
And unless they have a value bent, the nation's largest funds, too, had an unremarkable quarter. Without tech to bail them out, the $57.7 billion Investment Co. of America Fund, Fidelity's $109 billion Magellan Fund, and the $50.8 billion Janus Fund are essentially flat for the quarter. The AIM Constellation Fund, a $21.8 billion mid-cap growth fund, registered the highest gain, up 7.55%, while the $36.7 billion EuroPacific Growth Fund, which invests in world stocks, was hit the hardest, losing 8.15% in the third quarter.
So the question remains: Will the return to value stocks last? Jeffrey G. Morris, manager of the $1.4 billion Invesco Financial Services Fund, which rose 21.14% in the third quarter, thinks something more fundamental is taking place. Financials, he says, have legs because their performance is due to solid earnings growth, not just to a cyclical rotation or merger speculation.IMPATIENCE. Top managers whose performances were aided by the market's current love affair with biotech have a similar take. Timothy F. Bepler of the 14-month-old Orbitex Health & Biotechnology Fund, up 16.47% for the quarter and 100.21% this year, says that the industry is past the startup and development stage and into one of high growth. "There has never been a time in health care that's been as exciting with the level of innovation," Bepler says. "There's still a way to go."
The investors licking their wounds are those in Internet funds. The likes of Jacob Internet Fund, down 18.43%; Kinetics Internet Infrastructure Fund, down 16.31%; and Firsthand's E-Commerce Fund, down 14.34%; were among the third quarter's worst performers (page 195). Even Alberto W. Vilar, manager of the Amerindo Technology Fund--which gained 250% in 1999--admits: "You're not going to make a lot of money this year." The fund was up 13.88% in the third quarter. Explains Vilar: "People are just impatient. These stocks are like sprinters in a race ready to take off for the next two years."
Some are convinced the start is imminent. The large pool of cash in money and bond funds, says Brian Belski, market strategist for U.S. Bancorp Piper Jaffray Inc., could "be put to work in equities during the fourth quarter."
What's more, many analysts still have a rosy long-term view. "There's been a perception that the Nasdaq has been outperforming forever," says market strategist Bernie Schaeffer, of Schaeffer's Investment Research Inc., who notes that the tech-laden index only outdid the S&P in 1998 and 1999. "Believe it or not, it may be early in the game."
Still, investors shouldn't count on an 11th-hour tech rally to bail out poorly performing mutual funds in 2000. The key to success will likely be good stockpicking--and strong nerves.By Mara Der Hovanesian in New YorkReturn to top