Second-quarter returns of the mutual funds most used by defined contribution plans don't quite reflect the market's abrupt shift from large-capitalization growth stocks.
It will take a quarter or two before the one-year returns begin to reflect the market's second quarter small-cap and midcap stock rewards.
Among domestic equity mutual funds, Lipper's micro-cap investment objective posted the best returns for the quarter ended June 30 with 22%, according to data from Lipper Inc., New York. Small-cap funds returned an average 15.6%; midcap funds, 12.5%; growth & income funds, 9%; capital appreciation funds, 8.6%; and growth funds, 7.1%, according to Lipper numbers.
This surge in the returns of smaller-cap and value-oriented stocks breaks the six-quarter winning streak of large-cap stocks, which were the best-performing Lipper objective in eight of the past 10 quarters.
"In the U.S. equity market, it was certainly a story of small-cap predominance," said Jim McKee, quantitative analyst at Callan Associates Inc., Morristown, N.J. "It really didn't matter if the investment style was growth or value for the smaller-cap styles. But in large-cap, it did matter. People demonstrated that they were tired of the large-cap and Internet stocks and picked up on value stocks, especially in basic materials and commodities areas. This was driven by the perception that the Pacific economies were rebounding and would need industrial and raw materials as they grew. The two real winners, actually, were the emerging companies of the U.S. market and the emerging countries."
Big and aggressive
But among the stock funds most used by defined contribution plan investors, the returns for the year ended June 30 still were dominated for the most part by large-cap, aggressive growth funds.
Eighteen of the 25 best performers are growth funds, one is a value fund and six are blended growth-value funds. All but one of the top 25 -- the midcap, growth-oriented INVESCO Dynamics Fund -- are large-cap funds.
Every one of the top 25 is actively managed. The four best-performing index funds ranked between Nos. 26 and 30.
For the year ended June 30, the Internet-heavy T. Rowe Price Science & Technology Fund moved up to the No. 1 spot from third in the first quarter with a phenomenal 60.1% return, according to data from Morningstar Inc., Chicago. The Fidelity Aggressive Growth Fund remained in second place with an impressive 54.8% return. The Janus Twenty Fund was bumped out of the top spot to third, with a one-year return of 50.4%. Fidelity's OTC Fund moved up to fourth from seventh with a 39.9% return, followed by Capital Research & Management's Growth Fund of America with a 37.1% return that moved it up from 14th last quarter.
Among other success stories, the Vanguard PRIMECAP Fund, a large-cap value fund, moved up to ninth from 25th in the first quarter with a 32.1% return. The INVESCO Dynamics Fund leapt up to 11th from 40th last quarter, with 30.4%, and Capital Research & Management's New Economy Fund, a large-cap blend fund, moved up to No. 14 from 44, with 26.6%.
Across the longer span of the five years ended June 30, the blip of smaller-cap stock success in second quarter 1999 has not registered at all and there was little change quarter-to-quarter in the dominance of large-cap growth funds within the P&I ranks.
Eight passively managed funds that track the Standard & Poor's 500 stock index straddle the middle of the top 25.
Nine funds beat the S&P 500's 27.85% compound annualized return for the five years ended June 30.
The Janus Twenty Fund seems unassailable in its quarter-after-quarter dominance of the top spot on P&I's five-year equity ranking. As of June 30, its 36.7% five-year return held at bay the T. Rowe Price Science & Technology Fund, which moved up to No. 2 from No. 4 with a 33.9% return. (All five-year returns are compound annualized.)
The Fidelity Aggressive Growth Fund moved up to third from sixth with a 32.9% return. The MFS Massachusetts Investors Growth Fund dropped one spot to fourth with a 31.6% return and the Fidelity Dividend Growth Fund dropped to fifth from second with 31.3%.
INVESCO Dynamics also made inroads in the five-year ranking, moving up to place 23rd from 46th with a return of 26.6%. The MFS Emerging Growth Fund entered the top 50 for the first time to rank at 31 with a 25.7% return.
