The huge year-end rebound of the U.S. stock market pushed quarterly returns to a new high and salvaged year-end returns for many of the mutual funds most popular with defined contribution plans.
The broad market Russell 3000 index gained 32.6 percentage points to return 21.4% in the fourth quarter alone, the biggest single-quarter gain in 20 years, according to historical data from Frank Russell Co., Tacoma, Wash. That last-quarter boost saved the day for many equity mutual funds, pushing the return of the Russell 3000 to 24.1% for the 12 months ended Dec. 31, a remarkable feat, given that the index's year-to-date return for the first nine months of 1998 was only 2.2%.
Twenty-four of the top 25 best performing funds matched or beat the 28.6% return of the Standard & Poor's 500 index for the year ended Dec. 31. Three S&P 500 index funds, managed by the Vanguard Group, Malvern, Pa., narrowly beat the index, due to efficient trading practices, said John Demming, a Vanguard spokesman.
There was little change between the third and fourth quarters in Pensions & Investments' rankings of the 50 best performers among the 100 stock and bond funds with the most defined contribution plan assets under management (P&I, March 23, 1998) for five-year and one-year periods. But the disparity between third and fourth quarter returns is amazing.
Returns of the 50 best-performing equity funds in P&I's ranking for the year ended Dec. 31 range from 73.4% to 22%. Compare that with the third quarter, when the range of one-year returns was from a high of 32.5% to a low of 2.4%. The 25th best-performing equity fund in the year ended Dec. 31 had a return of 28.5%; the 25th best fund in the third quarter returned only 7.5% for the one-year period ended Sept. 30.
Large-cap growth thrives
Consistent with several quarters' worth of performance data, P&I's list of the top 25 performers for the five years is dominated by funds with large-capitalization and strong growth focuses.
The Russell 1000 Growth index's 25.7% annualized return over the five years ended Dec. 31, compared with 20.9% for the Russell 1000 Value index return for the same period, is reflected in P&I's ranking.
Twenty-four of the top 25 funds for the five-year period ended Dec. 31 have large-cap biases, seven are growth funds, 13 are growth-value blended funds and just five are value funds. All of the value funds on the list outperformed the 20.9% annualized five-year return of the Russell 1000 Value index. Eight of the top 25 beat the 24.1% annualized return of the Standard & Poor's 500 index for the five years ended Dec. 31, compared with six funds in the third quarter that beat the 19.9% annualized five-year return for the index as of Sept. 30. Seventeen of the top 25 equity performers are actively managed.
Continuing its inexorable march to the top of the charts was the Janus 20 Fund, which was No. 1 for the five years ended Dec. 31 with a 29.6% return. In the hands of portfolio manager Scott W. Schoezel, the $18.3 billion fund moved into the top slot from second place last quarter, eighth in the second quarter and 41st in the first quarter. For the one-year period, this fund, with a concentrated portfolio of stocks, has been the best-performing equity fund in P&I's ranking for three consecutive quarters and was 10th best in the first quarter of 1998.
The Fidelity Dividend Growth Fund was edged out of its first-place slot for the five-year period and dropped down to No. 2 this quarter with a 26.5% return for the five years ended Dec. 31. The Vanguard U.S. Growth Fund remained in third place with a 26.2% return. The Morgan Stanley Equity Growth Fund held onto the fourth place spot for the second quarter in a row with a 25.1% return, which was tied by the Vanguard/PRIMECAP Fund, moving up from seventh place in the third quarter.
A beneficiary of the fourth quarter's gigantic technology stock rally was the T. Rowe Price Science and Technology Fund, which moved up to sixth place from 49th with a 24.4% return for the five years ended Dec. 31. The fund clearly benefited from the 68.2% return of the Russell 3000 technology sector in the 12 months ended Dec. 31, which helped to propel it to third place for the one-year period with a 42.4% return, up from 86th place in last quarter's one-year ranking.
