Growth-oriented stock funds continued to outperform their peers, despite the technology stock rout that shook the market in the second quarter and has worsened in recent weeks.
The top mutual fund, culled from a Pensions & Investments universe of those most popular with defined contribution plans, was PIC Institutional Small Cap, with a 60.5% return for the year ended June 30, beating its closest competitor by more than 15 percentage points. The runner up, with 45.3%, was Putnam New Opportunities, followed by T. Rowe Price New Horizons, with 41.4%.
Also in the top 10 (but not in order) were two more Putnam funds - Vista and Voyager; another T. Rowe Price fund, New America Growth; MFS Emerging Growth; Scudder Development; Vanguard U.S. Growth; and Delaware Delcap Institutional.
Returns were calculated by Morningstar Inc., Chicago.
Over five years, the top three funds in terms of compound-annualized returns were: Putnam New Opportunities, with 31.9%; T. Rowe Price Science & Technology, 29.2%; and T. Rowe Price New Horizons, 24%. Those funds also were the leaders on a risk-adjusted basis, with 30.7%, 27.1% and 22.2%, as measured by the Pension Research Institute, San Francisco.
Rounding out the top 10 on a risk-adjusted basis, but in no particular order, were two more Putnam funds, Vista and Voyager; two more T. Rowe Price funds, New America Growth and Small Cap Value; two Fidelity funds, Contrafund and Equity Income; and Harbor Capital Appreciation.
On an unadjusted basis, the top 10 group for the five years would have included Keystone Small Cap Growth and Twentieth Century Ultra instead of T. Rowe Price Small Cap Value and Fidelity Equity Income.
In bonds, high-yield funds continued to surge despite overall bond market weakness in the year ended June 30. The top funds were neck and neck, led by Dean Witter High Yield with 12.6% and Capital Research's American High Income Fund with 12.4%. Oppenheimer Strategic Income and Oppenheimer High Yield tied for third place with 12.3%.
For the five years, Dean Witter's fund was far ahead, with a 17% compound-annualized return. Kemper High Yield was second with 13.8% and Merrill Lynch Corporate High Income was third with 13.6%.
Growth managers seemed a bit frazzled by the current market. Jeffrey Miller, managing director of Provident Investment Counsel, Pasadena, Calif., said: "Our strategy is one of hard hats and flak jackets."
The $175 million PIC Institutional Small Cap fund, which has 32% in technology stocks, is sticking to its favorite names: Oxford Health Plans Inc., HFS Inc., Tommy Hilfiger Corp. and Parametric Technology Corp. as well as Fastenal Co., a nuts and bolts company.
"Companies with good numbers aren't going up, and you have to avoid the ones that are getting clocked," Mr. Miller said. "There are some buying opportunities, but if you want to take a 1% position, maybe you should start with 30 basis points rather than try to pick off a bottom."
The fund was up 6.3% in the year to date through July 23, while the Russell 2000 Growth Index was down 3.7%, he said.
Mr. Miller and other managers say liquidity is poor. "There's a lot of liquidity for stocks where there's news, even negative news. The more difficult part is where there (are) no events, no news and no buyers."
But sometimes lack of liquidity can be a blessing.
The T. Rowe Price Small Cap Value fund picked up some bargains when other buyers are few and far between.
The $1.2 billion fund closed to all new investors except defined contribution plans in March. Its portfolio manager, Preston Athey, had 16% in cash at the time because he had trouble finding attractive stocks. Now he has 13% and is starting to bargain hunt.
The fund's turnover has averaged less than 20% in the last four years. "I typically let the winners run. A big holding two years ago is probably a big holding today," said Mr. Athey.
Small Cap Value owns 10% of Electro Rent Corp., which leases electronic equipment to Fortune 500 companies. Another large holding is Phoenix Reinsurance
Three months ago, Mr. Athey "wouldn't have touched" a technology stock, but that's changed. A Massachusetts technology company that went public earlier this year at $11 a share and traded as high as $16 in May was trading at $12.25 recently. Mr. Athey was the only buyer for a seller's large block and was able to snatch it up for $11.75 a share. "It's not every day you can buy below the bid," he said. He wouldn't reveal the name of the company, because he's still buying the stock.
The fund is holding up well. In the month through July 23 it was down 4.3% while the Russell 2000 was down 10.1%.
The $3.6 billion T. Rowe Price New Horizons fund, which was down 1% in the year to date through July 23, also had more cash than usual - 10% - going into July. It closed to new investors except defined contribution plans June 18 "because of the huge cash inflows, but also because the market had become very speculative and frothy," said Jack Laporte, portfolio manager.
