Technology drove the growth mutual fund market last year and helped spread the performance gap between growth and value as wide as it's ever been.
The Russell 3000 Growth benchmark returned 33.8% in 1999, compared with the Russell 3000 Value benchmark, which returned 6.7%. While the gap was also wide in 1998 (35% for growth vs. 13.5% for value), in 1997 the Russell 3000 Value benchmark outperformed its growth counterpart 34.8% to 28.7%. The Standard & Poor's 500 finished 1999 with nearly 30% of its stocks in technology while the Russell 2000 had a technology weighting of 23.6% -- an all-time high.
And among funds in Pensions & Investments' universe of mutual funds most used by defined contribution plans, technology also made the difference. Overall, the fund with the best return for the year, the Putnam OTC Emerging Growth Fund, had a 68% weighting to technology. The fund with the worst, the Oakmark Fund, had zero. And the technological edge held true across value or growth biases, and across market capitalization as well. With help from Lipper Inc., Summit, N.J., the funds in the P&I universe were categorized by market-cap size and style.
The data show that not only were technology stocks, or the lack thereof, a determining factor in the success of a fund in 1999, but that smaller company stocks outperformed larger companies on the growth side and larger outperformed smaller on the value side.
Small group `phenomenal'
"It was a case of a smaller number of managers producing phenomenal returns last year," said Brad Lawson, senior research analyst at the Frank Russell Co., Tacoma, Wash., "and a larger group of managers trying to keep up with the index."
Basically, the more successful managers held technology and other high-priced stocks in their portfolios.
"To the extent that you don't play in that neck of the woods, meaning your process doesn't take you there or you don't have a belief in those types of stocks, then you probably struggled," Mr. Lawson said.
The increasingly strong performance of growth companies and technology stocks contributed to the gradual narrowing of the market as the year went on, said David Masters, senior fund analyst, Standard & Poor's Fund Services, New York. Investors turned away from traditional asset allocation in favor of a far less diversified, far more concentrated and theoretically more risky, portfolio of investments that were generating big returns. But also, said Mr. Masters, "the products available to diversify into haven't necessarily been looking particularly attractive."
What this created was a situation in which some money managers were moving to the fringes of their expertise in order to keep pace, he said. "The opportunity cost of not being invested in this end of the market is considerable, at the moment, but so is the potential cost of finding oneself overexposed in a highly volatile market area when a correction comes."
Dynamic growth
An analysis of P&I's universe of the 100 equity mutual funds most used by defined contribution plans shows the disparity in returns between the top funds and the bottom funds. Across the board, growth funds dominated value, and the value funds that performed the best had exposure to technology stocks.
Unlike years past when large-cap growth stocks dominated and smaller company stocks lagged, 1999 saw a role reversal. The top-performing fund on P&I's list, for example, the Putnam OTC Emerging Growth Fund, which returned 126.9% in 1999, is a midcap growth fund. The PBHG Growth Fund, with an annual return of 91.9%, and the INVESCO Dynamics Fund, which returned 71.8%, helped propel the average annual return of midcap growth funds in the P&I universe to 74.4%, according to Lipper.
Not surprisingly, each of these funds had a significant portion of its portfolio in the technology sector. Technology stocks made up 68% of the Putnam fund, 65% of the PBHG fund and 40% of the INVESCO fund at year's end. Smaller companies flourished because many of these high-flying technology companies are small.
Small-cap growth funds in the P&I universe posted an average annual return of 61.7%, according to Lipper, with the Franklin Strategic Small-Cap Growth Fund topping the list with a return of 97% followed by the Vanguard Explorer Fund, with a return of 37.2% in 1999. The Franklin fund was heavily weighted in the tech sector with about 53% of its portfolio in technology-related stocks, including JDS Uniphase Corp., i2 Technologies Inc. and VoiceStream Wireless Inc.
Large-cap growth funds on the P&I list posted an annual average of 38.1% for the year led by the Janus Twenty Fund, which returned 64.9%, a slight drop from its 1998 return of 73.4%. The Janus Fund was second with a return of 47.1% followed by the Prudential Jennison Growth Fund in third with a return of 41.6%. More than half of the Janus Twenty Fund's holdings are computer, technology or telecommunications stocks such as top holdings America Online Inc., Cisco Systems Inc., and Dell Computer Corp.
