Active mutual fund managers continued their struggle against the mighty charge of index funds in the second quarter.
Stock index mutual funds continued to show remarkable performance for the second straight quarter, fueled by the market's huge appetite for the large-capitalization stocks that are their bread and butter.
By contrast, most active managers, with their preferences for small- and midcap stocks, had trouble keeping pace at the very top of Pensions & Investments' quarterly ranking of the mutual funds most used by defined contribution plans.
Equity funds based on the Standard & Poor's 500 Index occupied six of the top 10 spots in P&I's performance ranking for the 12 months ended June 30. But the four active managers who made it to the top 10 had large- or upper midcap biases, which probably was the primary reason these four beat out so many other active funds with a focus on smaller cap stocks.
The best performing fund for the year ended June 30 was the Massachusetts Investors Trust/A, one of the oldest mutual funds in America, which returned a whopping 36.6%, handily beating the S&P 500 return of 34.7%. The MIT fund invests in large-cap stocks using a mix of growth and value stocks in its portfolio.
In the one-year period ended March 31, the fund returned 19.9%.
Second-ranked New England Growth/A Fund dogged MIT with a one-year return of 36.5%; the fund also uses an active large-cap growth/value strategy. Performance of the New England Growth/A Fund surged so strongly during the second quarter that it yanked the fund up from No. 36 ranking of one-year returns for the period ended March 31.
Another active large-capitalization fund, with a decided growth bias, the Dreyfus Appreciation Fund Inc., took third place in the one-year ranking with a return of 35.4%.
The venerable Vanguard/Windsor Fund, with its mid- to large-cap value focus, slipped to sixth place for the 12 months ended June 30 with 34.8%; it had ranked second for the year ended March 31.
The top performing index funds from the list of those managing the most for 401(k) plans were the T. Rowe Price Index Trust Inc. fund and the Vanguard Institutional Index Fund, which both beat the S&P slightly with a 34.8% return, ranking them fourth and fifth. From seventh to 10th place were: the Vanguard Index Trust 500 portfolio with a 34.6% return; SSgA S&P 500 Index Fund, 34.4%; Fidelity Spartan U.S. Equity Index Fund, 34.3%; and MasterWorks S&P 500 Fund, 34.2%
The $5 billion MIT Fund, managed by Massachusetts Financial Services Investment Management Co., Boston, has been a consistent top performer. John Laupheimer, senior vice president and the fund's lead portfolio manager, said the fund is in the top decile rankings of growth and income funds for the one-, three-, five-and 10-year periods ended June 30, according to data from Lipper Analytical Services Inc., New York. The fund ranked 19th for the five years ended June 30 within P&I's survey with a 20% return.
(All returns for the five-year rankings are compound annualized.)
Mr. Laupheimer attributed the fund's performance to good fundamental research and a disciplined investment approach. The portfolio management team concentrates on blue-chip growth stocks. Five quantitative screens are used to winnow the list of possible investments. The investment team then concentrates on finding large-cap companies that offer conservative growth at a reasonable price and that have dividend yields at about 90% of the S&P 500.
The fund remains fully invested and volatility is kept below that of the S&P 500.
The fund has been overweighted in financial stocks this year, because, as Mr. Laupheimer said, they are being driven by a wave of consolidation and offer above-average growth, but are selling at below-market prices.
One of the fund's top five holdings is a financial stock, Norwest Corp. The bank, based in Minneapolis, has had a 15% growth rate annually over the past five years and is selling at 16 times projected earnings.
Mr. Laupheimer said the MIT*fund has held the stock for more than five years and won't sell it soon.
Gillette Co. is another of the fund's top five holdings and "one of the best growth companies in America," according to Mr. Laupheimer.
Other stocks that Mr. Laupheimer said have really helped the performance of the fund this year have been E.I. du Pont de Nemours & Co., Gannett Co. and CIGNA Corp.
P&I's quarterly mutual fund survey ranks the top 50 equity and 50 fixed-income performers from the universe of the 100 equity and 100 bond funds with the most defined contribution plan assets under management as of Jan. 1.
Funds that invest in the largest cap stocks simply couldn't go wrong, according to a breakdown of the performance of stocks in the S&P 500 by Frank Russell Co., Tacoma, Wash. The top 50 stocks in the S&P 500 returned 41.4% for the 12 months ended June 30, compared to 31.8% for the next 150 stocks in the index. The 23.2% return of the bottom 300 stocks in the S&P 500 index seriously lagged that of larger-cap stocks.
By comparison, Russell's data showed that for the 12 months ended March 31, the top 50 stocks in the S&P returned 25.9%, the next 150 returned 16.1% and the bottom 300 stocks returned 12.9%.
The Merrill Lynch Growth Fund for Investment and Retirement/A, which was the best performing equity fund for the one-year periods ended March 31 and Dec. 31, fell off the top 50 for the most recent period, returning 24.9%.
The fund also slipped slightly in the five-year rankings, placing fourth at 25.9%, compared with first in the period ended March 31.
The Merrill Lynch Growth Fund was affected by its heavy concentration in energy service stocks, said portfolio manager Stephen Johnes. The oil service, exploration and drilling companies in which Mr. Johnes invested were all adversely affected by a warm winter and the portfolio suffered with the stocks.
