A Fast And Furious First QuarterJeffrey M. Laderman
Roger McNamee is in Fat City. He runs the T. Rowe Price Science & Technology Fund, which, as he puts it, "went ballistic" during the first quarter--up nearly 44%, the fourth-best return of 941 equity funds. The fund, which only had $61.5 million in assets at yearend, boomed on the surge in technology and small-capitalization stocks. And as that was happening, investors poured more than $60 million in new cash into the fund's coffers, hoping to ride along with a winner.
Flush with success, McNamee now is pulling back a bit. Rather than buy more and more stocks at higher and higher prices, he let the cash build up to where it now comprises 25% of the $155 million portfolio. The fund has appreciated more in three months than it did in all of 1989--its best year, when McNamee racked up returns of nearly 41%. Now, he says, preserving profits is as important as making gains. "The truth is, the market went up so fast that aggressive managers like myself didn't have time to mess things up," he says. "I certainly don't want to mess things up now."
SAVORING THE MOMENT. McNamee is not alone. Most fund managers, if not the whole world, were taken by surprise that the market could be so strong in the face of war and recession. The Standard & Poor's 500-stock index was up 14.59% in the first quarter, and added another 1% in the first days of the second. So fund managers figure that the gains from here on will be harder to come by. "The managers we talk to are stepping very gingerly," says Michael D. Hirsch of M. D. Hirsch Investment Management Inc., which invests its clients' money through mutual funds.
Fund managers and those who entrust their money to them want to savor the moment. In the first quarter, equity funds earned on average 15.14%, and U. S. diversified funds, 17.58%, leaving the the S&P 500 and the Dow Jones industrial average, with a 11.5% total return, in the dust. The average fund hasn't beaten the S&P in years.
What put the sparkle into the funds were the small stocks, which weigh more heavily in mutual funds than they do in pension accounts or in the S&P 500. The total return from the Russell 2000, a broad measure of small-capitalization issues, was nearly 30%. That could be a major turnaround. Except for 1988, returns on small-cap stocks have trailed the S&P 500 every year since 1984.
Health care, technology, and maximum-growth funds that also invest in small companies flourished. In the first quarter, health care funds, the only
category of fund to end up in the black last year, added another 30.24% in total return to 1990's 22.3%. Financial funds soared 24.65%, aided by the fall in interest rates. Growth funds, the largest category of equity mutual funds, outpaced the S&P 500 by three percentage points. That may not sound like much, but by the past decade's record, it's enormous.
The conservative funds--asset allocation, balanced, income, and utility--performed as expected in a bull market, trailing the more aggressive portfolios. International funds paled in comparison to the domestic variety. Although most overseas markets rallied during the quarter, so did the dollar. That undercut the foreign returns for U. S. investors.
JUNK JUMPS. The strength in the equity market carried over to the junk-bond funds, which rose from the depths to post a 13.74% total return for the quarter. Of the top 25 taxable bond funds, 20 were junk portfolios. The quarter's best was Dean Witter High-Yield Securities, up 30.61%. For 1990, that fund lost 40.1%. Junk got its lift the same way that equities did -- from lower interest rates and the hopes for an end to the recession. And a stronger stock market allowed some junk issuers to use equity to soak up some of their debt.
Precious metals funds, which typically go in the opposite direction of most equity funds, did just that. They ended up in the red, down about 6.59%. That's better than gold, which declined 9.1% during the quarter. All but 3 of the 25 worst performers were precious metals funds.
The market was so strong that it turned some chumps into champs. The American Heritage Fund, down 30.7% in 1990, was up 54.17%. The Prudent Speculator Leveraged Fund, up 48.32%, looked anything but prudent last year, when it lost 37.6%. Part of its problem was leverage--the fund buys stocks with borrowed money--a recipe for disaster in bear markets. This year, however, with a modest amount of leverage, about 15%, manager Ed Bernstein has built a winning portfolio of about 90 companies.
What also worked in these funds' favor was their minuscule size. Prudent Speculator started the year with $4.2 million and has grown to $11 million. The No. 3 Oberweis Emerging Growth Fund, up 43.85%, had $11.6 million at the start of the year and now has $15 million. Both tower over American Heritage, which had a microscopic $1 million in assets at the beginning of the year and still amounts to only $1.5 million. Of course, none of these will be this small for long as investors hear about their recent eye-popping returns.