The category of multicap growth funds, as categorized by Lipper, was led by Fidelity funds as the Aggressive Growth, Growth Company and OTC Fund finished in the top three spots with returns of 103%, 79.4% and 72.5%, respectively. At the head of the class, the Fidelity Aggressive Growth Fund held about 46.8% technology stocks at the end of the year, including top holdings Exodus Communications Inc., Brocade Communications System Inc., and Microsoft Corp. Overall, the multicap growth funds had an average annual return of 54.2%.
Some underperformed
At the opposite end of the spectrum, there were some growth funds that underperformed their benchmarks, including the midcap Baron Asset Fund, which returned 16.2% in 1999 and the large-cap Vanguard U.S. Growth Fund, which returned 22.2%.
Among its holdings, the Baron fund contained a broad range of stocks from retail stores and restaurants to financial services, which returned just 2.2% in 1999 on the Russell 3000 index. Technology, however, represented only about 3% of Baron Asset's holdings.
Overall, it wasn't a great year to be a value manager in 1999, but there were some bright spots. Looking at the value funds in the P&I universe, large-cap funds outperformed small-cap and midcap funds, as categorized by Lipper. Again, technology was key as those that managed to have some exposure to the sector performed the best.
Among multicap value funds, the top performer in 1999 was American Funds Fundamental Investors Fund with a return of 24.5%, which far outpaced its benchmark. Drew Taylor, assistant vice president at Capital Research and Management, said a broad spectrum of holdings was what allowed the fund to have a good year. While the Fundamental Investors Fund might not fall into the textbook definition of a true value fund, said Mr. Taylor, the traditional parameters play a central role. "To us, value is identifying some hidden value or asset of a company, and purchasing it," he said.
The management team found value in some of the industries that took off in the latter part of 1999, such as technology, wireless telecommunications and media. Valuations went through the roof in these areas last year, but the management team didn't do much of its purchasing then.
"Most of our exposure to those industries was built up two, three, even four years ago," when it was easier to find values, said Mr. Taylor. "It was just a matter of holding on to these positions and riding them as they started to do better."
Sectors helped
These holdings, along with some new values that emerged and did well in the early part of 1999, including energy, chemical, and forest and paper products companies, gave the Fundamental Investors Fund the balance to prosper.
"We got the benefit of what a lot of your true value funds did early in the year from your cyclicals, but then as the market narrowed throughout the year, our ability to have and hold areas like media, technology and communications allowed us to continue to do well as the year progressed," he said.
The Dodge & Cox Stock Fund also performed well in 1999 in the multicap value category. Its benchmark-topping return of 20% might have been driven by its exposure to energy and technology as well. The fund held 11.1% in energy stocks at year's end and 10.3% in electronics and computer stocks. Health care stocks, which returned -7.1% in the Russell 3000, represented just 4.9% of the portfolio.
Among large-cap value funds, the Vanguard Growth & Income Fund was the top performer, with a return of 26%; followed by the American Century Income & Growth Fund, which returned 17.9%; and the Investment Company of America Growth Fund, which returned 16.5%. The largest sector represented in the Vanguard fund was technology at 24.5% followed by financial services at 15.2%.
Small-cap value funds performed the worst among asset classes in the P&I universe. The Fidelity Low-Price Value Fund and the Neuberger Genesis Fund were among the best in the asset class with returns of just 5% and 4%, respectively.
There were some funds in negative territory in 1999, most of which were value funds. The Oakmark Fund returned -10.4%, while the Vanguard Windsor II Fund returned -5.8%. The Oakmark Fund held 27 stocks at the end of the year, including top holdings such as Black & Decker, Phillip Morris Companies Inc., and Nike Inc. The largest sector represented in the portfolio was industrials at 28.5% while technology was at zero. The Vanguard Windsor II Fund had a 5.2% exposure to technology and a 26.2% exposure to financial services.