The fund reduced technology holdings earlier in the year to 17% from 24% but is now buying stocks in all sectors so cash is back below 5%.
His favorites among his 350 stocks include Paychex Inc., a payroll processor for small businesses; Maxim Integrated Products Inc.; Boston Chicken Inc.; and OEA Inc., which makes components for air bags.
"I feel very comfortable with prices here. This is a normal correction we get every 12 to 18 months in the small-cap sector. It's been over two years since such a correction occurred, in the second quarter of 1994. The magnitude is entirely in line with that of past corrections," Mr. Laporte said.
He added that his portfolio's relative price-earnings ratio to the Standard & Poor's 500 Stock Index as of June 30 was "not nearly at the extended level it gets to at prior small-company stock peaks."
But Tony Santosus, co-manager of the $1.7 billion Putnam Vista fund, a midcapitalization growth fund, said: "I'm still deciding .*.*. whether this will be an extended downturn or correction." Since early 1996, growth funds like Vista experienced heavy cash inflows "that we had to deploy. The stock market was overvalued." Mr. Santosus said there are signs the Federal Reserve Board will tighten monetary policy; Europe's economic downturn is hurting many global U.S. stocks; and earnings gains from cost-cutting are pretty much over.
"Companies have to continue to grow by growing their top line (sales)," Mr. Santosus said.
Since early 1996, he has been trimming technology holdings that have done well, like U.S. Robotics Corp. and Corrections Corp., and redeploying dollars into less risky sectors with stocks like Gucci America Inc., a retailer; Halliburton Co., an oil service company; and First Brands Corp., which makes plastic bags, cat litter and autoproducts.
In fixed income, high-yield bonds were the only bright spot this year.
But Vincent Lathbury, senior portfolio manager of the $5.3 billion Merrill Lynch Corporate Bond Fund-High Income portfolio, New York, is becoming conservative, holding about 9% in cash. "There's some interest rate risk out there and risk spreads could widen vs. Treasuries .*.*. Certainly the trend so far this year has been negative. We're getting closer to a peak in rates. It could very well be before the end of the year."
His portfolio's sector weightings and duration are neutral relative to the high-yield index. Among his holdings: Comcast Corp.; Time Warner Inc. preferred stock; and satellite television companies such as EchoStar Communications Corp. and PanAmSat Corp., which leases communications satellites.
In 1991, when the high-yield market was rebounding from its down period of 1989 to 1990, he was quite heavy in CCC rated bonds; now he holds very few. "We're pursuing a much more moderate course. Lower quality credits are not particularly cheap now," Mr. Lathbury said.
Other managers are more sanguine. "All these indices are negative in bond land. And now we've surpassed stocks. .*.*. It's the best performing domestic asset class I know of," said Harry Resis, senior vice president of Kemper Zurich Investments, Chicago.
The $3.7 billion Kemper High Yield fund was up 4.94% in the year to date through July 23, while the Shearson Lehman Government/Corporate index was down 1.82%.
Junk bonds' shorter duration and coupons averaging 400 basis points over Treasuries have provided protection even though bond prices are down slightly. "Because of rising rates and strength in the economy, single Bs have been the best place to be this year," because they are less interest rate sensitive than higher rated BB bonds, Mr. Resis said.
His biggest bet within that credit sector is media, which is also the largest high-yield sector. In addition to domestic cable companies like Continental Cablevision which he sold when it was acquired by US WEST Inc. and the bonds became BBB+; Cablevision Systems Corp. and Century Communications Corp., he owns four U.K. cable companies including TeleWest PLC and Comcast U.K. Cable Partners Ltd.
Is the junk market getting toppy? "Spreads are very tight. There's no doubt about it," Mr. Resis said. But he's not nervous because defaults remain low and the economy is growing, which is good for high-yield issuers.
Ralph Stellmacher, senior vice president and portfolio manager of the $1.3 billion Oppenheimer High Yield Fund, New York, said that earlier in the year the strong equity market enabled many junk bond issuers to raise capital and improve their balance sheets. The strong stock market also fueled mergers and acquisitions. Many lower credit companies were purchased by higher credit companies, resulting in "positive event risk" for bond holders of the targets.
"The high-yield market has been in very good shape. There has been record new issuance, but demand has been equally or more impressive," he said.
Still, Mr. Stellmacher is a little concerned about interest rates, so he is keeping his duration slightly shorter than the high-yield indexes. He also has increased the portfolio's average credit quality to BB- from the B/B+ range he favored through March, and is holding more senior securities.
Oppenheimer continues to overweight the gaming sector and has 15% in foreign bonds, mainly in emerging markets. The fund also has shifted into cyclicals based on Mr. Stellmacher's positive economic outlook.
