The equity market rebounded nicely in the fourth quarter but it was too little too late for stock managers in the Pensions & Investments survey of mutual funds most used in defined contribution plans.
In 2002, every equity fund in the P&I universe finished the year in negative territory.
On the other hand, it was a great year for fixed-income managers, who saw their funds post better returns than in 2001.
The negative equity returns reflect a market that was badly beaten in 2002. Despite a more than 8% gain in the fourth quarter, the Russell 1000 index finished the year at -21% while the Standard & Poor's 500 closed the year at -22%.
It's the third straight down year for the benchmarks, marking the first time since the 1930s that the market has dropped in three consecutive years. "This has been one of the worst periods in history," said Bridget Hughes, fund analyst at Morningstar Inc., Chicago, and it might not be over yet. The fourth-quarter rebound was a "low-quality rally," she said, adding she doesn't expect to see the market turn until capital spending increases. "I don't know that anyone has seen that yet," said Ms. Hughes.
Bears attack value
Equity managers that had the most success in 2002 found it in the value equity universe, but even value funds got hurt last year. "It was the year that the bear market caught up with the value universe," said Wendell Birkhofer, portfolio manager on the Dodge & Cox Stock Fund.
The Neuberger Berman Genesis Fund, managed by Robert D'Alelio, Judith Vale and Kevin O'Brien, was the top-performing fund in 2002 with a return of -2.7%. But even the best had their problems. "Last year was a tough year by any measure," said Mr. O'Brien. "No matter how good you are, it's tough to make money in a market where a majority of your stocks are down."
The fund management team sticks to its strategy of finding stable companies that generate cash flow "through thick and thin," said Mr. O'Brien. But it's through "thin" where the fund really stands out among its peers, said Mr. O'Brien, because the team stays away from companies that carry debt and are more influenced by swings in the market. "Anyone dependent on the capital markets got killed last year," said Mr. O'Brien.
Energy, consumer staples and healthcare were the best performing sectors in the portfolio. Energy and consumer staples holdings were up 10%, while healthcare stocks were up 9.5%, he said.
Energy winners include XTO Energy Inc., Patterson-UTI Energy Inc., Varco International Inc. and Oceaneering International Inc.
In the consumer staples area, Alberto-Culver USA Inc., Church & Dwight Co. Inc. and Lancaster Colony Corp. were strong in 2002.
In the healthcare sector, top performers include Mentor Corp., Taro Pharmaceuticals Industries Ltd. and Trigon Healthcare Inc., which was acquired last year by Anthem Inc.
In addition, by increasing positions in the semiconductor area in the third quarter, the fund managed to get in front of the fourth quarter rally, said Mr. O'Brien. Strong performers in the semiconductor area were Actel Corp. and Cognex Corp.
The second best performer for 2002 was the Income Fund of America, managed by Capital Research & Management Co., Los Angeles. The team-managed fund posted a return of -4.4%.
Drops to third
Fidelity Low-Priced Stock Fund, the year-end leader for the past two calendar years, dropped to third place in 2002. Managed by Joel Tillinghast, the fund returned -6.2%, its lowest return since Mr. Tillinghast took over management of the fund in 1989. It had returns of 26% and 18% in 2001 and 2000 respectively.
Mr. Tillinghast's strategy is to find steady growers with clear visibility for growth. Overall, the best performers in the portfolio came from the consumer sectors. "Consumer spending tends to be less volatile than capital spending," explained Mr. Tillinghast. Winners in the consumer sector include homebuilder D.R. Horton Inc., Safeway Inc. and CVS Corp.
While most managers have a watch list of stocks they are interested in adding to the portfolio, Mr. Tillinghast takes a different approach - he adds them. His strategy is to own companies he likes, even if it's a very small position, and slowly build positions in the stocks he really likes and believes will make a positive move.
With a relatively low turnover ratio of 25%, he doesn't engage in much short-term maneuvering. However, a decision in the third quarter to add some technology positions helped boost returns in the fourth quarter when the market rallied. He would not disclose the names of the positions he increased or added to the portfolio in 2002.