Still, warns Don Phillips, editor of Mutual Fund Values, "this quarter's top performers list is not a good hunting ground for long-term investors. Some of these funds are as likely to be on the bottom performers list as they are on the top." Even health care funds, which sprinted through the bear market, are looking suspect. The Vanguard Group recently sent a letter to shareholders of its own health care fund warning them the generous returns of recent years are "highly unlikely" to continue. Vanguard also sends the letter to those who wish to purchase the fund.
Fund mavens also look warily at superhuman returns generated by managers running only small portfolios. "It's easier to have an outstanding performance with a small fund because a few big winners can have a large impact," admits Heiko H. Thieme, the Deutsche Bank investment strategist who ventured into U. S. fund management by taking over the beleaguered American Heritage Fund in
January, 1990. "But a few losers can gut my performance."
Thieme's recent success didn't come from small stocks alone. About 60% of the portfolio is in larger companies such as General Motors, ITT, and Navistar. The remainder is in little-known but fast-growing outfits such as American Biogenetic Sciences, American Business Computers, and American Film Technologies.
But performance often slows with size. Look at two Fidelity funds, Equity Portfolio: Growth and Fidelity Growth Company. They have most of the same stocks and are run by the same manager. Yet in the first quarter, Equity Portfolio was up a little more than 37%, and Fidelity Growth, a shade under 25%. Why the difference? Equity Portfolio, a fund with a $100,000 minimum investment, has only $40 million in assets; Growth Company has $1.1 billion. The relative sizes of the funds, says fund manager Robert Stansky, certainly affects the results.
WALLFLOWER STOCKS. But don't get the impression that big funds were left behind in the last quarter. The $14.8 billion Fidelity Magellan Fund, under Morris Smith since the retirement of Peter Lynch last May, racked up an impressive 20.23% return. The $7.6 billion Windsor Fund, which underperformed badly for the last two years, gained 18.25%.
So much for the first quarter. What's next? Thieme thinks the market has seen most of the gain it will make this year--a sentiment echoed frequently. "Now, it's a stock-picker's market," he says. That should benefit portfolio managers, who seethed in frustration during the 1980s when unmanaged index funds beat most of them handily.
"Investors are going to be more discriminating going forward," says T. Rowe Price's McNamee. With the sluggish economy, he says, the key to success will be investing in the companies that can demonstrate reliable earnings growth. Among his favorites on that count are his three largest holdings: Adobe Systems, Apple Computer, and Phoenix Technologies.
Then there's the question that could be key to mutual fund investing in the 1990s: Will small-capitalization stocks continue to outperform the S&P 500? Several times in the past few years--most recently in the first half of 1990--the small-cap stocks raced ahead for a while, only to collapse. All stocks plunged in the third quarter of last year, but the S&P 500 revived in the fourth. The small-cap stocks never rebounded in 1990. That leads some to suggest that the small stocks' runup is only a catchup from last year and not necessarily the start for them of a long bull market.
James Oberweis, who runs his own Emerging Growth fund, has no doubt about the long-term prospects. "Smaller stocks are still enormously undervalued," he says. "One quarter in the right direction does not make up for years of underperformance." If the S&P 500 didn't gain an inch, he says, small-cap stocks could go up 50% before they were fully valued and a good deal more before they're overvalued. Oberweis thinks small stocks will continue to outpace the big ones for at least five years, albeit with some "steps and stumbles along the way." If he's right, the best investment advice today is to think small.
