Special Report: The Best Mutual Funds
The Best Mutual Funds
Our ratings tell you who gave the best return--with the least amount of risk
Investors didn't have to dig too deep to unearth winning mutual funds during the bull market. But nowadays, excavating good returns means breaking out the heavy machinery. There's a heap of rubble to pick through.
The stock market's skittish 21st century debut left most mutual funds in a shambles: Equity funds posted an average 3.6% loss, respectable considering the 9.1% loss of Standard & Poor's 500-stock index last year. Yet 42% lost shareholders even more than an index fund tracking the S&P. The tech funds' 33.2% tumble put them on the ropes. Hot-shot rookie fund managers got clobbered, while value managers--who bank on corporate financial health, free cash flows, and real earnings--are back on top.
It all underscores a forgotten investing truism: Chasing the flashiest new fund or a performance streak is a loser's game fraught with peril. Better to buy tried-and-true funds with low expenses and a proven track record. But where to start? The BusinessWeek Mutual Fund Scoreboard, that's where. This 16th edition of the Scoreboard, prepared for BusinessWeek by Standard & Poor's Corp. (both are owned by The McGraw-Hill Companies), draws on a database of 3,198 equity funds.
We use a proprietary system that measures the performance of each of these funds by the amount of risk its manager took to achieve the results. These risk-adjusted returns are calculated over a five-year period. Our analysis shows that only 134 funds meet our standards for the highest-quality A rating (table, page 70).
This analysis won't point to superstar funds that swept the markets in 2000 or even 1999. That's information too easily found in almost any newspaper, business magazine, or online tally. What we are giving you is performance adjusted for risk. Investors are becoming painfully aware that minimizing risk is the most important element in prudent investing. Consider 1998 and 1999, blowout years for technology stocks and the mutual funds that loaded up on them. Sure, they delivered triple-digit returns, but we simply deemed them too risky: Only one tech fund made the A list in the two years: the 33-year-old Franklin DynaTech Fund.
The Scoreboard is an invaluable guide to savvy investing. You'll find total returns, both pretax and aftertax, for the past year, plus 3-, 5-, and 10-year periods where available. And you'll get a good look under a fund's hood: cash levels, turnover, and largest holdings. A bonus Scoreboard feature this year tells how much of the fund's assets are in the top-10 stock holdings. That'll let you know if your fund is betting on relatively few stocks. Look for even more useful fund data in the pages that follow: assets under management, sales charges, and operating expenses. Another vital Scoreboard feature is aftertax returns. A fund full of unrealized past gains bears watching: Not only could investors get saddled with market losses, but they could also face a capital-gains tax bill (see related story, page 78). It's one of those picky details fund companies and trackers don't always carefully report. We do.RISK RESOURCE. The equity fund Scoreboard (page 84), features 605 funds drawn from the entire database; it represents almost 90% of the assets of all the Scoreboard funds. Visit our Web site, www.businessweek.com/mutualfunds/ and you'll find those, plus an additional 2,500 or so more, in an interactive version of the Scoreboard. If you're not familiar with the online Scoreboard, there's no better time than the present to study it. It's a resource you should bookmark on your computer, since returns--and ratings--are updated every month. The magazine's list ranges from the $92.6 billion Fidelity Magellan Fund (which once again overtook Vanguard's 500 Index fund to become the nation's largest, despite shedding $7 billion in a year) to the Fidelity Select Brokerage & Investment Management Fund, with just $590 million in assets.
How do we adjust for risk? For each fund, we look at every month's return for the last five years and match it against the comparable month's return on Treasury bills. Each time a fund underperforms Treasury bills, it earns negative marks. And the greater the magnitude of negative results, the higher the risk of loss. The risk calculation is not reduced when the fund outperforms Treasuries because that in no way has offset the erratic performance behavior of the portfolio. We then re-rank the funds and score them on a curve. Of the rated funds, 7.5% get A's, our highest rating.
The pick of the litter is the Dresdner RCM Global Tech Fund, with a five-year average annual return of 44.2%. It is one of two tech-sector funds worthy of an A rating this year. While the fund stumbled in 2000, losing 14.3%, that's less than half the loss of most tech funds. Credit an experienced San Francisco-based management team with more than a decade of high-tech stock-picking experience. Bringing up the rear is a tempered "hybrid" fund, which mixes stocks and bonds: The Gabelli Investor ABC fund has a five-year average of 10.3%.
In between the overall A-rated Dresdner and Gabelli funds, you'll find a wide range of investment styles and returns to peruse among the top-rated funds. Large-cap funds have turned up in spades--no surprise, considering most large-cap stocks have outperformed the market since 1996. Yet S&P index funds are conspicuously absent after nearly a dozen made the A list last year. What's more, 16 of the A-rated large-cap funds are value funds, up from only four last year. "Providence is on your side when you're in a stock that's out of favor," William V. Fries says of the $1.6 billion Thornburg Value Fund, which boasts a five-year annualized return of 26%.
Managers like Fries, whose risk rating is "low," pay attention to how much they pay for a stock and whether or not the company they buy is making money. Thirty-two-year veteran Robert Olstein of the $515 million Olstein Financial Alert Fund explains that buying expensive stocks in a hyped market is finally catching up to aggressive growth managers. "These momentum guys have been out of their minds," he says. "The only thing that matters is the company's financial statement; knowing how to read it is an ancient art." Olstein's A-rated fund has been lifted with the bull market and posts a five-year return of 24%. Still, Olstein views the performance as unsustainable: "I'll be happy to get 12% in the next five years."UNSUSTAINABLE? Even unabashed growth stock-pickers concede that the market's exceptional recent performance is unsustainable. Claire Young, of the $5.3 billion Janus Olympus Fund (which closed to new investors in March at $8.5 billion), is undaunted by a 21.6% free fall in 2000 after a 101.6% gain the previous year. "I never expected to do a triple-digit return in my life as a portfolio manager," remarks Young, who took over from Scott W. Schoelzel when he moved to Janus Twenty in 1997. The Olympus Fund is among the top 10 A-rated Scoreboard gems. You'll see from the tables that the fund's concentrated style of investing in tech earns it a high risk rating, which for some investors is a fair trade-off for an average 30.6% annual five-year return.
