After a year like 1995, who's going to complain? Diversified equity mutual funds, the meat and potatoes of most investors' portfolios, earned an average return of 32.1%, including dividends and capital gains. Think your funds' managers are so smart? Think again. The Standard & Poor's 500-stock index recorded a smashing 37.5% return, and it beat more than 80% of the mutual-fund managers. Even with its stock-picking smarts and trading prowess, the $53.7 billion Fidelity Magellan Fund came close but could not beat the market.
Maybe you made a lot of money, but perhaps you could have made more in another fund. Or perhaps you could have had a fund that earned as much without taking as much risk. Last year, risk-taking paid off, but the returns earned in 1995 were a once-in-two-decades occurrence. And investors continue to throw money at funds--an estimated record $16 billion in the first three weeks of 1996, says Robert Adler of AMG Data Services, which tracks flows to funds. But this year, returns will likely be tempered and the market not so forgiving to those who misjudge their risks.
A LONG VIEW. That's why you need the BUSINESS WEEK Mutual Fund Scoreboard. It's a feast of information on 885 equity funds that's an indispensable tool for mutual-fund investors in monitoring the funds they own or searching for the funds they need to build their investment programs. Want some suggestions? We've asked four investment advisers who specialize in mutual funds to design portfolios that fit the kind of financial goals you must meet.
The Scoreboard includes what you need to know about a fund's performance, fees, and expenses. We examine returns earned over the past three-, five-, and 10-year periods, both before and after taxes. After all, it's not what you make but what you keep that counts. We peer inside the portfolio to see what's behind the numbers. We look at "turnover," or how frequently the fund trades, "style," the kinds of stocks it invests in, and its largest holding. We also categorize the fund's risk from "very high" down to "very low."
The Scoreboard takes risk seriously. It's what sets the BUSINESS WEEK ratings apart from most others. At BW, it's not enough to get the highest returns: A fund has to get the highest returns after adjusting for the risk its managers took with your money. And we don't award ratings to hot performers that burst on the scene in the past year or so. We rate a fund only after it has built a five-year track record, long enough to see how the fund performs in a variety of market conditions.
We know you've been taking on a lot more risk. During 1995, some 60% of the estimated $120 billion that poured into equity funds went to the riskiest categories of funds, such as growth, maximum growth, small-company, and specialty funds, according to Avi Nachmany of Strategic Insight, a mutual-fund consulting firm. In 1994, the riskiest funds took just one-third of the money, and in 1993, only one-quarter. The reasons for the shift? Perhaps investors are lengthening their horizons, realizing that more short-term volatility could mean better long-term results. The other reason, says Nachmany, is simpler: "Money flows to the best performers, and that's where the performance has been."
This year, 48 funds earned three upward-pointing arrows, the highest rating for the period 1991 through 1995 (table). The ratings and all Scoreboard data are prepared for BUSINESS WEEK by Morningstar Inc., the fund ratings company. The top-rated funds span the investment spectrum from the T. Rowe Price Spectrum Income Fund, an asset allocation fund with an 11.2%-a-year average annual return, to Fidelity Select Home Finance, a specialty fund concentrating on savings-and-loan stocks with a 39.1%-a-year average annual return. It's a varied lot; it includes eight funds specializing in small companies and two maximum-growth funds, those empowered to take the biggest risks. What they all have in common is that they give their shareholders the most reward for the amount of risk taken.
HAT TRICK. The list includes 17 holdovers from last year, and several have been on the list frequently in the past--including Heartland Value, Lindner Dividend, and SoGen International. It also includes repeaters such as Mutual Beacon, Mutual Qualified, and Mutual Shares, all run by the same portfolio manager, Michael F. Price. Price's fund are unique, investing in bankruptcies, corporate reorganizations, and private placements and mergers--and there is some question about their future. Last week, BUSINESS WEEK reported that Price is trying to sell the funds' management company to pursue investments on his own (BW--Jan. 29).
Price isn't the only mutual-fund manager to pull off a hat trick. Fidelity's George A. Vanderheiden has three funds with three up-arrows, all for the first time: Fidelity Advisor Growth Opportunities A, Fidelity Destiny I, and Fidelity Destiny II. Tapping Vanderheiden's expertise isn't cheap--the two Destiny funds carry stiff 8.24% loads, among the highest of all funds in the Scoreboard--and that's not all. The two funds are sold as installment plans, which obligate investors to make monthly payments of $50 to $10,000 for a 10- or 15-year period. The cost for dropping out early can be stiff. In the first year, half the monthly investment goes to paying a sales charge. Vanderheiden's Advisor fund, a part of the Fidelity family that's sold by brokers and financial planners, carries a 3.5% load.
If you're worried about the high level of the stock market and the high prices of many stocks, you will like the three-up-arrow funds. All have average or less-than-average risk profiles. Of them, 36 practice a "value" investment style: They buy stocks with below-average price-to-earnings and price-to-book ratios, as opposed to "growth" stocks, which have higher growth rates but higher p-e and p-b ratios. John Rekenthaler, publisher of Morningstar Mutual Funds, thinks the value-dominated list is particularly well-timed. "After last year's strong performance from the growth side," he says, "this could be the year for value stocks." Eleven funds are blends of value and growth, and only one, SteinRoe Capital Opportunities Fund, has a pure growth portfolio. The fund caught the crest of the growth-stock wave in 1995, racking up a 50.8% return.
