Any day now, Fidelity Magellan will become the first mutual fund to cross the $100 billion mark, just four years after its assets hit $50 billion and long after many had written it off as a bumbling giant. But in BUSINESS WEEK's mutual fund performance ratings, Magellan rates just a B when compared with the general universe of funds. And it gets a C-, a below average grade, in its peer group of large-cap blend funds.
To find higher rated funds, turn to BUSINESS WEEK's Mutual Fund Scoreboard. Appearing every January in the magazine, the ratings get updated monthly in the Interactive Mutual Fund Scoreboard at Business Week Online (go to www.businessweek.com/investor/, then click on Mutual Funds). In the six months since our 1998 ratings ran in the magazine, domestic hybrid funds composed of stocks, bonds, and cash have outperformed many equity offerings such as Magellan on a risk-adjusted basis. They also hold their own against the Standard & Poor's 500 index funds when adjusted for risk.
The first half of 1999 was a lot like the past few years, when the major stock market indexes continued to reach new highs. But this year, U.S. diversified mutual funds are faring relatively better. They lagged behind the Standard & Poor's 500-stock index by only 1.23 percentage points, compared with more than six points in the first half of 1998. That's because a broader swath of stocks are participating in the market's rise. In the second quarter, investors began to favor value over growth stocks, and to step away from large-caps to mid-cap and even small-cap issues--shifts that have helped to bolster fund returns. Even so, the sorts of funds that earned superior ratings for overall performance have not changed dramatically. Nor has much improved performance from many international funds allowed any of them to approach an A rating, our highest. Still, 33 funds have joined the top ranks this year (table). Among the new stars are large-cap growth funds including Gabelli Growth, Pioneer Growth A, and Reynolds Blue Chip Growth. Seventy-six equity funds that were on the 104-fund list at yearend remain there, and 56 funds have been on the list every month in 1999.
BOND FUND BLUES. While equity funds have thrived in the first half, bond funds haven't. Rising interest rates took their toll, leaving taxable-bond funds down 0.3%, and muni funds off 1.35%. Still, the list of A-rated bond funds hasn't changed much since yearend. Sixty-one of the 98 funds that were on the list at the end of 1998 remain on it now; 46 have been on the list every month. This year, 29 funds have joined the bond funds' top ranks (table, page 126). Four are convertible bond funds--no surprise, since their fortunes are more closely linked to the performance of equities than to the course of interest rates. All told, five convertible funds--or 25% of the convertible funds that have ratings--reside on the A-list. A strong stock market has not yet made much difference in ratings of high-yield bond funds, whose less-than-investment-grade holdings also tend to trade more in sync with stocks than bonds. Seven high-yield funds that made the A-list in December are on it now and all but one are the same.
Even when bond funds do well, they get scant attention from investors. In part, that's because yield is what sells bond funds, and for the last few years yields have been relatively low. In fact, only high-yield funds have taken in much new cash recently. Many investors also shun fixed-income funds because they already own a slug of bonds in their domestic hybrid funds.
GOOD BALANCE. Hybrid funds are a broad category that includes balanced and asset-allocation funds. Their portfolios dampen volatility and give investors one package offering the advantages of stocks, bonds, and sometimes, other assets. Often used as starter funds, they're popular in 401(k) and individual retirement accounts. The balancing act works--investors get a high degree of reward for the amount of risk. Thus, domestic hybrid funds have always been well represented in our Mutual Fund Scoreboard.
Today, 41 domestic hybrids make the 111-name A-list--37% of the total. For the period ended last Dec. 31, such funds occupied 30 of the 104 slots. Hybrids have done well even in the face of rising rates that have put pressure on their bond portfolios. That's partly because as rating periods have moved forward from December, the first half of 1994--one of the worst periods for bond investors in decades--has dropped off their records.
Some of the hybrid funds that have moved up to the A-list are American Balanced Fund, FBP Contrarian Balanced and Rainier Balanced. All three have beaten the 15% average annual returns that the funds in this category have earned over the last five years. But the highest absolute return comes from a fund which has been on the list for a while. Value Line Asset Allocation Fund, on the A-list for all but one month since August of last year, posts the highest numbers--a five-year average annual return of 24.7%. That's a better return than the average large-cap value or large-cap blend funds, and nearly as good as the average large-cap growth funds.
LARGE-CAP DROP. The domestic hybrids' ratings gains have come mainly at the expense of the large-cap funds. Even as value investing came back in the second quarter, only a dozen large-cap value funds made it to the A-list, three fewer than last winter. Five funds dropped off; two new ones, American Mutual Fund and Salomon Brothers Investors O, came aboard. American Mutual, run by the Capital Group, is an $11 billion giant with a 19.8% a year return over the last five years. The Salomon fund has higher returns, 25.1% for the same period, but the no-load shares are closed to new investors. Newcomers have to buy the fund with a load.
Large-cap blend funds, which span the middle ground between value and growth, also gave ground in the first half, placing 33 funds on the A-list, vs. 36 at the end of last year. Eleven funds in this category are S&P 500 index funds, leaving just 22 actively managed portfolios. Large-cap growth funds, which have posted strong returns over the last five years, put 11 names on the A-list, the same as in December.
Considering the pickup in the mid-cap and small-cap sectors, most funds in those categories remain far from the A-list. At the end of last year, the only small-cap funds to rise to the top were Longleaf Partners Small-Cap and Royce Total Return, both value portfolios. Now, the Royce fund is gone from the all-fund A-list, but still retains an A rating in its category. In its place comes a new star from the small-cap blend group, Weitz Hickory Fund, with a smashing 32.8%-a-year return over the last five years. That's more than twice the average annual return of the average fund in its category.
Unfortunately, the fund is closed to new investors, as is Longleaf. For alternatives, look to some of the small-cap funds rated A in their groups: Royce Total Return in value, the Fasciano or Value Line Special Situations funds in growth, and Meridian Value fund in small-cap blend. Mid-caps are not making any more headway than small caps. The mid-caps placed five funds on the A-list, same as last winter, and only one name is new, Gabelli Asset Fund.
HIGH-POWERED UTILITIES. Among the specialty funds, some staid utilities funds have jumped to the A-list. They grabbed four slots, compared with none last year. Their low volatility helped them significantly in the overall ratings. Of 35 rated utilities funds with ratings, 22 earned a B or better. The runaway winner was Fidelity Select Utilities Growth, which earned a 26.4% a year return, vs. 17.3% for the average utilities fund. The fund places a far greater emphasis on lower yielding, but higher growth, telecoms than on electric and gas utilities, which feature higher yields but lower growth.
Technology funds, meanwhile, had the highest returns of any category over the last five years. But not one of the 16 funds with ratings made the A-list. Five funds earn Cs overall, the best that any did. In the category ratings, Invesco Technology II was the only one to get an A.
Investors wanting a jump on tomorrow's leading funds might consider buying relatively good funds in down-and-out sectors with improving prospects. One possible choice: SSgA Emerging Markets Fund. Like many volatile emerging market funds, it rates an F compared with all other funds. But it alone gets an A when graded against its peers. As for highflying Internet funds, none have yet earned ratings--they're too new. Even with their huge recent returns, don't be surprised if some fall short of the A-list when they become eligible to be rated. When it comes to ratings, it's not only what a fund earns, but also how much risk it takes.