HOW FUND GROUPS FARED Group Total return* HEALTH CARE 30.24% TECHNOLOGY 26.94 SMALL COMPANY 25.14 FINANCIAL 24.65 MAXIMUM GROWTH 23.98 SPECIALTY-MISCELLANEOUS 17.64 GROWTH 17.43 GROWTH/INCOME 13.73 EQUITY-INCOME 12.31 BALANCED 10.66 OPTION 10.28 INCOME 9.97 ASSET ALLOCATION 7.88 INTERNATIONAL 7.62 UTILITIES 5.90 NATURAL RESOURCES 5.54 PRECIOUS METALS -6.59 DIVERSIFIED U.S. FUNDS 17.58 DIVERSIFIED U.S. FUNDS 17.58 ALL EQUITY FUNDS 15.14 ALL EQUITY FUNDS 15.14 S&P 500 14.59 S&P 500 14.59 *Appreciation plus reinvested dividends and capital gains DATA: MORNINGSTAR INC. RAY VELLA/BW THE BEST AND WORST OF THE FIRST QUARTER LEADERS Fund Total return * American Heritage 54.17% Prudent Speculator Leveraged 48.32 Oberweis Emerging Growth 43.85 T. Rowe Price Science & Technology 43.58 Fidelity Select Medical Delivery 41.61 Twentieth Century Ultra Investors 40.75 Fidelity Select Biotechnology 40.42 Transamerica Technology 40.02 Oppenheimer Global Biotech 38.97 Equity Portfolio: Growth 37.09 FPA Capital 36.98 Security Ultra 36.65 Sherman Dean 36.65 Shearson Small Capitalization 35.63 Security Omni 35.21 Seligman Communications & Information 35.17 Financial Strategic Technology 34.76 Fidelity Select Computers 34.47 Fidelity Select Health 34.45 Harbor Growth 34.37 Vista Growth & Income 33.98 Keystone Custodian S-4 33.94 CGM Capital Development 33.91 Twentieth Century Giftrust 33.88 Parnassus 33.81 Pacific Horizon Aggressive Growth 33.79 MFS Lifetime Emerging Growth 33.59 Twentieth Century Vista Investors 33.24 Merrill Lynch Phoenix A 33.04 Financial Strategic Health Sciences 32.89 Fidelity Select Technology 32.62 Fidelity Select Retailing 32.36 John Hancock Special Equities 32.31 MIM Stock Appreciation 32.28 MetLife-State Street Cap. Apprec. 32.11 Merrill Lynch Growth For Investment B 31.76 Nautilus 31.51 PBHG Growth 31.35 United New Concepts 31.29 Fidelity Select Brokerage & Invest. Mgt. 31.28 SAFECO Growth 31.27 Pasadena Growth 31.23 Berger 100 31.15 Transamerica Special Emerging Growth 30.85 Fidelity Select Electronics 30.53 Wall Street 30.51 Aegon USA Capital Appreciation 30.49 Merrill Lynch Special Value A 30.29 Fidelity Select Savings & Loan 30.19 CIGNA Aggressive Growth 30.13 *Appreciation plus reinvested dividends and capital gains DATA: MORNINGSTAR INC. LAGGARDS Fund Total return* Strategic Investments -22.22% Strategic Gold/Minerals -13.37 Benham Gold Equities Index -11.87 United Services Gold Shares -11.64 Blanchard Precious Metals -10.76 Kemper Gold -9.61 United Services World Gold -9.50 Shearson Precious Metals & Minerals -9.28 McKeever Total Return -8.44 USAA Investment Gold -7.77 Shearson Precious Metals -7.73 Financial Strategic Gold -7.64 Enterprise Precious Metals -7.35 Scudder Gold -7.03 Fidelity Select American Gold -6.42 Thomson Prec. Metals & Natural Res. -6.08 Lexington Goldfund -5.96 International Investors -5.92 Bruce -5.90 MFS Lifetime Gold & Precious Metals -5.86 Van Eck Gold/Resources -5.64 IDS Precious Metals -5.46 Dean Witter Prec. Metals & Minerals -4.95 MainStay Gold & Precious Metals -4.73 European Emerging Companies -4.72 Fidelity Select Precious Metals/Min. -4.72 DFA Continental Small Company -4.67 Colonial Advanced Strategies Gold -4.67 Oppenheimer Gold & Special Minerals -4.43 DR European Equity -3.45 United Services Global Resources -3.30 Bull & Bear Gold Investors -2.46 Vanguard Specialized Gold/Prec. Mtls -2.21 Dreyfus Capital Value -1.89 Shearson European -1.77 United Gold & Government -1.65 Excel Midas Gold Shares -1.49 Franklin Gold -1.30 Keystone Precious Metals Holdings -0.63 Colonial VIP Inflation Hedge -0.23 Freedom Gold & Government +0.35 United Services European Equity 0.45 Financial Strategic Energy 0.46 Merrill Lynch Global Utilities B 0.60 Strategic Silver 0.66 American Gas Index 0.73 Fidelity Select Energy 0.86 Huntington CPI+ 0.88 Shearson Telecommunications Incom e 0.90 Financial Strategic European 1.00 RAY VELLA/BW HOW THE LARGEST FUNDS PERFORMED Total return* FIDELITY MAGELLAN 20.23% WINDSOR 18.25 INVESTMENT COMPANY OF AMERICA 12.12 WASHINGTON MUTUAL INVESTORS 10.89 FIDELITY PURITAN 11.27 FIDELITY EQUITY-INCOME 13.86 PIONEER II 11.71 TEMPLETON WORLD 14.67 AMERICAN MUTUAL 8.09 AFFILIATED 9.49 *Appreciation plus reinvestment of dividends and capital gains DATA: MORNINGSTAR INC.