Young and her value-style counterparts are unanimous in their belief that the market will be more treacherous to navigate in the future, which makes our Scoreboard list more valuable to investors searching for long-term success stories. More stock-pickers are expected to shine in the next five years. The Scoreboard highlights repeat performers such as Michael C. Sandler, manager of the $1.37 billion Clipper Fund, who won't buy a stock unless it's selling at a 70% discount to its intrinsic value. Again, the usual yardsticks apply: dominant companies with good management and excess cash flow. The average price-to-earnings ratio of the Clipper Fund's portfolio--which includes stocks such as Freddie Mac, Philip Morris, and Sara Lee--is 14 times earnings. "The multiple of earnings that the S&P sells for today is close to previous market peaks, not bear market bottoms," he cautions. "We had better be in a different environment to justify these valuations--but of course that's the biggest lie on Wall Street, that things are different this time."
Small-, mid-, and large-cap growth funds--28 in all--make the Scoreboard's top grade. Still, the bulk of these A-rated managers temper their portfolios with slow-growth stocks. And if they favor tech at all, they dabble in the sector with trepidation. "I have as much fear as I do greed," confesses Robert Gardiner of the $200 million Wasatch Micro Cap Fund, which closed in March to new investors. Gardiner slashed his tech holdings in half, to 23% of assets last January. A "back-door" tech player, he buys tiny companies like Micrel Semiconductor and hangs on while they grow into superstars. He picked up Micrel in 1995 when it was an obscure $200 million company below Wall Street's radar; today it is a $3 billion outfit followed by some dozen analysts.
In keeping with a theme of moderation, 18 funds in the Scoreboard are domestic hybrids, a breed of fund that mixes stocks, bonds, and a bit of cash. Such concoctions smooth out the bumps of the market's volatility: Every one of the 18 hybrid funds listed sport a "low" or "very low" risk rating.
These best-of-breed hybrid funds aren't necessarily passive. They use an approach that strikes a balance between value and growth stockpicking. "We invest opportunistically," says Heidi Hu, co-manager of the $108 million Transamerica Premier Balanced Fund, which blends convertibles, bonds, and stocks according to how the market is behaving. Hu continues to favor convertibles and the bond market. "Ours is the best of a growth strategy, with a lot of sensitivity to valuation," she explains. Many of these hybrid managers operate to the beat of their own drummers, ignoring outside noise about a slowing economy or earnings shortfalls. "We really don't think Wall Street research is very good," says Frank Mastrapasqua, portfolio manager of the $155 million Touchstone Growth/Value Fund. Mastrapasqua runs his stock targets through a custom screen that measures whether three-to-five-year growth rates are higher than risk-adjusted price-to-earnings ratios. There are no price targets, and he doesn't buy companies without profits. "Obviously, we never owned any dot-com companies, and that wasn't fashionable," he says. "For a while there, it didn't look good, but we avoided unmitigated disaster."LOW ON TECH. Few sector funds are on the Scoreboard's A list. Although technology continues to be the top-performing category of funds over the past 3-, 5-, and 10-year periods (table, page 72), only two appear: the Dresdner fund and the Firsthand Technology Value Fund, which has a five-year return of 40.8%. Both management teams took considerable risk to make the grade, yet both are also known to buy little-known companies that they've held for the long term. As these holdings mature and grow into market leaders, trading volumes have increased, subjecting the stocks to more volatility. Stocks such as PMC-Sierra Inc. also account for a larger share of the fund's assets. Only three financial funds and two telecom funds show up this year, while nine utility and natural-resource funds--including the MFS Utilities B Fund, up an average 20.2% since 1996--make an appearance.
Although health-care and biotech funds were hopping in the past 18 months, only the $1.34 billion Eaton Vance Worldwide Health Sciences Fund's 30% five-year return earned it an overall A rank. Manager Samuel D. Isaly, who has run the fund for more than a decade, "fuel-injects big-cap returns" with smaller companies in the early stages of drug discovery. And even though this is a concentrated fund of 35 to 45 stocks, the 33% turnover rate--one stock change per month--earns the fund an "average" risk rating. "We're not rapid traders," Isaly says. "We keep the portfolio pretty tight."
A handful of funds sought better returns in resurging global markets. Six foreign funds, which do not include U.S. stocks, ranked high, while only three world funds, which include U.S. stocks in their portfolios, made the cut. There are also three funds that concentrate on European stocks, and one international hybrid that mixes stocks and bonds. None of the diversified emerging-markets funds made it to the A list this year: The sector has registered losses in the last 1-, 3-, and 5-year periods. Although there have been pockets of revival here and there, emerging-market funds have turned in an abysmal 10-year average performance of less than 1%.
You may be one of many investors sitting on the sidelines right now. You're not alone: Money-fund assets gained a remarkable $88.16 billion in the week ended Jan. 9., bringing money-market assets to a record $1.89 trillion. If you're wondering how to put some money into equities, turn to page 86 and read on. Next week, the Scoreboard will turn its analysis to bond funds, and in two weeks, closed-end funds.By Mara Der Hovanesian in New YorkReturn to top