Non-U.S. stock managers were far and away the top performers among the most popular mutual funds used by defined contribution plans in the year ended June 30.
The top three stock fund performers were Vanguard World International Growth, a fund sponsored by the Vanguard Group, Valley Forge, Pa., and subadvised by Schroder Capital Management International, London; T. Rowe Price International Stock; and Harbor International, a fund sponsored by Harbor Capital Advisors, Toledo, Ohio, and subadvised by Northern Cross Investments, Hamilton, Bermuda, with returns of 25.46%, 22.13% and 21.24%, respectively.
On the home front the year was a tough period, with the majority of domestic stock managers logging returns in the single digits or even negative numbers.
Fixed income wasn't much prettier. The highest one-year return - by the Kemper High Yield Fund - was 5.09%. Runners up, which also were high-yield funds, included Putnam High Yield Trust and Merrill Corporate High Income Fund, with 4.74% and 3.86%, respectively. Most of the other fixed-income funds ranked by Micropal Inc., Boston, were flat or down for the period.
Domestic bond managers were gloomy on their prospects for the U.S. economy, and therefore some were bullish on the bond market.
Vincent Lathbury, vice president of Merrill Lynch Asset Management, Princeton, N.J., which runs the $3.2 billion Corporate High Income fund, said: "Our strategy is to remain fully invested. Fixed-income markets are attractive and have upside potential on the convincing evidence that the economy has slowed.
"At current interest rate levels we're not overly concerned about interest rate risks to investors. The opposite of risk is reward. A longer maturity can lock in favorable yields for a long period of time," he said. The average maturity in the portfolio is eight years.
Still, the road will be bumpy based on inflationary fears until the economy shows a decisive sign of softening.
Mr. Lathbury said the coming six months will be as frustrating as a 10-mile delay on a summer road trip. "But once we get to Maine, we're going to have a great time on vacation," he said.
Once the economy shows signs of decline, "like sheep being led to the barn by the shepherd, everyone will get bullish again," he said.
Mr. Lathbury's favorite junk bond sectors include airline equipment trust certificates of such companies as Delta Airlines Inc. and USAir Group Inc. "because we think their operations are improving and the asset protection is sterling."
He also likes first mortgage bonds of Atlantic City gaming casinos such as Showboat Inc., Trump Plaza and Bally's Park "We think the market is overly concerned about (possible) competitive gaming in Philadelphia and New York. We don't think it will happen soon, and those bonds have nice strong asset protection," Mr. Lathbury said.
Investors are being paid handsomely too. "We're talking big yields here," he said, noting, for instance, that Trump Plaza is yielding 16%.
Another area Merrill likes is emerging markets. The firm has less than 5% in investment-grade companies in the below-investment-grade markets of Argentina and Mexico.
Jin Ho, senior portfolio manager of the Putnam Cos., Boston, and manager of the $3.5 billion High-Yield Trust, is following a two-prong strategy, under the assumption that interest rate volatility will continue.
Putnam is keeping durations short vs. benchmark indexes and is continuing to emphasize sector and issue selection.
The sectors Mr. Ho likes include cable and wireless communications, and cyclicals such as chemicals, paper and steel; basic industries; health care; and supermarkets. Among his favorite values in individual issues are Gaylord Container Corp. and The Multicare Cos. Inc.
It's no accident the sector mix looks fairly recession proof. "As we move through the economic recovery, good portfolio managers need to keep an eye on the short and intermediate term, but also the long haul. Trees don't grow to the sky. One needs to think about a slower environment for the companies we follow," Mr. Ho said.
He said sectors such as cable and health care will continue to experience heady mergers and acquisitions activity. That's often a negative for debt securities, but these deals can be positive "if you're in the right names," he said.
Unlike some other fixed-income managers, Mark Durbiano, portfolio manager and vice president of Federated Investors, Pittsburgh, manager of the $400 million Federated High Yield Trust, is bullish on the economy, at least for the next six months.
