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How the fund world has changed. In the beginning of 2000, 56 large-cap funds held an A rating in BusinessWeek's Mutual-Fund Scoreboard. Halfway into 2003, only five rank that highly when measured against all stock funds. In place of such well-known behemoths as Dodge & Cox Stock (DODGX
) Longleaf Partners (LLPFX
) and all the Janus funds, you now find Buffalo Small Cap (BUFSX
) Value Line Emerging Opportunities (VLEOX
) and other small-cap offerings that simply held up better during the stock market's slide.
Does that mean you should replace your large-cap funds with small caps? No. The scoreboard, which is updated monthly at BusinessWeek Online, ranks all stock funds from A through F based on their five-year returns, adjusted for downside risk. It also assigns category ratings, comparing a fund's five-year risk-adjusted returns against its peers with the same investment style. Without considering the category grade, you're seeing only half the picture.
Take Dodge & Cox Stock. Even though it rates a B+ against all stock funds, it's still an A in the large-cap value category. So if you already own it, the fund may be worth keeping. If you're looking to buy a large-cap fund, you might want to pick one of the five surviving ones rated A overall and in their category. These are Clipper Fund (CFIMX
), Thompson Plumb Growth (THPGX
), MFS Strategic Value (MISVX
), Parnassus Income Equity (PRBLX
), and Smith Barney Aggressive Growth (SHRAX
That said, it's worthwhile to consider newcomers to the A-list, especially if they also have an A category rating. One such fund is Aegis Value (AVALX
), which has been trouncing its small-cap value peers since its inception in May, 1998. Manager Scott Barbee's strict buy-sell discipline has enabled him to deliver a 15.7% five-year annualized return. He buys stocks of tiny companies, with market caps less than $1 billion, which trade below their book values or the value of their assets. If he can't find what he's looking for, he holds cash. That strategy differs from most value managers, who are often fully invested, buying stocks that are less expensive than the market average, even though they may not be intrinsically cheap.
Barbee is none too pleased with the prospects for stocks now. Since the rally began this April, "valuations have gone way, way up," he says. Because of the dearth of cheap stocks, he has raised his cash levels from 13% in March to 25%. He's convinced the market's gains will be transient. "Unless this economy turns around in a strong way, investors and the market in general are cooked," he says.GROWING OPTIMISM. Ironically, while many large-cap funds have fallen off the A-list, some A-rated managers who buy larger stocks have grown optimistic. Bill Nygren of Oakmark Select (OAKLX
) Fund, rated A overall and in the mid-cap value category, has been buying giant companies such as media powerhouse AOL Time Warner (AOL
). "In the market peak of 2000, small stocks were much cheaper than large," he says. "But there are now values across the capitalization spectrum." Nygren thinks AOL is selling at "insane valuation levels, less than the old Time Warner company [a subsidiary of AOL] is worth."
Managers of growth-stock funds, which suffered more than value funds in the bear market, also think the rally can continue. Given how their favorite sectors, technology and health care, have rallied more than others, 11 growth funds have joined the A list this year, nine of them small-cap growth funds. "I've been able to find many good small companies that are able to do well, regardless of how the economy is doing," says manager Frank Sustersic of Turner Micro-Cap Growth (TMCGX
), which has a pair of A ratings -- and is closed to new investors. Sustersic likes generic drugmaker Able Laboratories (ABRX
) which is ready to move in as many name-brand drugs come off patent.
Some of the most promising funds invest in out-of-favor sectors. Consider that only six emerging-market funds have managed to get A's overall, and you realize that manager Arjun Divecha of GMO Emerging Countries III (GMDEX
) Fund must have figured out something that has eluded his peers. What's his secret? "We focus on the countries we invest in more than picking stocks," he says.
Before Divecha invests in a country, he wants to make sure it isn't vulnerable to an economic crisis. He likes to see a cheap currency and a positive trade balance. Now, Divecha favors Brazil and Thailand, which have recovering economies and cheap stocks.
More than 40 funds on the A list are in hot sectors such as gold and real estate. But most of them may just be riding a positive trend in their sector. Only a few also have A category ratings, including Security Capital U.S. Real Estate (SUSIX
) and Tocqueville Gold (TGLDX
Manager Ken Statz of Security Capital's fund thinks real estate stocks could deliver 10% or 11% returns going forward, although he admits they're not as cheap as they once were. "In 2000, real estate stocks traded at a 20% to 30% discount to the value of their underlying real estate," he says. "Today they trade at 5% to 10% premiums." His team of 25 analysts and co-managers scrutinize property values to find bargains, and steer clear of volatile stocks.
Gold stocks and bullion tend to perform best when the market is in panic mode, and John Hathaway of Toqueville Gold believes the bad times are far from over. "We're in a bear-market trend for stocks and bonds," he says. "The analogy would be from 1968 to 1982, when gold was the top-performing asset class and rose from $35 an ounce to $800." During that period, inflation soared, and so did gold and other hard assets. Hathaway thinks there'll be a different trigger this time: the credit bubble. Americans borrowed so much during the 1990s as interest rates fell that now there's overcapacity in the economy, he says. When the bubble bursts, investors will flee to gold.
Even Hathaway doesn't recommend putting more than 10% of your assets into a gold fund as a form of financial insurance. The funds can be volatile. Of 13 gold funds with A ratings overall, only Hathaway's receives an A in the category.
Despite the recent runup in tech stocks, only two tech funds receive A overall and category ratings: Icon Information Technology (ICTEX
) and Kinetics Internet (WWWFX
). Given how terrible tech has performed in the last three years, that's understandable. But investors should take note of them. After all, three years ago there was only one small-cap fund on the list. Now look how many.For the full list of the best-performing offshore funds, go to http://bwnt.businessweek.com/mutual_fund/ By Lewis Braham