The worst quarter for equities in a decade has put about 95% of the equity mutual funds most used by defined contribution plans into negative territory.
The already ailing equity market plunged into a tailspin following the Sept. 11 terrorist attacks. All of the major indexes fell dramatically in the third quarter, including the Standard & Poor's 500, down 14.7%; the Russell 2000, down 20.8%; and the Nasdaq composite, down 30.7%. Returns for the 100 funds in the Pensions & Investments equity universe reflected the downturn as the top-performing funds fell precipitously. Only six of the equity funds in P&I's listing of the top-performing mutual funds for the 12 months ended Sept. 30 remained in positive territory.
Fixed-income funds, on the other hand, continue to thrive. One-year returns actually improved in the rolling one-year period ended Sept. 30 from the one-year period ended June 30. Overall, about half of the fixed-income funds in the 100-fund P&I universe were in positive territory for the one-year period, with about one-third posting double-digit numbers.
Equity still sinking
The only equity fund to post a double-digit return for the year ended Sept. 30 was the Fidelity Low-Priced Stock Fund, managed by Joel Tillinghast, which returned 15%. That's down from 32.2% for the year ended June 30, when it also topped the list.
The fund returned a relatively decent -8% in the third quarter. While it was a difficult period, Mr. Tillinghast said it wasn't as difficult to manage money as it was in 1999, when momentum drove the market. "The current market is more understandable" because it is driven by earnings growth, he said, "but unpleasant because earnings are down and stock prices are down."
Other than adding technology exposure because prices came down so low, Mr. Tillinghast said he didn't make many changes in the portfolio in the third quarter. Its relative outperformance was due to changes made earlier in the year, he said, when he added positions in sectors that would continue to show earnings growth in a difficult economic environment, such as discount retailers and low-priced family restaurants.
The portfolio's top performers were Outback Steakhouse Inc., Applebee's International Inc. and Sonic Restaurants Inc. Autozone Inc., Ross Stores Inc. and BJ's Wholesale Club Inc. also were top performers among discount retailers.
The Dodge & Cox Stock Fund placed second on the equity list for the second straight quarter with a return of 8.6%, down from 28.4% for the year ended June 30. It posted a return of -10.2% for the quarter ended Sept. 30, not so bad when compared to the market.
portfolio manager Wendell Birkhofer said the fund's underweighting in technology continues to be the key to its performance for the 12-month period. Now, with technology stock prices so low, Mr. Birkhofer said the management team has started to "creep back into technology." The sector, comprising 8% of the portfolio at the start of 2001, represents 11.5% of the fund as of Sept. 30. Of the six stocks added to the portfolio in the second and third quarters, four are technology stocks, said Mr. Birkhofer, including Hewlett-Packard Co.
John Gunn, chief investment officer at , said the team took about $250 million from cash positions and invested it in stocks in the portfolio in September. They added positions to 39 of the 84 stocks in the fund, he said, because prices had come down so low after the Sept. 11 terrorist attacks.
Another area that contributed to performance in the past year, said Mr. Gunn, is industrial commodities. About 15% of the portfolio is in this sector, focusing on large global firms that sell products around the world. He said the names are diversified across industries within this sector, including chemicals, metals and forest products. Among the winners are Dow Chemical Co., Alcoa Inc., Weyerhaeuser Co., and mining company Rio Tinto PLC.
The biggest winner in the portfolio year-to-date, Mr. Birkhofer said, has been Xerox Corp., added late last year.
Rounding out the top five mutual funds for the year ended Sept. 30 were the team-managed Capital Research Income Fund of America, which returned 7%; the T. Rowe Price Equity Income Fund, 2.6%; and the Capital Research Washington Mutual fund, 1.15%.
The T. Rowe Price Equity Income Fund, managed by Brian Rogers, was down 8% for the quarter ended Sept. 30. Mr. Rogers said decisions made a year or two ago have contributed to the relative success of the portfolio this year. Being overweighted in consumer staples such as food and beverage companies and underweighted in technology, transportation and utilities, helped performance in the past 12 months, he said. "A lot of it boils down to what one was doing in technology, or wasn't doing, in technology, and what one was doing with some of the defensive consumer names," he said.
There weren't a lot of places to hide in the third quarter, Mr. Rogers added, but there were some places that didn't hurt as much as others. Healthcare, communications services - including telephone companies - and consumer staples, were areas of the market that performed relatively well for the period.
Selling relative strength
Utilities did well for the portfolio last year, he said, but he started selling utility positions in the beginning of 2001, as prices rose. That strategy paid off in the third quarter, as the sector was down 20%. "A lot of what we do is try to identify weakness, invest in it, and try to sell relative strength," said Mr. Rogers. "We're always focusing on sectors that have already been disappointing," and if well executed, "that strategy helps protect our investors from an awful lot of downside."
Among the top performers in the portfolio were Verizon Communications, up 2% in the third quarter and 10% for the year, and Alltell Corp., down 5% in the quarter and up 13% for the past year. Abbott Laboratories and American Home Products Corp., both pharmaceutical companies, also were strong performers.
While the one-year numbers are down, the top five-year returns are in line with historical averages. The top-performing fund over the last five years was the Hartford Capital Appreciation Fund. The fund, managed by Saul Pannell, was up a compound annualized 22.2% for the five-year period ended Sept. 30. Second was the team-managed Capital Research Growth Fund of America, up 16.1%; and third was the Fidelity Dividend Growth Fund, managed by Charles Mangum, up 15.1%. Rounding out the top five for the five-year-period are the Janus Growth & Income Fund, managed by David Corkins, and the Stock Fund, up 14.92% and 14.9%, respectively.
The Vanguard Intermediate-Term Bond Index Fund, managed by Kenneth Volpert, posted a return of 15.3% for the year ended Sept. 30, leading the universe of fixed-income funds most used by defined contribution plans. That return is 180 basis points higher than the top-performing 13.5% return the fund posted for the one-year period ended June 30.
The fixed-income market also suffered a jolt following the events of Sept. 11. Lower-grade corporate bonds had been doing well for the quarter, boosted by the Federal Reserve's aggressive easing of interest rates, but that changed following the terrorist attacks. "That was a huge setback for cyclical credits," Mr. Volpert said.
He found all of the gains made before Sept. 11 on the lower-grade corporates virtually wiped out. However, the fund managed to get through the quarter with positive returns because of its duration. Mr. Volpert said a portfolio with durations focused in the middle of the yield curve, as opposed to a barbell approach, is beneficial in an environment where the yield curve has steepened.
In September, the fund managed a 1% return, and it was up 5.2% for the quarter.
While fixed-income funds continue to outperform equity funds, Mr. Volpert said, there's a lot of uncertainty about what will happen to the economy and the markets over the next six months or so.
Second on the list for the best one-year performers was the LM Western Asset Management Core Bond Fund, a team-managed fund that returned 15.1% for the year period. Third on the list was Pacific Investment Management Co.'s Total Return Fund, managed by William Gross, which returned 14.4%. Fourth was the Kent Income Fund, managed by Mitchell Stapley, which posted a 13.9% return, followed by the team-managed MAS Advisory Mortgage Fund, with a return of 13.5%.
For the five-year period ended Sept. 30, the PIMCO Total Return Fund tops the list with a compound annualized return of 8.9%, followed by the LM Western Asset Core Fund, which returned 8.5%. Three Vanguard Group funds - the Intermediate Term Index, Total Bond Market Institutional Index and Total Bond Market Index funds - round out the top five with returns of 8.3%, 8.1% and 8%, respectively.