Mutual-fund investors found few places to hide in 1994's first half. K.O.'d by interest-rate hikes, the bond market was a disaster. The stock market wasn't much of a contender, either, falling 10% in an eight-week period. But there may be a silver lining: Many battered funds are far better values now. And savvy investors can still find funds likely to perform well in an uncertain market. Among the better bets: funds that invest in mortgage securities, junk bonds, small- cap stocks, emerging markets, and Japanese equities.
Granted, fund investors are operating against a grim backdrop: Unlike last year, when the average fund outpaced the market, and often by a wide margin, funds have been underachievers so far in 1994. Only three stock-fund groups sport positive returns. The star:
The specialty-financial group, which made a 5% return by filling up on bank stocks. But overall, equity funds had a total return (appreciation plus reinvested dividends and capital gains) of -2.4%, while the return on the Standard & Poor's 500 fell just 0.17%.
The picture was uglier among bond-fund groups. As of June 6, none of the groups tracked by Morningstar Inc. had positive returns.
To get good returns, investors may want to put money in some of the investment locales that have proved hospitable thus far in 1994, such as Japan. Funds that placed bets on an improving Japanese economy, and a resulting rise in Japan's badly depressed stock market, raked in big rewards. The first half's largest pot went to the DFA Japanese Small Company Fund, a $305 million index fund that racked up a 34.09% return. The yen's 9% rise against the dollar bolstered the fund's results. The No.2 spot went to the $4 million Capstone Nikko Japan Fund, which uses a "systematic contrarian strategy." After figuring out which 300 stocks on the Tokyo Stock Market have underperformed the market the most, the fund then focuses on 70. The strategy returned 27.69%.
BOTTOMS UP. Where should investors look among the Japan funds? Funds that invest in beaten-down Japanese exporters could be a good buy, advises William McBride, international fund analyst at Lipper Analytical Securities Corp. He thinks Japan funds can move further up because their economy has fallen so far in recent years: "It sounds perverse, but everyone believes that things are so chaotic with the Japanese government that this must be the bottom for their economy." McBride also suggests looking at funds that would benefit from an upturn in consumer spending in Japan, such as funds investing in consumer service, goods, and infrastructure stocks.
If investors are worried about the currency risk in Japan funds, McBride has an idea: Pacific basin funds with big Japanese holdings. Since Asian currencies track the dollar, the Asian investments cancel out some currency risk.
A few domestic sector funds also managed to rack up double-digit returns. Among the top 15 were Fidelity Investments' Select Chemicals, Select Regional Banks, and Select Home Finance Funds. The Merrill Lynch Technology B Fund earned third place with its 21.22% return. But none of the largest equity funds earned in the double digits. The leader in 1994 was
the $10.6 billion Vanguard/Windsor Fund, up 3.95% year-to-date. Portfolio manager John Neff achieved that by concentrating on oil and gas, savings and loans, and bank and insurance company stocks.
Overall, success stories were few and far between in 1994's first half. Rising interest rates triggered what Walter Frank, chief investment officer at Donoghue's Moneyletter, calls a "semihysterical period" in the bond market. Bond investors ran for the hills, pulling $7.7 billion out of bond funds in March. April's outflow, though, slowed to $4.8 billion, and Arcata (Calif.)-based AMG Data Services reports small inflows in recent weeks. Fueling some of the initial panic were accounts of huge losses from fund holdings of highly volatile esoteric mortgage securities. The worst-hit of all U.S. bond funds: the $634.5 million Piper Jaffray Institutional Government Income Fund, which plunged 22.44%.
OVERDUMPED. Investors dumped mortgage funds more than any other type of bond fund. As a category, the funds suffered a -2.83% return. Treasury funds were even worse, returning -3.22%. But the worst performers were the international bond funds, which were hurt by higher rates in Europe and a plunge in emerging market debt. They fell 6.23%.
Dare investors move back into bond funds? Some pros see selected bargains. Plain-vanilla mortgage funds may benefit from the halt in prepayments. Bond funds that took big hits from mortgage derivatives may be shrewd plays. Mortgage derivatives have been "dumped beyond all rationality," says John Rekenthaler, editor of Morningstar Mutual Funds. "A portfolio manager who buys these will probably make a lot of money in the next few years."