Although she works in a highflying sector of the market, Gloria J. Santella, SteinRoe Cap's portfolio manager, strives to keep risk under control. She put a lid on technology stocks when they hit 25% of the portfolio, while many of her competitors increased their allocations to technology. "That hurt us early in the year, when tech did so well, but it certainly paid off in the fourth quarter," she says. She maintains a fairly concentrated portfolio, just 48 stocks, but argues that with fewer companies, she can minimize risk by doing more thorough research on each. Once she finds an investment she likes, Santella gives it time. Her portfolio turnover is only about a third that of her peer group.
Another new name on the top performers' list is Oppenheimer Quest Opportunity Value Fund A, managed by Richard J. Glasebrook. Categorized as an asset allocation fund, the portfolio's asset mix--87% stocks, 12% cash, and 1% bonds--looks more like that of a growth fund. "I can make more money by selecting stocks than by trying to shift assets around to take advantage of small moves in the capital markets," he says. "But I have the flexibility to preserve capital in a difficult market."
Glasebrook also invests in relatively small number of stocks, usually less than 50--"stocks everybody has heard of." Two of his largest positions are McDonnell Douglas Corp., a stock that doubled in price over the past year and now makes up 7.5% of the fund. The next-largest position is Intel Corp., about 5%. With a contrarian bent, Glasebrook was busy adding to his Intel stake on Jan. 17, when a bad fourth-quarter profit report triggered a gusher of sell orders. "Intel's aftertax return on capital is over 20%," he says. "And its competition is falling further and further behind."
STRONG IN A REBOUND? The willingness to swim upstream is a key factor behind the success of Pioneer Capital Growth Fund A. Portfolio Manager Warren J. Isabelle hunts for Wall Street's unloved or unnoticed companies and selects those where he finds the most value. And he has so far been able to knock out double-digit returns every one of the past five years--including the very difficult 1994, when the average fund lost money.
Now, Isabelle's largest holding is the unloved Toys `R' Us Inc. In a small-company fund? "The bulk of our fund is small-cap, but it's not our mandate," says Isabelle. "We'll go where we can make money." Isabelle says Toys needs to revamp its format to put more emphasis on electronics, but its basic problem is the retail sales slump. "But it's a survivor," he says, "and in a rebound, it will have some operating and pricing leverage."
What's also notable about the top-performers' list is what it doesn't have--technology funds and international funds. Eight tech funds made the list for the 1990-94 period, but all slipped off in 1995, despite the 44.5% average return from the tech funds. The funds plunged in the fourth quarter--along with the rest of the tech sector--and that lowered their risk-adjusted scores enough to cost them their top-notch ratings. The tech blow-off also took a toll on the Fidelity fund complex, which had taken big stakes in the sector and started to sell them off in the latter part of the year. In the first nine months of 1995, 13 of the 22 Fidelity growth-oriented funds in the Scoreboard beat the S&P; by year-end, only five were ahead of the index.
No portfolio of funds is complete without a dollop of international funds. But the best rating you'll find on a non-U.S. fund is average, and most are below average. That's because foreign markets have woefully underperformed the U.S. in four of the past five years. From 1991 through 1995, international funds lagged U.S. funds by nearly seven percentage points. In 1995, the gap was even wider, nearly 23 percentage points. Yet there's virtually no difference between U.S. and international funds over the past 35 years, says fund expert A. Michael Lipper of Lipper Analytical Services Corp. That leads him to believe non-U.S. funds are a buy. "The gap will close," he says, "if not in 1996, then in 1997." Indeed, some investors are already moving their money abroad. AMG's Adler says about 20% of this year's fund cash flow is going into non-U.S. funds.
In BW's Scoreboard, the best-rated international funds are "world" funds, but those funds combine both U.S. and non-U.S. stocks. They owe their stronger performances to the U.S. portions of their portfolios. To really play the rebound, select from the foreign funds, which explicitly don't contain any U.S. stocks. Among the better-rated foreign funds are GAM International, Managers International Equity, and the Templeton Foreign Funds. Lipper thinks the biggest rebounds will come in the battered emerging markets funds, particularly those investing in Latin America.
As you turn to the Scoreboard, note some of its features:
--Portfolio manager. You'll see a head-and-shoulders figure next to some funds. If the figure is filled, the manager has been on the job 10 years or more--a plus in selecting a fund. If the figure is outlined, there's been a change in the past 12 months. Take note of Govett Smaller Companies Fund A, which got a new manager near the end of the year. That 51.1% average annual return for the last three years was someone else's work.
--Assets. Rapid asset growth can cool a fund manager's hot hand. During 1994, Crabbe Huson Special Fund increased its asset base more than tenfold. In 1995, assets were up 143%--and the fund was up only 10.8%. (Part of the reason for the poor performance was that the fund sold tech stocks short well before they started to fall. That bet may yet pay off.)
--Expense ratios. The average expense ratio for the Scoreboard funds is 1.28%. It hasn't gone up in the past few years, nor has it come down, which it should have, considering the funds have much larger asset bases over which to spread their cost. Note that some of the worst-performing funds have among the highest expense ratios.
--Pretax and aftertax returns. Aftertax returns assume a 31% federal tax rate on income and short-term gains, and 28% on long-term capital gains. The difference between pretax and aftertax returns should be small for growth funds, but greater for yield-oriented funds such as balanced and equity-income funds. Yield-oriented funds may not be attractive for taxable accounts. But they make good choices for tax-deferred individual retirement accounts and 401(k) plans.
--Style. You can't rely only on the name on the door, or the fund's investment objective to tell you how it invests. Despite its name, the Alger Small Capitalization Fund has a mid-cap portfolio, according to Morningstar's analysis.