Charles A. "Chip" Morris of T. Rowe Price Associates is a lone bearish voice.
He also happens to be portfolio manager of the Baltimore-based firm's $1.8 billion Science & Technology fund, the top-ranked stock mutual fund for the year ended June 30 in Pensions & Investments' universe of funds most popular with defined contribution plans.
As much as he loves the long-term prospects for technology, he warned shareholders of the fund in a July 12 letter that a pull-back in technology stocks may be long overdue. It's a tactic fund industry veterans call "managing expectations."
But portfolio managers of other highly ranked funds, which also are heavy in technology, don't share his view. In fact, they say valuations of technology stocks are perfectly reasonable.
T. Rowe Price Science & Technology left its competitors in the dust with a 68.3% return for the year ended June 30, as measured by Morningstar Inc. The No. 2 fund, Twentieth Century Vista, run by Investors Research Corp., Kansas City, Mo., earned 55.6%, followed by Keystone Small Company Growth, run by Keystone Investment Management, Boston, with 40.8%.
Science & Technology also triumphed in the five-year period, with a compound-annualized return of 26.7%. Twentieth Century Ultra logged 22.3% and Keystone Small Company Growth returned 21.4%. The three funds also were in the first quartile on a risk-adjusted basis, as measured by the Pension Research Institute, Menlo Park, Calif.
Among fixed-income funds most heavily used by defined contribution plans the returns also were strong, although not nearly as dramatic. Long bond funds took top honors led by the Vanguard Fixed Income Securities Fund - Long-term U.S. Treasury portfolio with 18.2% for the year ended June 30; the Vanguard Fixed Income Securities Fund - Long-term Corporate portfolio with 16.7%, and the MFS Bond/A, with 15.2%.
For five years, high-yield funds prevailed. Fidelity Capital & Income was on top with 15.8% compound annualized, followed by Kemper Diversified Income with 14.3% and Merrill Lynch Corporate High Income with 14.2%.
All three funds also were in the top quartile on a risk-adjusted basis.
Risk is clearly on the mind of Price's Mr. Morris. In his cautionary letter to shareholders, he wrote: "during these times of extraordinary returns, it is easy to overlook the risks that accompany substantial rewards .... Science and technology stocks can be a 'hang-on-to-your-hat' kind of investment. Periods of strong advances are often interrupted by declines, sometimes abrupt and steep."
"We cannot predict what may touch off the next pull-back, how severe it might be, or even when it might occur. However, this industry sector has experienced 10% declines or more every year since 1986 and we have not seen such a retreat in 1995."
The fund has appreciated nearly 195% during the five years ended June 30, on a cumulative basis. For the past 12 months, the fund's assets have tripled to more than $1.8 billion, with more than half of the asset growth occurring this year.
"We had a tremendous secular trade wind behind us in the technology market," said Lise Buyer, vice president of T. Rowe Price, noting the fund was virtually fully invested in technology at the beginning of the year but has since reduced the allocation to 90%, with the balance in health care stocks.
Science & Technology is holding quality names that might be hurt less in the event of a correction such as software-makers like Microsoft Corp. and Intuit Inc.; Nokia Inc., a networking company; Intel Corp., in semiconductors; and First Financial Management Corp., in computer services.
Glenn Fogle, portfolio manager of the $1.45 billion Twentieth Century Vista fund is happy with his fund's 60% to 70% technology weighting. "Our strategy is to look for companies showing the most dynamic rates of earnings acceleration .... That phenomenon was heavily concentrated in technology and has been for the last year. We were sort of painted into a corner of technology that's paid off well for us. We really have not seen p/e multiple expansion. Prices of semiconductor stocks have just kept up with earnings gains .... That's tremendous news."
He said while semiconductor stocks have gained 81%, sectors such as peripherals, networking and mainframes actually have lagged the Standard & Poor's 500 Stock Index in the first half, "so investors still had to pick the right technology stocks."
Among his core holdings: LSI Logic Corp., a semiconductor maker and KLA Instruments Corp., which makes test equipment for semiconductor manufacturers.