Ironically, one of the brighter spots in the bond market were high-yield corporate bond funds, which emerged relatively unscathed at -1.79%. About $1.1 million has moved into junk-bond funds so far this year. Many of the funds took hits from holdings of emerging market debt. Among their U.S. holdings, however, an improving economy should raise profits, lessening credit risks.
Investors in stock funds aren't feeling quite as much pain as their bond-fund brethren. Having learned to take the long view from the crash of 1987, they didn't cash out at the first signs of a correction. While the inflow into equity funds dropped from $14 billion in February to $6 billion in March, the pace picked up to an $11.3 billion inflow in April, according to the Investment Company Institute. Equity funds received $2 billion to $2.5 billion a week in May, "among the strongest flows we've seen in 1994," says Robert Adler, of AMG Data Services.
As usual, some of 1994's biggest stock-fund losers were 1993's biggest winners. After racking up a 97% return in 1993, precious metals funds, for example, are down about 10%. The worst-performing stock fund at midyear: Monitrend Gold, down more than 31%. BJB International Equity A took the second-worst slot, falling about 25% for the year to date. That's a far cry from the healthy double-digit returns that many international equity funds produced last year.
Investors who ventured into emerging markets funds also saw their fortunes take an ugly turn. The high-risk funds had been immensely popular. Estimated net sales of Pacific region funds skyrocketed from $693 million in 1992 to $6.3 billion in 1993, according to Lipper. An additional $500 million went in during 1994's first quarter--even as the market was going down. Many overheated Southeast Asian and Latin American markets tanked in the first half. Pacific funds ended the first half down 3.81%, despite the Japanese market's big rebound.
Investors would do well to keep an eye on emerging markets funds. "I don't know if the emerging markets will rebound in the next six months," says Rekenthaler. "But the long-term story is more attractive now because the markets are down 10% to 20% and the fundamentals are the same." Jay Schabacker, editor of Mutual Fund Investing, is advising hardy investors to move into the $682 million Montgomery Emerging Markets fund, which focuses on Southeast Asian markets but invests in about 25 emerging market countries. The fund is somewhat bearish on Mexico but likes Argentina and Brazil. Its portfolio managers are looking at Southeast Asia and say that Taiwan "looks favorable."
THRIVERS. But rather than bottomfish, some advisors suggest latching onto funds that have thrived in this difficult environment. Kurt Brouwer, president of San Francisco investment advisory firm Brouwer & Janachowski, thinks value-oriented small-cap funds will continue to do well and likes "special-situation" funds, such as Michael F. Price's Mutual Beacon Fund, which rose 4.54% as of June 6. The $1 billion fund invests in the stocks and bonds of bankrupt companies and in takeovers, among other things. Such funds, Brouwer reasons, can do well even if the overall market does poorly.
Special-situation funds favored by Schabacker include the Robertson Stephens Contrarian Fund, which has been making natural resource, energy, and commodity investments. Portfolio manager Paul Stephens has also taken short positions in overvalued stocks with good downside potential.
Most investors realize that it will be more difficult to achieve high returns in the future. Instead of the annual average of 16% from 1982 to 1993, industry execs say annual returns will be closer to 5% to 8% in coming years. That may not seem like very happy returns. But after 1994's first half, even single-digit returns may look very good.
