The Best Mutual FundsJeffrey M. Laderman
What else can you call it but mutual-fund mania? Investors pumped $128.2 billion into equity mutual funds last year. That's about 10% more than they invested in 1991 and 1992 combined, each of which were record years, too. In December, cash pouring into the funds hit a new high of $14.5 billion, and when the January figures are reported, that record is likely to fall again.
So far, fund buyers have been rewarded handsomely. In 1993, diversified U.S. funds racked up an average 13.8% total return (appreciation plus reinvestment of dividends and capital gains)--soundly beating the Standard & Poor's 500-stock index by nearly four percentage points. And with the Dow Jones industrial average pushing 4000, 1994 is off to a rousing start as well.
ON A TEAR. With the huge drop in long-term interest rates, the conservative funds that hold some fixed-income securities also beat the S&P 500. Even precious-metals funds, perennial laggards, went on a tear in 1993, up 97%. The average one-year return for all 760 equity funds in the 1994 BUSINESS WEEK Mutual Fund Scoreboard was a juicy 20%--boosted by fat profits from funds investing overseas.
Indeed, U.S. mutual-fund investors are going crazy for foreign investing as well. During 1993, the assets of equity funds investing abroad swelled 146%, to $113 billion, according to the Investment Company Institute. Especially hot are the "emerging markets" funds, which invest in the developing economies in Asia, Latin America, Europe, and Africa. The Fidelity Emerging Markets Fund soared 81.8%, making it the best-performing foreign fund of the year. U.S. fund investors have been getting an extra dose of foreign investing without even knowing it. Nearly 9% of the holdings of domestic funds are in non-U.S. stocks, according to Morningstar Inc., which compiles the data for the Scoreboard.
While fund managers are awash in cash beyond their wildest dreams, there's also an unsettling undercurrent. How much better can things get? Investors have gale-force winds at their backs: low interest rates, low inflation, and improving economies both in the U.S. and abroad. No one can rely on such favorable investment weather all the time.
That's why investors need the Scoreboard. It's a guide that can help identify what funds are delivering the most reward for the least risk. As always, it gives you the lowdown on mutual-fund performance, fees, and expenses, as well as what's going on inside the portfolios. In addition, you get the BUSINESS WEEK ratings, which rank funds based on their five-year, risk-adjusted total returns.
But that's not all. This year, the Scoreboard is introducing several new features that will help you view funds in a different light:
nAftertax returns. Federal tax rates went up last year, and everyone is more tax-conscious than ever. Funds don't pay taxes. Instead, they must distribute their dividends and realized capital gains to the shareholders, who, in turn, pay the taxes on those profits. So it's vital to know what the total returns are after taxes as well as before taxes.
Many funds look a lot different after adjusting for the Internal Revenue Service. For instance, CGM Capital Development Fund has a five-year average annual return of 29.2% that falls to 24.5% after taxes. That's enough of a tax bite to push the fund down from No.2 to No.12 in five-year total returns. Twentieth Century Ultra Investors, on the other hand, manages to run up big gains without making big taxable distributions to its shareholders. Its five-year average annual returns are 28.1% pretax and 27% aftertax. Taking taxes into account, the fund jumps from No.7 to No.2.
Of course, not every fund shareholder is in the same tax bracket. Our tax calculations assume an investor is in the highest federal tax bracket through 1990 and in the 31% bracket since 1991. In addition, all capital gains are assumed to be long-term--and since 1991, at least, subject to a maximum tax of 28%. If you are in a lower tax bracket, the aftertax return will be understated. If the fund is in your Individual Retirement Account or 401(k) plan, there are no current tax consequences at all. Investors who pay the highest tax rates may need to rethink their investment strategy, dumping funds that pay dividends for those that shoot for capital gains.
-- Untaxed gains. Suppose a fund buys a stock at $10 a share and it's now worth $15. But the fund manager thinks it has a lot further to go and holds on to the stock. The fund has an unrealized capital gain, and no taxes are due. One day, the fund manager might start taking profits, and that could result in taxable distributions to shareholders. Right now, unless the fund shareholder is a whiz at deciphering financial statements, there's really no way to know how much untaxed profits are locked up in the fund.
But you can find this information in the column titled Untaxed Gains. This estimates both the unrealized gains and gains that have already been taken but not yet distributed to shareholders. Funds usually distribute capital gains once a year. The number is shown as a percentage of the total assets of the portfolio. The $31.7 billion Fidelity Magellan Fund, for example, has untaxed gains amounting to 20% of the portfolio.