Another beneficiary of fourth-quarter tech stock mania was the $5.7 billion Fidelity OTC Fund, which moved into fourth place in the one-year ranking with a 40.4% return, up from 67th in the third quarter. The fund, managed by Robert Bertelson, moved to 33rd place on the five-year rank, up markedly from 56th place at the end of the third quarter.
Mr. Bertelson said he isn't aware of another mutual fund that invests at least 65% of its assets in over-the-counter stocks. In fact, Mr. Bertelson said, the fund's OTC weighting is usually about 80%. This further increases the fund's exposure to the kinds of emerging growth companies of all capitalization ranges that first get their start as publicly traded companies on the NASDAQ and prefer to remain there even when they become large, such as Microsoft Corp., Intel Corp. and WorldCom Inc. The universe of the NASDAQ's OTC stocks is split fairly equally between small-cap, midcap and large-cap companies, an advantage when looking for new stock ideas, he said.
"These emerging growth companies are turbo-charged, in high-growth industries, and you can catch them early in their life cycle. It's a universe that has a lot of swing in it, but its record over the past five years shows that it is good for long-term capital appreciation," Mr. Bertelson said.
The fund was hit, along with the rest of OTC investors, by major events in early 1997 -- the Asian financial crisis; an inventory correction in the personal computer market and a "total collapse" in technology and emerging growth funds -- which resulted in "low valuations and great despair," Mr. Bertelson said.
But in 1998, the core franchise of technology companies began to rally as other industries slowed considerably, he said, drawing the immediate attention of the market. As non-tech companies posted disappointing earnings, some of the OTC stocks such as Microsoft, Dell Computer Corp., Oracle Corp.and Cisco Systems showed strong earnings, especially in the second half of year, when the market began to pay more attention to the OTC segment of the market.
Mr. Bertelson is confident OTC stocks will continue to reward investors. "As long as dynamic new companies are looking for capital, they will likely come onto the NASDAQ, and we'll have an opportunity to look them over."
Another fund specializing in the same kind of turbo-charged stocks was the Fidelity Emerging Growth Fund, which roared up to second place in the one-year ranking with a 43.3% return, up from 25th place in the year ended Sept. 30.
The Vanguard U.S. Growth Fund was in fifth place for the one-year period with a return of 40%.
As with the five-year period, P&I's one-year ranking of the equity funds most popular with defined contribution plans is dominated by large-cap funds. Of the top 25 funds, 23 are large-cap and two are midcap. The fourth quarter also rewarded growth on a short-term level: only one of the top 25 is a value fund, 12 are growth funds, and 12 growth-value blend funds.
The environment in the fourth quarter favored passive management and S&P 500 index funds charged back into the top 25 equity funds, compared with only four passive funds for the one-year period ended Sept. 30. But the active funds in the top 25 for the year ended Dec. 31 held their own: funds from No. 1 to No. 24 beat the 28.6% one year return of the S&P 500.
After years of dominance of P&I's one- and five-year rankings, high-yield bond funds remain battered over the one-year period, although their prospects improved considerably in the fourth quarter. High-yield bond funds were the best-performing domestic bond category among Lipper Inc.'s investment objective categories, with a return of 2.8% for the fourth quarter, compared with a negative 7.2% for the third quarter. There were no high-yield bond funds in the top 25 bond funds for the year ended Dec. 31, but there were 11 in the five-year ranking.
There was no change in the order of the top four funds for the five-year period between the third and fourth quarters. The Fidelity Spartan High Income Fund remained No. 1 with a 10.8% return, the PIMCO High Yield Institutional Fund was second with 10.7%, the Strong Corporate Bond Fund was third with 9.4%, and the Federated High-Income Fund was fourth with 9%. The Franklin AGE High Income Fund, the Janus Flexible Income Fund and the Vanguard Corporate High Yield Fund tied for fifth place with 8.7% returns for the five-year period.