While Lipper found that all equity investment objectives for the mutual funds it tracks posted positive returns for the second quarter, the bond market was another story. Lipper reported the majority of domestic fixed-income objectives posted negative total returns for the quarter. Higher quality and longer-duration mutual funds suffered more than junk bond and short-term funds, according to Lipper's analysis.
P&I's one-year bond rankings showed a big movement to shorter-term and lower-quality bond funds. Thirty-nine of the top 50 funds on P&I's one-year performance ranking beat the 3.13% return of the Lehman Brothers Aggregate bond index. Seventeen of the top 25 funds were either high-yield or short-duration bond funds. Seventeen bond funds with more diversified, longer-duration investment styles that had been among the top 50 performers for the first quarter dropped significantly within the top 50 list or fell below the cutoff mark. The PIMCO Total Return Fund, which was the top for the year ended March 31, fell precipitously to No. 18, for example, as did the former second-place fund, the Payden & Rygel Total Return Fund, which dropped to No. 17.
The flip-flop in one-year returns is a duration story, said John Isaacson, a principal at Payden & Rygel Investment Counsel, Los Angeles.
In the first quarter of 1998, interest rates were declining, favoring longer duration bond funds, he said. Between March 1998 and March 1999, the 10-year Treasury bill rate fell to 5.25% from 5.65% and the five-year T-bill rate fell to 5.1% from 5.6%.
When those first-quarter 1998 numbers rolled off the one-year return as of June 30, interest rates were rising, favoring the kind of short-duration funds dominating the top of P&I's one-year numbers. The 10-year T-bill rate rose to 5.78% from 5.45% between June 1998 and June 1999 and the five-year rate rose to 5.65% from 5.46%.
From the beginning of the second quarter, Mr. Isaacson said, the bond market moved in anticipation of an interest rate hike by the Federal Reserve, which was finally imposed in June. Payden & Rygel's response to an impending hike was to move the duration of its $90 million Limited Maturity and $100 million Short Bond funds to the lowest end of their permissible duration bands. In the $250 million Total Return Fund, duration was shortened slightly and Payden & Rygel moved from an overweighting in corporate bonds to a more neutral position as quality spreads widened in the second quarter.
When asked to anticipate further Federal Reserve interest rate moves, Mr. Isaacson laughed. "We're telling clients that it's really difficult to gauge what will slow the economy down. The feds want to slow the rate of economic growth, but by their own admission, they don't know how to do this. The Fed thinks the advance of the stock market is responsible for economic growth, but no one really knows what the relationship is between stock market returns and interest rates increases on a one-to-one basis. We've been advising clients not to get too defensive in the bond market because they need to be in a position to benefit should the stock market begin to slow down," he said.
Chief among all bond funds for the year ended June 30 was the high-yield Fidelity Capital & Income Fund, which had a 9.6% return and entered the top 50 for the first time. The Payden & Rygel Limited Maturity Fund was second, up from 50 last quarter, with a 5.3% return. In third place was the PIMCO Low Duration Fund, which had a 5.1% return. Fourth place was held by the Firstar Short-Term Fund with a 4.9% return, which raised it from No. 34 last quarter. In fifth place was the Fidelity High-Income Fund, with a 4.9% return.
There was almost no movement in P&I's bond ranking for the five years ended June 30, which is characterized by a preponderance of high-yield funds. Fifteen of the top 25 funds invest in high-yield securities.
The Fidelity High-Income Fund remained the No. 1 bond fund among those used most by defined contribution plans with a 12.7% return. Its sister fund, the Fidelity Capital & Income Fund moved up to second place from sixth with an 11.5% return, bumping the MAS High Yield Fund down to No. 3 with 11.4%. The MainStay High Yield Corporate Bond Fund was fourth with a 10.9% return and the Capital Research & Management American High Income Fund was fifth, up from ninth, with a 10.1% return. The Strong Corporate Bond Fund also returned 10.1% for the second quarter.
The top 50 rankings by performance are based on the list of the 100 funds most used by defined contribution plans (Pensions & Investments, May 2).