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Mutual Funds: Keeping Fit In A Flat Market


It's hard to draw a bead on the stock market these days. With the major equity indexes flat for the year, it feels like neither the bulls nor the bears are in charge. So where does that leave an investor in search of a few good places to stash some cash?

Try BusinessWeek's Mutual Fund Scoreboard. Although the magazine runs an annual roundup of funds every January, we update the list monthly at BusinessWeek Online (bwnt.businessweek.com/mutual_fund/). Now, we're taking a look at the funds that have risen to the top in the past six months.

The scoreboard doesn't screen for the hot fund of the day. It takes a long-term view, measuring funds by their five-year track records, adjusted for downside risk. The funds receive an overall grade from A to F. Equity funds are rated against other equity funds, and taxable and tax-exempt bond funds are also stacked up against their counterparts. The Scoreboard goes one step further, giving category ratings that compare funds to their peers, such as large-cap growth or foreign stock funds.

All told, there are 188 equity funds with overall A ratings, and 45 are new since January. Thirty-one of the newcomers come from two corners of the investment universe -- real estate and small-cap stocks. That's not surprising, because those sectors did well in recent years. Does that mean you should dump all of the large-cap funds and replace them with real estate and small-company investments? Absolutely not. And it doesn't mean you should sell real estate and small-cap funds, either. Both are good sectors to stick with for the long haul.

New entries on the A-list are worth careful consideration, especially if they also have an A rating in their category. The ABN Amro Mid Cap Fund (ABMIX), up an average 14.8% a year over the past five years, is a prime example. Portfolio manager Thyra Zerhusen says mid-cap stocks are often overlooked by large institutional investors, such as pension funds. They tend to focus on large and small-company stocks. "Rarely do they pick mid-cap managers," she says. Mid-cap names also get ignored by Wall Street analysts.

TIGHT FOCUS

As a result, there are plenty of undiscovered winners among mid-caps, which Zerhusen defines as companies with market capitalizations of $1 billion to $10 billion. Zerhusen runs the no-load fund in a concentrated manner: She owns about 40 companies, and the 10 largest holdings account for 40% of the assets. "These are the companies where I have the highest level of confidence," she says. One example is Magna International (MGA), a Canadian auto-parts manufacturer. Magna's business is split between North America and Europe, and it's benefiting from the outsourcing boom on both continents. Revenues are growing in excess of 20% annually.

Although they're better known, large-cap stocks are idling. Profits at many companies doubled over the past five years, but "the stocks have done nothing," says Robert Smith, portfolio manager of the $6.5 billion T. Rowe Price Growth Stock Fund, which gets an A rating in the large-company growth category. He says investors are punishing large caps for failing to deliver the kind of earnings expansion seen in the late 1990s.

Higher earnings on lower share prices means price-earnings ratios of large-company growth stocks are more reasonable. Smith foresees a rebound in blue chips such as Microsoft (MSFT) and General Electric (GE). Another favorite is Citigroup (C), the fund's top holding, which has an array of global businesses, including credit cards and investment banking. By Smith's estimates, it's cheap, trading at 10 times 2005 earnings with a 13% growth rate. The recent $2.65 billion settlement with WorldCom shareholders hurt second-quarter earnings, yet Smith says the long-term outlook is bright.

The Scoreboard is also a good place to find specialty funds, such as Fidelity Investments' Select Medical Equipment & Systems Portfolio (FSMEX), which has an A ranking in the health category. Portfolio manager Sam Peters says he's investing in neurostimulation, a therapy in which small electrical devices are used to treat ailments such as back pain. Medtronic (MDT), a top holding, is making progress in the field with new technologies.

Peters is also a fan of Baxter International. (BAX) He sees the diversified medical-products company rebounding as the excess supply in the blood-plasma market starts to disappear. With demand for plasma expected to stay high, he expects better pricing power for Baxter's blood collection and processing systems.

Among other sectors, experts say real estate funds still have room to run, although returns are not expected to be as robust as in recent years. "We believe real estate investment trusts are expensive," says David Jellison, portfolio manager of the A-rated $900 million Columbia Real Estate Equity Fund. (CREAX) Nevertheless, Jellison found opportunities in sectors of the real estate market that have lagged and offer good value. They include apartment owners such as Equity Residential (EQR) and hotel operator Hilton Hotels (HLT).

What about small-company stocks? The pros say it is getting harder to find good ones. That's why the Third Avenue Small-Cap Value Fund (TASCX) has more than 25% of its $790 million portfolio in cash. "There's no question that the universe of opportunity is narrower than it once was," says portfolio manager Curtis Jensen.

Whitney George, who co-manages the Royce Pennsylvania Mutual Fund (PENNX) and the Royce Premier Fund (RYPRX) -- both of which are new additions to the overall A list -- is also pessimistic. "We're in a very tough environment and a low-return decade." Although Royce's record is stellar -- nine of its funds have an A rating -- George is advising people to look at sectors that haven't performed as well in recent years. From a value manager who makes a living finding gems in what most investors toss aside, that's solid advice.

By Lauren Young


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