TABLE: EQUITY FUNDS: THE GOOD, THE BAD, THE BIG THE WINNERS Total return* DFA JAPANESE SMALL COMPANY 34.09% CAPSTONE NIKKO JAPAN 27.69 MERRILL LYNCH TECHNOLOGY B 21.22 FIDELITY JAPAN 20.59 T. ROWE PRICE JAPAN 19.25 JAPAN 17.04 FAIRMONT 13.91 FIDELITY SELECT REGIONAL BANKS 13.62 DFA CONTINENTAL SMALL COMPANY 13.58 VANGUARD INTL EQUITY INDEX PACIFIC 13.52 FIDELITY SELECT HOME FINANCE 13.02 FIDELITY SELECT CHEMICALS 12.48 QUANTITATIVE BOSTON FORGN GR & INC ORD 11.80 FIDELITY SELECT ELECTRONICS 11.72 SIFE TRUST 11.37 G.T. JAPAN GROWTH A 11.11 SOUTHEASTERN ASSET MGMT VALUE 10.93 MONTGOMERY GROWTH 10.76 FIDELITY EUROPE CAPITAL APPRECIATION 10.67 METLIFE PORTFOLIOS INTL EQUITY C 10.34% JOHN HANCOCK FREEDOM REGIONAL BANK B 10.25 CONSULTING GROUP INTERNATIONAL EQUITY 9.96 STRONG GROWTH 9.90 COHEN & STEERS REALTY 9.81 FIDELITY SELECT MEDICAL DELIVERY 9.58 MORGAN STANLEY INSTL INTL EQUITY 9.44 G.T. AMERICA GROWTH A 9.37 FIDELITY SELECT COMPUTERS 9.32 PRA REAL ESTATE SECURITIES 9.03 GOLDMAN SACHS GROWTH & INCOME 8.87 FIDELITY SELECT FINANCIAL SERVICES 8.62 WARBURG PINCUS GROWTH & INCOME 8.56 TWEEDY, BROWNE GLOBAL VALUE 8.49 BERNSTEIN INTERNATIONAL VALUE 8.47 ROBERTSON STEPHENS VALUE PLUS 8.04 NOMURA PACIFIC BASIN 7.99 DFA INTERNATIONAL HIGH BOOK TO MARKET 7.94 JPM INSTITUTIONAL INTL EQUITY 7.80 PIONEER CAPITAL GROWTH A 7.80 PIERPONT INTERNATIONAL EQUITY 7.71 THE LOSERS Total return* MONITREND GOLD -31.69% BJB INTERNATIONAL EQUITY A -25.64 AMERICAN HERITAGE -21.57 KEYSTONE AMERICA HARTWELL EMERG GR A -19.71 FIDELITY SOUTHEAST ASIA -19.56 UNITED SERVICES GOLD -18.75 STEADMAN OCEAN TECHNOLOGY & GROWTH -18.55 EV TRADITIONAL GREATER CHINA GROWTH -18.35 WRIGHT EQUIFUND H.K. NATL FID EQ -18.34 STEADMAN INVESTMENT -18.31 EV MARTHON GREATER CHINA GROWTH -17.98 GAM GLOBAL -17.02 OPPENHEIMER GLOBAL BIO-TECH -16.79 T. ROWE PRICE NEW ASIA -16.72 CAPSTONE FUND OF THE SOUTHWEST -16.69 BULL & BEAR SPECIAL EQUITIES -16.47 FIDELITY SELECT SOFTWARE & COMPUTER -16.35 FIDELITY SELECT BIOTECHNOLOGY -15.80 MORGAN STANLEY INSTL ASIAN EQUITY -15.46 59 WALL STREET PACIFIC BASIN EQUITY -15.31 LEXINGTON STRATEGIC INVESTMENTS -15.30% VAN ECK ASIA DYNASTY B -15.08 IVY CHINA REGION A -14.78 MERRILL LYNCH DRAGON B -14.71 G.T. GLOBAL NEW PACIFIC GROWTH A -14.69 EXCEL VALUE -14.63 STEADMAN AMERICAN INDUSTRY -14.10 BULL & BEAR GOLD INVESTORS -13.98 FIDELITY SELECT BROKERAGE & INVESTMNT -13.88 DREYFUS EDISON ELECTRIC INDEX -13.81 KEYSTONE PRECIOUS METALS HOLDINGS -13.79 DEAN WITTER PACIFIC GROWTH -13.73 SCUDDER