You know times are tough when negative single-digit returns look good.
And times are tough. Only two of the top-performing equity funds in Pensions & Investments' universe of mutual funds most used by defined contribution plans had returns that high in the year ended March 31.
Performance was better on the fixed-income side, where the top performing funds in the P&I universe topped 20% for 12 months.
But the numbers were at the other end of the spectrum in equities.
The top two funds - the American Funds Capital Income Builder Fund with -5.4% and the American Funds Income Fund of America, -8.4% - are managed by Capital Research & Management Co., Los Angeles.
Performance of the two was helped by the fact that they are mixed asset funds, said Drew Taylor, vice president at Capital Research. The team-managed funds have a quarter or more of their assets in bonds and a significant portion of the equity assets are in dividend-paying equity, which helps offset the stock market declines, said Mr. Taylor. The Capital Income Builder fund can invest up to 40% of its assets in international equities, while the Income Fund of America can invest up to 20% in non-U.S. equities, added Mr. Taylor.
Edged out
The third best performing fund for the year ended March 31 was the Neuberger Berman Genesis Fund, managed by Judith Vale, Robert D'Alelio and Kevin O'Brien. The Genesis fund returned -13% for the period, edging out the Fidelity VIP Contrafund and Fidelity Contrafund, both managed by William Danoff. The VIP Contrafund returned -13.7% while the Contrafund returned -14.1% for the year.
The T. Rowe Price Small Cap Value Fund, managed by Preston Athey, was the sixth for the one-year period with -15%. And the Oakmark Select Fund, managed by William Nygren and Henry Berghoef, placed seventh on the list of the top performing mutual funds most used in defined contribution plans with -15.1%.
Oakmark Select also was the best performing fund in the P&I universe for the five-year period with an annualized return of 10.1%.
"We're not trying to pick stocks that are going to perform better next quarter," said Mr. Nygren. "We're looking for companies that are going to perform well over the next five years."
Mr. Nygren attributes the long-term success of the fund to the investment approach that is used across all of the Oakmark funds, which are managed by Harris Associates LP, Chicago. The Oakmark philosophy is to look for stocks that are trading at no more than 60% over their intrinsic value; companies with free cash flows and intelligent investment of excess cash; and companies that treat shareholders like partners and have a high level of management ownership so interests are aligned with the success of the firm. Mr. Nygren said there are a lot of companies that don't communicate well with shareholders, and he tends to avoid those companies. The philosophy allows the portfolio to reduce risk and enhance returns, said Mr. Nygren, adding: "That's a combination that academics say doesn't exist."
Steady grower
Among the winners over the past year were Washington Mutual Inc., the largest holding in the concentrated portfolio of 20 stocks representing 18% of the fund. Washington Mutual, the largest savings and loan firm in the United States, is a steady grower that has created economies of scale vs. its competition, said Mr. Nygren. "In a lot of ways it has positioned itself similar to the way Wal-Mart has positioned itself in the discount business," said Mr. Nygren. Other top performers in the portfolio were Xerox Corp., First Data Corp. and Mattel Inc.
New positions added to the portfolio in recent months include Bristol Myers-Squibb Co. and Starwood Hotels & Resorts Worldwide Inc.
Mr. Nygren also is seeing more large-cap growth names come on his radar screen, like AOL Time Warner Inc., which he purchased last year.
One stock he sold off this past year was EDS Corp., which failed to meet earnings estimates. "We make our share of mistakes, but we're good about catching them early," he said.
In general, Mr. Nygren sees brighter skies for the equity markets. "The probability of equity markets exceeding fixed-income markets is extremely high," over the next five years or so given the lower price of equities and the likelihood that interest rates will rise, he said.
The Franklin Balance Sheet Fund, managed by Bruce Baughman, William Lippman and Margaret McGee, placed eighth for the year in the P&I universe with -15.9%. Mr. Baughman, portfolio manager at Franklin Templeton Investments, San Mateo, Calif., said they look for well-established companies with low price-to-book ratios. "The primary focus of the fund is price to book," said Mr. Baughman. Established, financially sound companies with cheap price to book ratios are "golden opportunities," said Mr. Baughman, and can be found in this type of market.
As the name of the fund suggests, the portfolio management team looks to buy companies with "really good balance sheets at a discount," said Mr. Baughman. "We start with impossibly high standards and work down from there," he added. "If you don't, you'll accept imperfections too readily."