Consequently his fund, which ranked fourth for the year at 3.38%, is sticking to cyclical industries such as steel and paper, which it began buying a year ago on the expectation of an improving economy. Among his holdings are Stone Container Corp. and Truck Components Inc., which announced an initial public offering a couple of weeks ago.
Another area he likes is the cable industry, which the fund underweighted vs. high-yield benchmarks in the first half. Now in the aftermath of the Bell Atlantic/Tele-Communications Inc. merger that fell apart, the sector looks cheap. His holdings include: Continental Cablevision and Cablevision Systems Corp., both of which are big companies "with the wherewithal to play in the business going forward," he said.
Mr. Durbiano noted "the entire high-yield market's done pretty well relative to other fixed-income investments." He expects long-term interest rates to remain in the 7.25% to 7.75% range. In light of that stability, "you want as much income as possible and corporate exposure to benefit from the strong economy in the next six months or longer," he said.
In contrast to the domestic fixed-income funds, managers of the top performing stock funds - all of them international - predicted economic recoveries in many markets.
George Murnaghan, vice president of Rowe Price-Fleming International Inc., Baltimore, which runs the $5.4 billion T. Rowe Price international stock fund, said: "Our outlook is relatively positive as to the potential for foreign markets. The larger (developed) economies have had recessions in the last several years and falls in interest rates in 1992-1993, which were supportive to equity markets."
Rates popped up a bit earlier this year in response to the rise in U.S. rates, but Mr. Murnaghan doesn't expect the rises abroad to continue. He expects rebounds in corporate profits in Europe and Japan. In addition, Southeast Asian and Latin American markets will continue to experience double-digit profit increases.
The fund has 23% in Japan, a low percentage relative to the Morgan Stanley Capital International Europe Australasia Far East Index, and 18% in the Pacific excluding Japan, led by Hong Kong, Malaysia and Australia. Its 46% European weighting is heaviest in the Netherlands, France and Switzerland.
Among Rowe Price-Fleming's favorite stocks are: Reed Elsevier PLC, the Anglo-Dutch publishing company that is expected to profit from a rebound in advertising revenue as economies turn around; Kingfisher PLC; the U.K. retailer; and Kyocera Corp., the Japanese semi-conductor manufacturer. In Southeast Asia, he likes media stocks such as Singapore Press Holdings and Malaysia's New Straits Times Press. Both will benefit from a long-term cyclical trend in which consumer wealth will increase, boosting ad spending, he said.
Like Rowe Price-Fleming, Schroder Capital Management International, London, the adviser to the Vanguard World International Growth fund, expects economic growth in a number of major non-U.S. markets.
"With the (Japanese) government's massive August fiscal package now having effect and a further package widely discussed, nobody should doubt that recovery will come, even if the exact timing is uncertain. We shall continue to add to our holdings of recovery stocks in Japan over the next six months," said Richard Foulkes, the fund's portfolio manager, in a report to shareholders dated March 10.
The portfolio had 21% in Japan, a reduction of 6% compared with six months earlier, as the firm lightened its exposure to interest rate sensitive stocks. But the portfolio manager increased holdings in manufacturing stocks, which are expected to lead the market in a recovery in corporate profits.
Like Japan, Switzerland and the United Kingdom are expected to see earnings recover in the future, as the countries have eased monetary policy significantly, the Schroder report said.
The Harbor International Fund has been overweighted in Europe, Latin America and the Pacific Rim, but underweighted in Japan. Interest rate increases hurt some of the fund's European holdings, but that was counterbalanced somewhat by the strengthening of most local currencies against the dollar, according to a semiannual report to fund shareholders.
As of June 30, the fund had 55.8% in Europe, led by the United Kingdom, Switzerland and France; 25.4% in the Pacific Basin; 8% in Latin America; 6% in Africa; and 4.8% in cash. Two of the fund's top 10 holdings are South African mining stocks: Anglo American Corp. and Gencor Ltd. Other major holdings include Sweden's AB Volvo; SGS Holding, a Swiss bank; and Hutchison Whampoa Ltd., a Hong Kong conglomerate.