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Mutual Funds: Time for Value

Based on BW's annual report on the best equity funds (see BW, 1/29/01, "The Best Mutual Funds"), Der Hovanesian reports that the average diversified fund actually did better than the leading market averages in 2000. Not surprisingly, the worst performance was turned in by tech funds, down 33%. Funds specializing in the health-care, financial, and real estate sectors all did well, however.

The best prospects currently are funds in the value category. Among the top performers in the BW Scoreboard were Excelsior Value & Restructuring and Weitz funds. Der Hovanesian also likes hybrid funds, which invest in both stocks and bonds, with Oppenheimer Global Growth & Income and Quest Balanced Value among the Scoreboard standouts.

Der Hovanesian was a guest at a chat presented Jan. 23 on BusinessWeek Online and Standard & Poor's on America Online. Her comments came in response to questions from the audience and from BW Online's Jack Dierdorff. Following are edited excerpts from the chat -- a full transcript is available on AOL at keyword: BW Talk.

Q: Mara, as we all know, individual stocks disappointed lots of investors in 2000. Would they have done better in mutual funds?

A: Not necessarily, Jack. Equity mutual funds disappointed many investors, too. The average diversified fund lost 3.6% in 2000.

Q: But isn't that less than what was lost by the leading market averages?

A: That's true. The S&P index was down 9% in 2000 and the Nasdaq down 33%. Still, compared to the year prior, [fund] investors still lost money. Sure, they were a little bit more shielded from losses than if they'd just tracked the indexes, buying an S&P 500 fund, for example.

Q: Your opinion on value funds as an investment for the immediate future?

A: On value funds, let me refer to the BusinessWeek Scoreboard [Jan. 29 issue]. We found a predominance of value-fund managers rising to the head of the class -- not just for year 2000 returns, but over the long term. Many of these managers came from so far behind that one might think they still have a long way to go to make up for lost time.

Q: What were some of the best funds in the new BW-S&P screen?

A: There are lots of value funds to choose from. They include Excelsior Value & Restructuring fund, which is an eight-year-old fund with 23% risk-adjusted annual five-year return. Another is Weitz funds. They have a large minimum initial purchase but score very high on risk-adjusted returns.

Q: I have owned Janus Worldwide for a year -- is it time to sell it?

A: I think as a rule of thumb when a fund or stock has disappointed, it's not time to cut out. It's too soon. That particular fund, Janus Worldwide, has a good tenure and a good long-term track record, so it might be a good idea to stick with it. It's also a five-star-rated fund by Morningstar.

Q: Among managers, who stands out now in BW's rankings?

A: In our rankings, managers who stand out are people who have been through different market climates. You don't find high-tech rookies. Who you will find are managers such as William Fries of the Thornburg Funds, or Wally Weitz of the Weitz funds. Another veteran is Sam Isaly of Eaton Vance funds.

Q: Did any sector funds do well in the last year? I am sure tech funds did not. Any sectors that hold hopes for 2001?

A: Of course, the tech sector didn't make it. In fact, it was the worst-performing sector, with losses of 33%. What did well were defensive sectors such as health care, up 51%; financial, up 30%; and real estate, up 25%. One thing about the health sector is the biotech component. Many equity managers view this as having long-term potential, though it's extremely volatile.

Q: The BW fund report says so-called hybrid funds did well. What are they, and who are the best?

A: Hybrid funds combine stocks and bonds, and the best managers actively manage those two portfolios, moving where they can get the best gains, so there aren't static allocations to one or the other sector. They don't just say, let's split it 50-50. They move where they see the best value in the market. Some of the best include a couple of Oppenheimer funds -- Global Growth & Income [for example] -- and Quest Balanced Value. Janus Balanced also has good returns while having a very low risk rating.

Q: Please discuss the Legg Mason Value Trust -- Bill Miller is the only manager to beat the S&P 10 years straight. Thoughts?

A: The record speaks for itself. Miller did make the BW A list of best managers. And the expectation is that he'll apply his own yardsticks to value investing and very likely do well going forward. But investors should note that he barely beat the S&P this year.

Q: Were there any significant changes in performance by fund families?

A: Well, the most obvious changes are the growth-oriented and momentum-style fund shops such as Janus, which had problems along with the general market. Also, many index shops such as Vanguard had similar fates, whereas two years ago both of these companies were soaring. Underdog fund companies like Franklin funds and some Oakmark funds are enjoying the limelight now.

Q: How are the biggest and most famous funds, such as Fidelity Magellan, doing?

A: The market has evaporated a lot of their assets. Some have fallen in terms of the BW overall ratings. For instance, Fidelity Magellan, the largest mutual fund at about $93 billion under management, is graded a C. Also, EuroPacific Growth, a foreign fund, has a C rating. That's a $31 billion fund. It's worth noting that of the top 20 largest funds, only two got A's. Those include Vanguard A Shares, a mid-cap growth fund, and Growth Fund of America, a large-cap growth fund.

Q: Is the Janus organization in trouble financially?

A: That's a difficult question to answer. There have been some reports that maybe they are, but just because a company is down for a couple of months doesn't mean you should count them out. There are a lot of smart people at Janus. We haven't heard the last from them.

Q: Are there any Janus funds you like? And what are they and why?

A: I would say that many of the Janus funds get top grades from BusinessWeek, except for the Janus Enterprise fund, which gets a C-, and the Janus Venture Fund, which gets a C. If you're in the market for concentrated growth funds, these funds have no rivals.

Q: Mara, you write in the magazine about "top-heavy" funds -- what are they, and why is this a problem?

A: Top heavy relates to the amount of money that managers allot to their top 10 holdings. That's to say it's another concentrated investing style. Investors should be aware of top-heavy funds because they might have more exposure to a smaller number of stocks than they bargained for. It also makes the fund riskier.

Q: Can I get true diversity by buying different funds in the same family, or should I diversify families of mutual funds?

A: You'll get more diversity in different fund families because you'll have exposure to different fee schedules, different management styles, and different investing techniques. Good question!

Q: How about small- and mid-cap funds? Are any of them outstanding?

A: Several. Let me name a few that are the best performers: In the mid-cap growth arena, there's Calamos Growth A Midcap Growth. In the mid-cap value category, there's Pimco Renaissance C Shares. And in the small-cap blend, there's Wasatch Core Growth fund, which mixes growth and value small-cap stocks.

Q: Any bright stars among international funds? And can you explain the difference between world- (or global-) stock funds and foreign-stock funds?

A: Foreign-stock funds do not invest in U.S. securities. Global funds can. Their charters are broader.... Putnam International Voyager A shares [is] a good foreign fund on our A list. Tweedy Browne Global Value is also on our A-rated list for world funds. Here's one more, if targeting Europe only: Consider Fidelity Nordic Fund, which is up 25% in average annual return for the past five years.

Q: Looking ahead, do you expect the market to continue to reward value funds in 2001? Is that the best place to be?

A: My sources tell me that value is probably the best bet until the economy gets back on its feet. So, yes, you might want to stay in value funds.

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