For some funds, the untaxed gains are negative. They have tax-loss carryforwards that the portfolio managers can use to shelter future gains.
-- Style. A mutual-fund prospectus may indicate that the fund has an investment objective, such as growth of capital, or the name of a fund may suggest a certain way of investing. But prospectuses and names can be misleading. Take the Dean Witter American Value Fund. Its name would imply that it buys out-of-favor stocks with low price-earnings ratios and solid assets. Far from it. Pricey growth stocks dominate its portfolio.
As mutual-fund investors become more sophisticated, they need to get a precise reading of just how their funds are investing. With that in mind, the Scoreboard contains nine classifications of investment "style." One element of style is the size of the companies the fund owns, measured by market capitalization. We break this into three groups. Large is $5 billion or more, small is $1 billion or less, and medium is greater than $1 billion but less than $5 billion.
The other key element is the companies' potential for growth. And that potential is measured by what the stock market is willing to pay for earnings and assets. The more it pays, the higher the p-e ratio and the price-to-book value ratio. Funds whose stocks have p-e's and p-b's higher than average are deemed growth funds. Those below average, we call "value" funds. If the p-e and p-b are stuck around the middle, they're "blend" funds. So we have three groups for potential: growth, value, and blend.
The Scoreboard sorts funds by the size of the companies they invest in and those companies' potential. This makes for nine categories of style, as the table on page 75 shows. In 1993, on average, large-cap value funds gained 17.5%, helped by a boom in the big economically sensitive cyclical stocks. That's a neat return. But small-cap growth funds, aided by a sizzling market for initial public offerings, zoomed 26.6%. That's not surprising, since small-cap growth stocks are among the riskiest.
To be a successful mutual-fund investor, you don't have to take big risks. BUSINESS WEEK's risk-adjusted ratings help find the best funds for you. Start with the 43 funds awarded three upward-pointing arrows, the highest rate for risk-adjusted five-year total return (table, page 73). It's a varied mix of high-risk but high-return funds, such as Berger 100 and Thomson Opportunity B, and low-risk but still strong-return funds, such as Fidelity Asset Manager and Franklin Income. Many of the more conservative funds on the list, especially those with low and very low risk ratings, make good all-weather investments, says Don Phillips of Morningstar. "They may not be the first-choice funds for everyone, but they're not the wrong funds for anyone."
TURNAROUND PLAY. Among returnees to the top honors list is Fidelity Contrafund, with a snappy 26.5% average annual return and a low-risk profile. Portfolio manager Will Danoff has it set for an economic upturn, emphasizing cyclical stocks with improving earnings. One big holding is a turnaround play--IBM.
Another familiar top-rated fund is Lindner Dividend Fund, which shut its doors to new investors for seven months last year because it couldn't find places to put the money. (Five three-arrow funds are closed to new investors.) Portfolio Manager Eric E. Ryback says that with the economy on the upswing, he's finding good investments in cyclical companies such as the convertible preferred stocks of USAir and Unisys. A combination of junk bonds and high-yield stocks allows Ryback to pay a 6.5% income distribution. "We try to at least match the yield on a long-term Treasury bond," says Ryback. "But unlike a Treasury bond, we have the potential for growth."
The three up arrows are also pointing to some new stars, such the Oppenheimer Main St. Income & Growth Fund. The fund has been around for years, but it was run as a private-label fund sold by West Coast banks. Recognizing its stellar record--a hefty 28.2% average annual return--Oppenheimer recently rolled it out nationwide, and it has been an enormous hit. Assets more than quadrupled last year, to $164.4 million.
The fund has a growth/income objective, but unlike many in that category, portfolio manager John L. Wallace invests mainly in small-to-midsize companies "where I think I can double my money in two to three years." That provides the growth. Convertible securities and utility stocks provide the income.
Another new name is the SBSF Fund, run by Louis R. Benzak, the "B" in the fund's name. Benzak describes himself as a cautious sort, who's hunkering down for a stock market correction: 25% in cash. He also buys stocks he thinks can weather a pullback. One favorite is Big-Board-listed Horsham, a Canadian company that owns Clark Oil & Refining, 20% of gold producer American Barrick Resources, and a German real estate developer. "It sells at 14 1/2, but it's worth over $20 a share," says Benzak. "If the market sold off, we'd buy more."
HOOPLA. Note the five asset-allocation funds on the star list. The managers of these funds are not only stock-pickers but must also rebalance the portfolio among stocks, bonds, and cash to optimize gain and minimize risks. Peter M. Antos of the Connecticut Mutual Total Return Fund says his fund is ideal "for people who know they should invest in stocks but can't stomach the risk." Over the past five years, the fund has slightly beaten the S&P 500 while subjecting investors to only 60% of the index's volatility.