"But natural gas prices have held up and gas prices are creeping up, so I think we're well-positioned for the second half of the year," he said.
The fund has averaged 25% per year returns for the past 10 years and Mr. Johnes said there have been "lots of occasions when the fund has been down for a quarter or two. In 1991, there were three lousy quarters in a row."
"Our relative ranking for this time period says a lot more about how spectacularly the market has done and how other funds have done, than about anything we have done differently," Mr. Johnes said.
The best performing equity fund for the five years ended June 30 was the PBHG Growth Fund at 27.8%.
The T. Rowe Price Science & Technology Fund Inc. moved up to second for the five years ended June 30 with 27.6% from third in the previous period. The Putnam New Opportunities Fund was third at 26.4% and the Vanguard/PRIMECAP Fund was fifth at 23.6%.
All of the top 10 performers over the longer time span are actively managed funds and all beat the S&P 500 return of 19.8% for the five-year period. Five of the top 10 funds are midcap growth funds, two are categorized as large-cap growth funds, two are small- to midcap growth funds and one is a mid- to large-cap value fund.
The American Century Ultra Fund jumped up 10th in the five-year ranking with a 21.2% return; it had been 47th in P&I's ranking for the five years ended March 31. The 20.2% return of the Fidelity Value Fund dropped it down 17th from seventh for the five years ended March 31. The T. Rowe Price New Horizons Fund jumped up a bit to rank sixth, with 23.1%, from 13th.
On a risk-adjusted basis, the Merrill Lynch Growth fund was first for the five years, with 23.5%, followed by the PBHG Growth Fund, which jumped from 26th in the last survey, with a 22.8% adjusted return. Putnam New Opportunity Fund was third with 22.7%; T. Rowe Price Science & Technology was fourth at 22.4%; and Vanguard/PRIMECAP was fifth at 21.7%.
Within the risk-adjusted, five-year ranking, all of the top 10 are actively managed and eight funds are growth-oriented with two offering value/growth blends. Four invest in midcap stocks, two are large-cap funds, one is small-cap, one invests in small- and midcap stocks and one invests in mid- to large-cap stocks.
Despite its strong long-term performance, the PBHG Growth Fund, a small- to lower midcap growth stock fund, had a hard time matching the performance of the larger cap funds and small-cap value managers in the 12-month period.
"We've dropped to the bottom of the barrel this year. We're just at the bottom of the market preference now. The market doesn't like high p/es and it doesn't like small stocks," said Gary Pilgrim, president and chief investment officer of Pilgrim Baxter & Associates, Wayne, Pa., and portfolio manager of the $6 billion PBHG Growth Fund.
Indeed, for the year ended June 30, growth stocks within the Russell 1000 Index returned 31.3% vs. 33.2% for value stocks. But growth stocks within the Russell 2000, with a 4.6% return, trailed miserably the 28.2% return of value stocks in that index.
But being out of market favor over the short term doesn't concern Mr. Pilgrim. His company started as institutional investors and it has maintained the same disciplined approach to small-cap stock investment even as the mutual fund assets it manages have surpassed institutional separate account assets.
Mr. Pilgrim said the fund's emphasis on high-growth, high-earning stocks means that it takes "a lot of growth and p/e sorts of risks and that leads to a lot of volatility," but the strategy works over the long term.
Stock capitalizations in the fund's portfolio have been creeping up as companies bought five years ago have grown, Mr. Pilgrim noted. Such stocks aren't sold just because they've exceeded the fund's average cap holding of about $2 billion, provided the company's underlying dynamics remain strong.
The fund continues to hold three stocks with market caps of more than $7 billion. One is the fund's most successful holdings ever, PeopleSoft Inc. The stock is up 10 times from the price Mr. Pilgrim paid for it five years ago.
Another great stock in the PBHG Growth Fund is General Nutrition Cos. Inc., with a growth rate up 50% year-to-date. Others are Health Management Associates, OmniCare Inc., Dura Pharmaceuticals Inc., Corrections Corp. of America, Microchip Technology Inc. and Cognex Corp.
High-yield funds continued to solidly dominate the fixed-income performance rankings, as they have for several quarters. The top 10 fixed-income funds for both the one- and five-year periods ended June 30 were all high-yield funds, and all beat the Salomon Broad Bond Index returns of 8.15% for the one year and 7.17% for the five years ended June 30.
In the one-year ranking, the Franklin AGE High Income Fund Inc. ranked first with a 16.1% return; the Federated High Yield Trust was second with 15.7% and Prudential High Yield, at 15.1%, was third. The American Funds/American High-Income Trust and the T. Rowe Price High Yield Fund were tied with 15%.
The Fidelity Spartan High Income Fund made the jump up to first place for the five years ended June 30 with a 13.9% return. It had ranked seventh for the five years ended March 31. The Dean Witter High Yield was second for the period with 11.9%. The AIM High Yield/A Fund, the Fidelity Capital & Income Fund and the Franklin AGE High Income Fund all tied at 11.8% to complete the top five fixed-income funds for the five years.