Vista has a median p/e ratio of 33 times trailing 12-month earnings, but a median earnings growth rate of 53%. "Yes we pay what appears to be a high price, but the earnings power more than justifies the higher price," Mr. Fogle said. He said because the median market capitalization is $750 million, these holdings are not as sensitive to a weakening economy as large-cap stocks.
Christopher Ely, senior vice president of the $1.6 billion Keystone Small Company Growth fund, agreed.
"This year the big companies are having slower growth as the economy slows. On a relative basis, small companies look much better."
"We came into the year trying to take advantage of a pretty decent market," he said. "Little did we know how decent it would be .... We're optimistic that we've achieved a soft landing." He predicts solid growth in 1995 with low inflation and stable interest rates. "We are as fully invested as you can imagine. We're buying a lot of technology issues and other companies that enjoy rapid unit growth despite the economy."
In addition to technology stocks like EMC Corp., (hardware); Adobe Systems Inc. (software), Xilinx Inc. (electronics) and KLA Instruments, Keystone Small Company Growth owns a mixed bag of stocks like SunGlass Hut Holding Corp. and Applebee's International Inc. (restaurants). Mr. Ely's technology stake has increased to nearly 50% from 40% in January. The portfolio's stock market caps range from $100 million to $1 billion.
"Valuations, despite the (market) move, remain surprisingly attractive. The small-cap market in general remains at the low end of its historic valuation range," at 1.3 to 1.4 times the average p/e of the Standard & Poor's 500 stock index, he said. The historical range is one to two times.
Mr. Ely predicts "corrections will be short, sharp and over with quickly.
"If the fundamentals are there, small caps come back pretty quickly, even from a 20% correction."
In the world of fixed income, the top-performing managers were cautious to optimistic on the market.
Robert Auwaerter, vice president of the Vanguard Group of Investment Cos., Valley Forge, Pa., and manager of the $758 million Vanguard Fixed Income Securities Fund - Long-Term Treasury portfolio, said: "The fund is designed to be a long fund and the long end of the market performed very well."
Its duration is now six months shorter than that of its benchmark, the Lehman Long-term Treasury index.
"We're shading a little to the bearish side. At the beginning of the year we were at a neutral point - more bullish than some competitors."
"Even if I was wildly bearish, I could only shorten by a year," because each Vanguard bond fund is very duration-specific, he said.
With an eye to finding value, "we've done some fine-tuning. We avoid owning the current long bond (the most recently issued 30 year Treasury). There's a large liquidity premium you have to pay to own those."
Geoffrey Kurinsky, portfolio manager of the $600 million MFS Bond Fund as well as $1 billion in bonds for balanced funds; said his fund concentrates on corporate issues rated BB. "That's not enough yield for high-yield funds, yet a lot of investment-grade people can't buy it."
The fund did well when a lot of holdings moved up to investment-grade ratings. It also owns sale-leasebacks, which some big players like insurance companies can't own for liquidity reasons. "Many are better credits than debentures," he said.
The fund, which rotates among sectors, racked up a 30% gain on its 3% position in unhedged Japanese bonds. It may invest up to 10% in non-dollar securities.
Mr. Kurinsky has reduced high-yield securities to 13% from 20%, the fund's upper limit, as industrials have gotten pricey. He hopes to whittle that down to 10%.
"For the first time in two and a half years I'm looking at mortgage (backed securities)." He hopes to go up to 25% vs. a current weighting of 10%.
"The mortgage market has underperformed. Most of the move to lower (interest rates) is behind us. We won't see a refinancing boom .... We're getting more than paid for pre-payment risk."
The portfolio is becoming more defensive, moving from economically sensitive cyclicals like airlines, paper and chemicals into energy and utilities.
Mr. Kurinsky predicts anemic economic growth of 1.5% to 2.5% for the second half, which is good news for inflation. "We don't expect a 5% long Treasury, but maybe 6%," as the Federal Reserve continues to lower rates through year end. The long bond was at 6.8% at presstime.
Among his holdings: Viacom Inc.; Time Warner Inc. and Tele-Communications Inc., in entertainment and cable; and Korea Electric Power, Commonwealth Edison Co. Inc. and Niagara Mohawk Power Corp. in energy.