For all the hoopla about global investing, none of those funds earned top ratings. That's because despite their knock 'em down showings in 1993, the world, foreign, Europe, and Pacific funds are coming off several years of poor showings. Still, there are a few that stand out from their peers. Scudder Global Fund and Dreyfus Strategic World Investors earned two up arrows. (So did Lexington Worldwide Emerging Markets Fund, but it turned global in only mid-1991.) The Templeton Foreign Fund has one up arrow. A. Michael Lipper of Lipper Analytical Services Inc., which tracks mutual-fund performance, suggests that investors ease their way into international investing with the broadest-based funds before they make more concentrated bets on regional and single-country portfolios.
In any case, Lipper warns investors that the high-flying overseas markets are ripe for a fall. There's more. As the U.S. economy strengthens, so may the dollar--and that could erode the value of foreign holdings for U.S. investors. Says Lipper: "You should buy these funds only if you're a long-term investor and you are willing to add to your holdings when prices drop."
To start your fund search, you need to know how to use the Scoreboard. First look for the Berger 100 Fund, near the top of page 80. Berger 100 is one of the top-rated funds. Notice that head-and-shoulders figure next to the fund's name. That tells you a portfolio manager has been on the job at least 10 years. That's no guarantee that a fund will win top honors, but eight of the highest-rated funds have managers with at least 10 years' tenure. Elsewhere on the page, you'll find outlines of the head-and-shoulders figures. That indicates there has been a change of managers in the last year. Fidelity Blue Chip Growth Fund, on page 84, is a fund with three up arrows that has had a change of management in the past year. That's neither good nor bad, but it tells you that most of the fund's record was built by someone else.
Moving to the right, the next column is Objective. Berger 100's objective--like 209 other funds in the Scoreboard--is "growth." True, all mutual funds are trying to make your money grow, but "growth" as a fund objective has generally come to mean U.S. diversified funds that choose stocks because of what the portfolio managers think is their potential to go up in price, not for their ability to generate dividends or preserve capital. All the funds are in 1 of 19 objectives. Under Size, the next heading to the right, is the fund's size by assets under management in millions of dollars. In Berger 100's case, it's $1,648.7 million, or $1.6 billion. As you can see in the next column, the assets of the fund are up 117%--more than double--during the past year.
Next come the various fund fees. In Berger 100's case, the Sales Charge column says No Load--which is fundspeak for no sales charge. But the Expense Ratio--what shareholders pay out of the fund for management, administration, and other expenses--is 1.69%--about one-third higher than the 1.28% equity-fund average. One reason for the higher expenses is the dagger next to the ratio--a footnote that indicates a 12(b)-1 plan. Funds with such plans can dip into shareholder assets to pay for advertising and other promotional costs.
But investors don't mind a fund with a little higher expenses if the management delivers the goods. Look at 1993's returns. The first thing you see is that pretax and aftertax returns are both 21.2%. That's because Berger 100 made no taxable distributions last year. Funds have to make distributions only to pass along dividends, interest, and realized capital gains. Like many growth funds, Berger 100 doesn't give a hoot for dividend-paying stocks or interest-bearing bonds, so there's no Yield, as you can see in the next column. In addition, the fund makes a capital-gains distribution only if it realizes profits in excess of its losses, and that didn't happen in 1993. Go to Rank Within Objective to see how the pretax return of the Berger 100 stacked up to its peers in 1993. The fund was 28th out of 210 growth funds.
BIG JUMP. More important than 1993 returns is the long-term performance. That follows on the next page. There are 3-, 5-, and 10-year average annual returns, both pretax and aftertax. All of Berger's returns are excellent, but you notice the most recent is exceptional. That's largely because of an 89% gain in 1991. That knockout performance catapulted Berger out of obscurity and into the big time. Notice, too, that the longer the time period measured, the greater the gap between pretax and aftertax rates of returns. That's an indication the fund has made taxable distributions in the past, and you should not necessarily assume that because Berger 100 made no taxable distribution last year, it doesn't make them at all.
The little boxes that follow provide some insight into those returns. Each box is a 2 1/2-year period. Note that in the first two boxes, the 1984-88 period, only one-quarter of each box is filled. That means during that period, Berger's returns put it only in the bottom 25%, or quartile, of all funds. The third and fourth boxes are completely filled, of course, indicating top-quartile performance. That indicates though the 10-year average annual return is high, it's largely because of superior results in the past five years.