PACIFIC OPPORTUNITIES -13.53 CAPPIELLO-RUSHMORE UTILITY INCOME -13.51 GAM INTERNATIONAL -13.51 FIDELITY EMERGING MARKETS -13.50 STEADMAN ASSOCIATED -13.25 DFA PACIFIC RIM SMALL COMPANY -13.13 MORGAN STANLEY ASIAN GROWTH A -12.95 MFS GOLD & NATURAL RESOURCES B -12.92 THE LARGEST Assets* Total return** Billions Year-to- 5-yr. avg. date FIDELITY MAGELLAN $34.34 -1.06% 14.38% INVESTMENT COMPANY OF AMERICA 18.68 0.27 10.93 WASHINGTON MUTUAL INVESTORS 12.40 0.58 9.91 FIDELITY ASSET MANAGER 11.21 -3.72 12.84 VANGUARD/WINDSOR 10.57 3.95 9.48 INCOME FUND OF AMERICA 10.25 -3.14 9.89 FIDELITY PURITAN 10.40 1.89 11.69 TWENTIETH CENTURY ULTRA INVESTORS 9.27 -4.96 19.09 JANUS 9.22 -0.62 13.48 VANGUARD INDEX 500 8.37 -0.44 10.39 FIDELITY GROWTH & INCOME 8.43 0.26 13.81 VANGUARD/WELLINGTON 8.23 -0.05 9.46 VANGUARD/WINDSOR II 7.77 0.59 9.68 FIDELITY CONTRAFUND 7.71 -0.53 20.81 EUROPACIFIC GROWTH 6.85 0.41 14.57 FIDELITY EQUITY-INCOME 6.94 0.93 9.91 DEAN WITTER DIVIDEND GROWTH SECS 6.69 -1.88 9.54 VANGUARD/WELLESLEY INCOME 6.00 -2.24 10.74 MERRILL LYNCH GLOBAL ALLOCATION B 5.82 1.30 14.27 FIDELITY EQUITY-INCOME II 6.10 3.10 0.00 In the first half of 1994, mutual funds investing in Japanese stocks racked up double-digit returns, while gold and emerging-markets funds took the biggest hits *APPRECIATION PLUS REINVESTED DIVIDENDS AND CAPITAL GAINS, THROUGH JUNE 6 DATA: MORNINGSTAR INC.TABLE: HOW STOCK-FUND GROUPS FARED Total return* SPECIALTY-FINANCIAL 5.00% SPECIALTY-NATURAL RESOURCES 0.88 EUROPE 0.51 FOREIGN -0.26 SPECIALTY-TECHNOLOGY -0.32 GROWTH & INCOME -0.96 WORLD -1.06 EQUITY-INCOME -1.22 BALANCED -1.69 GROWTH -1.90 ASSET ALLOCATION -2.28 SPECIALTY-MISCELLANEOUS -2.73% SPECIALTY-HEALTH -2.96 INCOME -3.21 SMALL COMPANY -3.54 PACIFIC -3.81 MAXIMUM GROWTH -4.52 SPECIALTY-UTILITIES -5.95 SPECIALTY-PRECIOUS METALS -9.79 ALL EQUITY FUNDS -2.43 U.S. DIVERSIFIED EQUITY -2.03 S&P 500 INDEX -0.17 *Appreciation plus reinvested dividends and capital gains through June 6 DATA: MORNINGSTAR INC. *APPRECIATION PLUS REINVESTED DIVIDENDS AND CAPITAL GAINS, THROUGH JUNE 6 DATA: MORNINGSTAR INC. *As of May 31 **Includes dividends and capital gains All 1994 return data through June 6TABLE: HOW THE BOND FUNDS FARED IN THE FIRST HALF BOND-FUND GROUPS Total return* GOVERNMENT -ADJ. RATE MTG -0.33% CORPORATE -HIGH YIELD -1.79 CORPORATE -HIGH QUALITY -1.92 SHORT-TERM WORLD INCOME -2.17 TAXABLE FIXED-INCOME FUNDS -2.48 GOVERNMENT -GENERAL -2.73 CORPORATE -GENERAL -2.83% GOVERNMENT -MORTGAGE -2.83 MUNICIPAL -2.93 CONVERTIBLE -2.98 GOVERNMENT -TREASURY -3.22 INTERNATIONAL -6.23 TAXABLE BOND FUNDS THE BEST Total return* FRANKLIN/TEMPLETON HARD CURRENCY 6.03% FRANKLIN/TEMPLETON HIGH-INC CURRENCY 5.39 FRANKLIN/TEMPLETON GLOBAL CURRENCY 4.81 NORTHEAST INVESTORS 4.06 OLYMPIC LOW DURATION 2.18 SMITH BREEDEN INSTL SHORT DUR US GOVT 1.78 SMITH BREEDEN SHORT DURATION US GOV I 1.68 KEYSTONE AMERICA AUSTRALIA INCOME A 1.68 SEVEN SEAS YIELD PLUS 1.38 REGIS SIRACH SHORT-TERM RESERVES 1.30 FFTW U.S. SHORT-TERM FIXED-INCOME 1.27 MAINSTAY HIGH-YIELD CORPORATE BOND 1.22 EATON VANCE SHORT-TERM TREASURY 1.17 RSI RETIREMENT TRUST SHORT-TERM INVMT 1.11 PERMANENT PORTFOLIO TREASURY BILL 1.11 THE WORST Total return* PIPER JAFFRAY INSTL GOVT INCOME -22.44% MANAGERS INTERMEDIATE MORTGAGE -20.16 FIDELITY NEW MARKETS INCOME -19.72 MONITOR MORTGAGE SECURITIES TR -18.76 BAILARD, BIEHL & KAISER INTL F/I -18.06 G.T. GLOBAL STRATEGIC INCOME B -17.85 G.T. GLOBAL HIGH-INCOME B -16.51 FUNDAMENTAL U.S. GOVT STRATEGIC INC -14.63 G.T. GLOBAL GOVERNMENT INCOME B -13.65 FIDELITY GLOBAL BOND -13.37 BENHAM TARGET MATURITIES 2020 -11.89 BEAR STEARNS EMERGING MARKETS DEBT -11.80 BULL & BEAR GLOBAL INCOME -11.23 BENHAM TARGET MATURITIES 2015 -10.37 FIDELITY SPARTAN LONG-TERM GOVT BOND -10.37 TAX-FREE BOND FUNDS THE BEST Total return* HANIFEN, IMHOFF CO BONDSHARES 2.39% CALVERT TAX-FREE RESERV LIMITED-TRM A 1.04 TWENTIETH CENTURY TAX-EXMPT SHORT-TRM 0.89 VENTURE MUNI (+) PLUS 0.88 VANGUARD MUNICIPAL SHORT-TERM 0.54 KENT MI MUNI LTD MATURITY BOND INSTL 0.33 MERRILL LYNCH MUNICIPAL LTD MATURITY A 0.31 KENT MI MUNI LTD MATURITY BOND INVMT 0.23 SHORT-TERM MUNICIPAL INSTL 0.23 USAA TAX-EXEMPT SHORT-TERM 0.14 T. ROWE PRICE MD SHORT-TERM TAX-FREE 0.12 FORUM TAXSAVER BOND 0.06 STRONG SHORT-TERM MUNICIPAL BOND -0.01 UST MASTER SHORT-TERM TAX-EXEMPT SECS -0.07 WARBURG PINCUS NY MUNICIPAL BOND -0.11 THE WORST Total return* CALIFORNIA MUNI -9.46% NEW YORK MUNI -7.96 ALLIANCE MUNI INCOME II FL C -7.23 ALLIANCE MUNI INCOME II NJ C -6.23 GUARDIAN TAX-EXEMPT -6.21 ALLIANCE MUNI INCOME INSURED CA B -6.15 FINANCIAL HORIZONS MUNICIPAL BOND -6.14 CGM AMERICAN TAX-FREE -6.13 FIRST UNION NC MUNICIPAL BOND C INVMT -6.03 BULL & BEAR MUNICIPAL INCOME -5.92 ALLIANCE MUNI INCOME INSURED CA A -5.85 FRANKLIN FL INSURED TAX-FREE INCOME -5.30 LORD ABBETT CA TAX-FREE INCOME -5.27 CONSULTING GROUP MUNICIPAL BOND -5.26 ALLIANCE MUNI INCOME NATIONAL B -5.24 *Appreciation plus reinvested dividends and capital gains through June 6 DATA: MORNINGSTAR INC.