New positions added to the portfolio in the past year include Mueller Inc., a building firm; Kellwood Co., a clothing manufacturer; Universal Corp., a leaf tobacco processor; Saks Inc. and Zales Corp., both retailers; Old Republic International Corp., an insurance company; and Airborne Freight Corp., a shipping company.
Among the winners in the portfolio are homebuilders Lennar Corp. and D.R. Horton Inc., toy manufacturer Hasbro Inc. and technology firm Hutchinson Technology Inc.
Fidelity Low-Priced Stock Fund, managed by Joel Tillinghast, and Legg Mason Value Fund, managed by William Miller, placed ninth and 10th respectively. Fidelity Low-Priced Stock returned -17.6% and Legg Mason Value returned -18.3% for the 12 months.
Continue to thrive
In the fixed-income universe, long-term bonds continued to thrive in a low interest rate environment.
The top performing fund in the P&I universe of mutual funds most used by defined contribution plans, the PIMCO Long-Term U.S. Government Fund, managed by James Keller, posted a return of 21.7% for the one-year period ended March 31. The strategy of investing almost entirely in long-term Treasuries and not leaning into corporate bonds has maximized returns over the past 12 months and enabled it to outperform its peers, said Mr. Keller. "It has not paid to take credit risk," he said.
Mr. Keller believes long-term bonds will remain an attractive asset class and anticipates steady inflows into the asset class from pension funds as the decade-long trend of moving out of long-term bonds into equities continues to reverse. As pension funds adjust to the "post-bubble" world, Mr. Keller expects to see a continued flight to long-term bonds for their lower risk profile and because they are a better match for pension liabilities.
Flight to quality
The Vanguard Long-Term U.S. Treasury Fund, managed by David Glocke, placed second in the fixed-income rankings with 20.1% for the 12 months. Long-term bonds continue to perform well as interest rates remain low and the flight to quality continues in a weak U.S. economy, he said. But now that the military conflict with Iraq appears to be over, uncertainty about the U.S. economy continues, said Mr. Glocke. "It's not necessarily all-systems-go," said Mr. Glocke.
While some observers believe stimulus is in place for an economic turnaround, others say there is a fundamental weakness in the U.S. economy that will linger for a while. If the latter proves true, interest rates will remain low and the Treasuries will benefit as the flight to quality continues. Given the uncertainty, the best bet for investors is to be well diversified, said Mr. Glocke.
The third best performing fixed-income fund in the P&I universe for the year is the PIMCO Real Return Fund, managed by John Brynjolfsson, which returned 18%.
The portfolio consists entirely of Treasury inflation-protected securities, which have performed well in a low interest rate environment. In a fixed-income market where TIPS are outperforming everything else, it's difficult to add value over the benchmark, he said. The fund was able to outperform its peers by "avoiding the landmines" and security selection, said Mr. Brynjolfsson. For the five years ended March 31, the PIMCO Real Return fund posted a 10.1% annualized return, ranking second for that period.
(The top performing fund for the five years was the Fidelity Advisor Stable Value Fund, managed by David Prothro, with an annualized return of 32.1%.)
The Vanguard Long-Term Corporate Bond Fund, managed by Earl McEvoy, and the Vanguard Intermediate-Term U.S. Treasury Fund, managed by Mr. Glocke, tied for fourth with returns of 16.1% for the year.
Emerging market bonds
The Fidelity New Markets Fund, managed by John Carlson, was the next best performing fund in the P&I fixed-income universe with a one-year return of 14.4%. Unlike the other top-ranking funds, the New Markets fund invests in emerging market bonds. Emerging market bonds have been a strong performing asset class over the years as long as you look in the right places, said Mr. Carlson. "We look for credits and countries that may not be on most people's radar screens and find value," he said.
Despite the war in Iraq and the surrounding geopolitical uncertainty, Mr. Carlson said there are some strong emerging markets. Brazil has been a bright spot, he said, coming off a recent election of a pro-business leader. Turkey, which also had a recent government change, has been a solid performer as well. Russia has been a strong market as strong leadership, a flat tax and GDP growth have spurred the economy. South Africa, Colombia and Lebanon are other markets where Mr. Carlson has found value.