Just how does Berger 100 invest? Look at the Portfolio Data. The fund has average turnover, the rate at which the manager trades stocks. It also has 19% cash, high for a growth fund. This could mean the portfolio manager is nervous about a market pullback and has turned defensive. More likely, though, the high cash level means the money from investors is coming in faster than the management can deploy it.
The next column, P-E Ratio, is the weighted average of all the p-e ratios of all the stocks in the fund. At 34, it's high, about 50% higher than the S&P 500. The p-e is also one factor in determining the portfolio's "style," which in this case is MG. That stands for medium-capitalization growth stocks.
Untaxed Gains is next, and that's also a new feature in the Scoreboard. Berger 100's untaxed gains, unrealized capital gains, and capital gains realized but not distributed, amount to 20% of the fund. If you bought the fund today, and it sold all its holdings tomorrow, you would have to pay taxes on one-fifth of the proceeds. The final portfolio item is Largest Holding, which according to the last fund reports, is Oxford Health Plans. Oxford makes up about 2% of the fund. Finally, comes the Risk rating. It's "high," but you might have figured that by now. The high p-e ratio and the "midcap-growth" style were tipoffs. But before you shy away from the risks, remember the fund's three up arrow rating is based on risk-adjusted returns.
Indeed, all investing entails some degree of risk. There's nothing wrong with taking risks, as long as you are rewarded for it. The BUSINESS WEEK Mutual Fund Scoreboard shows you how to get the best returns for the amount of risk you're willing to take.
TABLE: The Top Performers BUSINESS WEEK'S Mutual Fund Scoreboard has awarded three upward-pointing arrows, the highest rating for risk-adjusted performance over the past five years, to these 43 funds Fund Average annual Investment Risk total return* objective BERGER 100 28.3% Growth High CAPITAL INCOME BUILDER 14.7 Equity-income Very low CGM CAPITAL DEVELOPMENT 29.2 Growth High CONNECTICUT MUTUAL TOTAL RETURN 14.8 Asset allocation Very low FIDELITY ADVISOR INCOME & GROWTH 16.3 Balanced Very low FIDELITY ASSET MANAGER 15.9 Asset allocation Very low FIDELITY BALANCED 14.2 Balanced Very low FIDELITY BLUE CHIP GROWTH 23.6 Growth Average FIDELITY CONTRAFUND 26.5 Growth Low FIDELITY SELECT BIOTECHNOLOGY 30.2 Health care High FIDELITY SELECT FOOD & AGRICULTURE 18.6 Specialty Low FIDELITY SELECT UTILITIES 16.0 Utilities Very low FIDELITY UTILITIES INCOME 14.8 Utilities Very low FORTRESS UTILITY 15.0 Utilities Very low FRANKLIN INCOME 15.2 Income Very low GATEWAY INDEX PLUS 11.9 Growth/income Very low HANCOCK FREEDOM REGIONAL BANK B 22.1 Financial Average IDS UTILITIES INCOME 15.1 Utilities Very low INCOME FUND OF AMERICA 13.5 Income Very low INVESCO INDUSTRIAL INCOME 18.1 Equity-income Low INVESCO STRATEGIC FINANCIAL SERVICES 27.1 Financial Average INVESCO STRATEGIC LEISURE 25.8 Specialty Average JANUS 19.7 Growth Average JANUS VENTURE 19.1 Small company Low LIBERTY UTILITY A 14.8 Utilities Very low LINDNER DIVIDEND A 13.1 Income Very low OPPENHEIMER MAIN ST. INCOME & GROWTH A 28.2 Growth/income Average PHOENIX BALANCED 13.9 Balanced Very low PHOENIX INCOME & GROWTH A 14.9 Balanced Very low PHOENIX TOTAL RETURN 14.2 Asset allocation Very low T. ROWE PRICE BALANCED 13.9 Balanced Very low PUTNAM CORPORATE ASSET 10.7 Income Very low SBSF 14.8 Growth/income