After the Low-Priced Stock Fund, Fidelity Investments Inc., Boston, owns the fourth, fifth and sixth spots in the performance rankings. The Fidelity Value Fund, managed by Rich Fentin, and the Fidelity VIP Contrafund, managed by William Danoff, were next with returns of -9.3%. The Fidelity Contrafund, managed by Mr. Danoff, returned -9.6%.
The Dodge & Cox Stock Fund placed seventh in the P&I universe with -10.5% for the year.
Despite outperforming its benchmark, the S&P 500, by 10 percentage points, a double-digit loss is nothing to feel good about, said Mr. Birkhofer, one of the portfolio managers on the team-managed Dodge & Cox fund. While the fund had positive returns in 2000 and 2001, in 2002 because there was no place to hide, he said.
"The big difference between last year and the previous two years, when we had positive returns, is that even value didn't deliver in 2002," said Mr. Birkhofer.
A key to the fund's strong relative performance last year lies in the technology sector, said Mr. Birkhofer. While the portfolio's tech holdings returned -23%, that was significantly better than the -37% return the sector had in the benchmark, the S&P 500. The portfolio was underweight in technology, he said, and that combined with the strong performance of its holdings helped the fund's performance.
The portfolio also got a boost from some of its holdings in the industrial sector, primarily transportation and capital equipment companies. Winners in the industrials area include FedEx Corp., Deere & Co., Lockheed Martin Corp., and Union Pacific Corp.
Other strong performers in the portfolio were Eastman Kodak Co., Golden West Financial Corp., Wachovia Corp. and Wellpoint Health Networks.
Rounding out the top 10 were: Capital Research's American Mutual Fund, -12.2%; the T. Rowe Price Equity Income Fund, -13%; and the T. Rowe Price Small Cap Fund, -14.2%.
While 2002 brought down long-term equity numbers, it improved long-term fixed-income returns as 2002 was a good year for bonds, particularly U.S. Treasuries. Buoyed by low interest rates, long-term Treasury funds dominated the fixed-income rankings.
The PIMCO Long-Term U.S. Government Fund, managed by Jim Keller, was the top-performing fund for the year in the P&I universe with a return of 18.9%. The fund benefited not only from low interest rates, but also low inflation, and a flight to quality in a weakening economy, said Mr. Keller.
Beyond that, Mr. Keller said he outperformed by taking risks in a variety of areas, including durations and the position on the yield curve: "Last year, every risk position we took went our way."
The Vanguard Long-Term U.S. Treasury Fund, managed by Ian MacKinnon and David Glocke, was the second best performer for the year, with a return of 16.7%.
Continued low inflation in 2002 has made long-term U.S. Treasuries attractive in general, said Mr. Glocke. Because the fund has a longer duration than most long-term Treasury funds, it outperformed in 2002. The fund also got a performance boost from its exposure to Treasury inflation-protected securities and agency securities, including Freddie Macs.
Placing third was the Vanguard Long-Term Corporate Bond Fund, managed by Earl McEvoy, which 13.2% for the year ended Dec. 31.
The Fidelity Spartan Government Income Fund and the Fidelity Government Income Fund, both managed by George Fischer, were next in the rankings with 11.5% and 10.9%, respectively.
The team-managed Dodge & Cox Income Fund was the sixth best performing fund in the P&I universe with 10.8%.
Tom Dugan, portfolio manager on the fund, said a healthy exposure to TIPS was one of the factors that helped performance. Also, security selection within the corporate bond sector enabled the fund to outperform its peers, he said: "In a year when corporate bonds were weighed down, we did a pretty nice job of picking some winners." While the corporate bond market had its share of meltdowns, the management team was able to find good securities in some areas of the market, including energy, healthcare and defense, he said. In addition, being overweight in mortgage-backed bonds added value last year, he said.
The Oppenheimer U.S. Government Trust Fund was seventh with a return of 10.4%. It was followed by the Prudential Government Income Fund, at 10.3%; the Fidelity U.S. Bond Index Fund, 10.2%; and the PIMCO Total Return Fund, 10.2%.