Avoiding disasters and going against the crowd were the keys to top third-quarter performance by the stock and bond mutual funds most heavily used by defined contribution plans.
According to figures compiled by Micropal Inc., Boston, for Pensions & Investments, the top performing stock fund for the year ended Sept. 30, with a 25.01% return, was Putnam Health Sciences, a domestic fund in a sector that had fallen out of favor. The two runners up were both international funds: Harbor International, which is subadvised by Northern Cross Investments in Bermuda; and Templeton Foreign, Fort Lauderdale, Fla. Their returns were 22.47% and 17.03%, respectively.
The top performing bond funds for the 12 months ended Sept. 30 were high-yield funds that steered clear of troubled credits: the Kemper High Yield Fund, with 4.65%; the Federated High Yield Trust, with 4.34%. They were followed by a short-term fund, the Federated Short-Intermediate Government Fund, with 3.45%.
For the five year period, the top equity funds were: Boston-based Fidelity Blue Chip Growth, with a compound-annualized 18.52%; Fidelity Contrafund, with 17.89%; and Twentieth Century Ultra Investors, with 17.53%.
The top bond funds over the five years ended Sept. 30 were: Fidelity Capital Income, with a compound annualized 13.17%; Merrill Lynch: Corporate High Income, with 12.86%; and Putnam High Yield Trust, with 11.09%.
When Joanne Soja began managing the Boston-based $850 million Putnam Health Sciences Fund in July 1993, the fund was defensive on the sector. The first thing she did was redeploy the portfolio's cash and other assets back into healthcare stocks.
"A lot of people were bailing out of (health maintenance organizations) and managed care ... We added to positions and HMOs have performed well," she said, citing such holdings as U.S. Healthcare and Humana Health Plan Inc.
Drug stocks also had been battered, making them attractive to Putnam. "A lot of people had given up on drugs. We hung in and drugs had a nice bounce this summer," Ms. Soja said. A number of her top picks were taken over, such as McKesson Corp.
She also put more into small-capitalization stocks, which had not been a focus under the fund's former portfolio manager. Among her holdings are software information companies such as GMIS and Cerner Corp. as well as IPOs "no one wanted to do" like Medisense Inc., which manufactures monitoring instruments for diabetics, of which she was able to amass 200,000 shares at $12. The stock now trades around $20.
Ms. Soja doesn't expect healthcare to continue to outperform by the margin of the past year, but "in general, healthcare is still a growth industry, more so than most industries out there. There's always a huge opportunity if you pick stocks and look for ones nobody wants."
The $10.2 billion Twentieth Century Ultra Investors fund, which ranked third for the five years, also benefited from the strong performance of the healthcare sector, which represents 8% to 10% of the portfolio, according to Christopher Boyd, vice president and portfolio manager of Investors Research Corp., Kansas City, Mo., investment adviser to the fund.
"Healthcare has bounced back quite a bit after 1992 and 1993. People overestimated the negative effects of healthcare reform," he said.
The portfolio tends to be heavy in technology and telecommunications. Technology represents 22% of assets and telecommunications, 10%. Among its larger holdings: Oracle Systems Corp., Microsoft Corp. and 3Com Corp.
"Technology is doing better after a violent sell-off in the first part of 1994 after the Fed raised rates," Mr. Boyd said.
The portfolio's diversification into international stocks - with 25% to 30% in both American depository receipts and ordinary shares - helped cushion the blow.
"International has helped us quite a bit. We had an excellent 1993. We gave some back on the domestic side. Foreign has helped stem the tide," he said.
Unlike many growth funds, Ultra does not have growth rate hurdles, but instead looks at overall growth trends.
Holdings range from tiny companies with earnings growth rates of 80% to IBM Corp., whose earnings trend only recently turned positive.
For Mark Durbiano, vice president and portfolio manager of the $400 million Federated High Yield Trust, Pittsburgh, high-yield was a great sector for the 12 months, if you avoided minefields.
"In this business, a lot of times it's what you don't own as much as what you own. We stayed away from troubled situations (such as Greyhound Lines Inc. and Megafoods Stores Inc.) and casino bonds," he said.
In the past 12 months, the portfolio has overweighted cyclical industries such as chemicals, steel and forest products, which have done well because of the strong economy. Now that these bonds seem to be fully valued, he is selling holdings such as Container Corp.
Mr. Durbiano also hopes to take advantage of spreads that have opened up between higher quality and lower quality bonds within the B rating category. "A year ago there was not a lot of difference between B+ and B-. Now there's more added value to taking extra credit risk selectively," he said. Spreads are now 250 to 300 basis points vs. 25 to 50 basis points a year ago, he estimated.
Federated is adding to positions in Computervision Corp., which makes computer- aided design systems; Specialty Foods Inc., which sells cheeses and bakery goods; Revlon Inc., the cosmetics and fragrance company; as well as some new issues yielding around 12% to 13%.
Like Federated's High Yield Trust, Kemper's $3.3 billion High Yield fund, Chicago, also is positioned for a strong U.S. economy. Michael McNamara, senior vice president and portfolio manager said: "We're weighted 2-1 in economically sensitive bonds (chemicals, paper, steel and autos) vs. recession resistant, defensive sectors," such as cable and supermarkets.
His top holding, at 2.3% of the portfolio, is K.F. Industries Inc., which provides brakes and wheels to airlines.
At the same time, Kemper in the past year has avoided poor-performing sectors such as riverboat casinos and some emerging markets bonds. "Brazil and Venezuela were hot a year and a half ago but really got crushed in early 1994," he said.
But like Mr. Durbiano, Mr. McNamara's appetite for risk is increasing.
"Now I am looking at a couple of riverboats. I'm picking through the debris for one or two golden nuggets (selling) at 80 to 85 cents on the dollar."
But Jin Ho, portfolio manager of the $3.4 billion Putnam High Yield Trust, which ranked third for the five year period, is sticking to higher quality issues.
Like the other top junk bond managers, his portfolio continues to focus on economically sensitive issues, but he expects even stronger growth overseas.
In 1995, "one of the themes we'll be concentrating on is identifying companies with exposure to overseas operations because economies in the Pacific Rim, Latin America and Europe will probably exhibit stronger economic growth," than the domestic market, Mr. Ho said. American Standard Inc. is one example.
The portfolio is also emphasizing bonds of companies in wireless, cable and telecommunications industries.
Big bets on high yield also helped another top quartile bond fund, the $631 million T. Rowe Price Spectrum Income fund, which allocates among seven other funds in the fund family with no layering of fees.
The fund has allocated its top limit of 20% to the high-yield sector. Going forward, it views junk bonds as an attractive alternative to equities.
Spectrum Income is allowed to invest in one stock fund, T.Rowe Price Equity Income. In the nine months through Sept. 30, the portion invested in stocks produced positive returns while virtually every component of the bond market was down. But now Spectrum Income is reducing equities to 13% from 15% and reducing short-term bond exposure.
"We're more bullish on bonds. Rates are attractive. We wanted to lengthen the duration of the fund a little bit," said Peter Van Dyke, managing director and president of the Spectrum Funds.