Low SKYLINE SPECIAL EQUITIES 23.7 Small company Average SMITH BARNEY SHEARSON UTILITIES B 12.6 Utilities Very low SOGEN INTERNATIONAL 13.3 Asset allocation Very low STAGECOACH ASSET ALLOCATION 12.6 Asset allocation Very low THOMSON OPPORTUNITY B 28.9 Maximum growth High USAA MUTUAL INCOME 12.2 Income Very low VANGUARD PREFERRED STOCK 13.4 Income Very low VANGUARD/WELLESLEY INCOME 13.7 Income Very low VISTA CAPITAL GROWTH A 25.8 Growth Average VISTA GROWTH & INCOME A 26.6 Growth/income Low *1989-93 pretax returns, includes appreciation plus reinvestment of dividends and capital gains DATA: MORNINGSTAR INC.TABLE: The Fund Groups After years in the doghouse, precious-metals funds glittered in 1993. But overseas funds stole the show. Back in the U.S., all but the ailing health-care portfolios posted plump results Fund objective Total return* Best-performing fund in 1993 1993 1991-93 1989-93 1984-93 (%) (%) (%) (%) PRECIOUS METALS 97.0 13.9 7.7 3.6 Lexington Strategic Investments PACIFIC 58.0 18.9 6.5 16.1 Dean Witter Pacific Growth FOREIGN 45.3 16.2 11.3 15.0 Fidelity Emerging Markets WORLD 32.9 16.4 11.2 13.9 Prudential Global Genesis B EUROPE 30.0 10.1 9.5 NA Dean Witter European Growth SPECIALTY 28.3 26.3 19.3 NA Evergreen Global Real Estate Equity TECHNOLOGY 25.3 28.7 20.0 12.2 Fidelity Select Industrial Equipment FINANCIAL 19.1 37.2 21.3 15.2 Fidelity Select Brokerage & Inv. Mgt. MAXIMUM GROWTH 18.0 25.3 18.5 11.8 American Heritage NATURAL RESOURCES 18.0 8.6 10.1 9.4 Vanguard Specialized Energy UTILITIES 16.9 15.4 14.8 15.1 G.T. Global Telecommunications A SMALL COMPANY 16.8 26.3 17.7 12.5 PBHG Growth ASSET ALLOCATION 15.3 14.8 12.0 10.3 Fidelity Asset Manager: Growth EQUITY-INCOME 13.4 16.9 12.4 12.8 IDS Diversified Equity-Income INCOME 13.1 16.0 12.7 12.9 Franklin Income GROWTH 12.9 19.3 15.5 13.4 Gabelli Value GROWTH/INCOME 12.6 16.8 13.8 13.3 Oppenheimer Main St. Income & Growth A BALANCED 12.0 15.3 12.8 13.0 CGM Mutual HEALTH CARE 1.7 16.0 22.5 17.1 Vanguard Specialized Health Care U.S. DIVERSIFIED FUNDS 13.8 20.1 15.5 13.1 ALL EQUITY FUNDS 20.0 19.0 14.6 12.9 S&P 500 10.1 15.6 14.5 14.9 *Pretax return, includes appreciation plus reinvestment of dividends and capital gain NA=Not available Average annual DATA: MORNINGSTAR INC.TABLE: The Largest Funds The big funds got that way because of their continuing strong performances. Five of the 20 largest funds earned superior Scoreboard ratings Largest Funds Fund Assets BW Average annual Billions rating total return* FIDELITY MAGELLAN $31.7 dd 19.3% INVESTMENT COMPANY OF AMERICA 19.0 d 14.5 WASHINGTON MUTUAL INVESTORS 12.6 AVG 13.5 VANGUARD/WINDSOR 10.6 f 11.7 INCOME FUND OF AMERICA 10.3 ddd 13.5 JANUS 9.2 ddd 19.7 FIDELITY ASSET MANAGER 9.1 ddd 15.9 FIDELITY PURITAN 9.0 dd 14.3 VANGUARD INDEX 500 8.3 d 14.3 TWENTIETH CENTURY ULTRA INVESTORS 8.4 d 28.1 VANGUARD/WELLINGTON 8.1 d 12.4 FIDELITY GROWTH & INCOME 7.7 dd 18.0 VANGUARD/WINDSOR II 7.6 AVG 13.5 FIDELITY EQUITY-INCOME 6.6 AVG 12.9 DEAN WITTER DIVIDEND GROWTH 6.5 d 14.0 FIDELITY CONTRAFUND 6.2 ddd 26.5 VANGUARD/WELLESLEY INCOME 6.0 ddd 13.7 EUROPACIFIC GROWTH 5.8 d 15.3 PUTNAM FUND FOR GROWTH & INC. A 5.3 d 13.5 AMERICAN MUTUAL 5.2 d 13.1 *1989-93 pretax returns, includes appreciation plus reinvestment of dividends and capital gains LEGEND: (3 arrows up) Superior, (2 arrows up) Very good, (1 arrow up) Above average, (1 arrow down) Below average, (2 arrows down) Poor, (3 arrows down) Very poor DATA: MORNINGSTAR INC.