It's been a long time coming for growth equity managers.
With the wind finally at their backs after the best quarter for the S&P 500 since 1998, growth managers took six of the top 10 equity spots in Pensions & Investments' quarterly survey of the top-performing mutual funds most used in defined contribution plans.
But while growth equity was dominant, a value fund - the Legg Mason Value Trust, managed by William Miller - was No. 1 for equity, returning 18.8% for the year ended June 30.
The top equity returns for the one-year period, however, pale in comparison to the asset class that was the real winner, high-yield bonds.
High-yield fixed-income funds dominated the top of the fixed-income charts, led by the Fidelity Capital & Income Fund, managed by David Glancy, which returned 42.8% for the year ended June 30.
The rebound for equities was due to the second-quarter increase in the Standard & Poor' s 500 index, which jumped 14.9% for the three months ended June 30, the best quarter for the S&P 500 since the fourth quarter of 1998. As a result, about half of the equity mutual funds in the P&I universe moved into positive territory for the year ended June 30. For the one-year period ended March 31, there wasn't a single equity fund in positive territory in the P&I universe.
There were limits to the recovery, however: The Legg Mason fund was the only one to post double-digit returns.
Nancy Dennin, assistant portfolio manager for the fund, sees the second-quarter boom as just the beginning. "We believe this is the beginning of a new bull market," she said, explaining that the economy will continue to grow and that she foresees a low interest-rate environment going forward. Ms. Dennin looks for high single-digit equity returns over the next few years.
Seeking outperformers
The fund looks for stocks that will outperform over a three- to five-year period, which led the value trust team to purchase stocks such as Amazon.com Inc. and Tyco International Ltd. These stocks were beaten down when the fund bulked up on positions throughout the bear market as valuations remained low, but now they have come back and are among the top performers in the portfolio, said Ms. Dennin.
The value trust team tries to add positions when the price of a stock is below an average share price, she said. Another example is Nextel Communications Inc., which the team determined to have an average share price of $19 and bought for $8 a share. Now the stock is around $19 a share. Recent additions to the portfolio were Intuit Inc., Eastman Kodak Co., Tenet Healthcare Corp. and Baxter Healthcare Corp.
Others winners in the portfolio include Washington Mutual Inc., Citigroup Inc. United Healthcare, Qwest Communications International Inc. and AES Corp.
Another reason the Legg Mason Value Trust outperformed was that it stayed fully invested, said Ms. Dennin. When market weakness and the war led many portfolio managers to build cash positions in the first quarter and early into the second quarter, the value trust team was better positioned to capture the broad market gains that followed.
Edged out
The T. Rowe Price New Horizons Fund, managed by John Laporte, was the No. 2 equity fund, with a return of 8.07% for the one-year period. It narrowly edged out another T. Rowe Price fund for third place, the Science & Technology Fund, managed by Michael Sola, which returned 8.05%.
The New Horizons Fund was well-positioned for the bounce-back, said Mr. Laporte. Coming out of a market bottom, small caps tend to outperform large caps, and growth stocks tend to outperform value, he said. "Small-cap growth is the place to be in an economic and market recovery," said Mr. Laporte, because the stocks are more sensitive to economic and market conditions.
What set the New Horizons portfolio apart from its peers are its diversified holdings, said Mr. Laporte. "We try not to bet the ranch on a couple of stocks." The portfolio, comprising about 240 stocks, concentrates about 80% of its holdings in four sectors - consumers, healthcare, technology and business services - each of which makes up about 20% of the portfolio.
A decision to beef up on biotechnology stocks within the healthcare area helped the portfolio when the market turned positive in the second quarter, said Mr. Laporte, adding about 10% of the health care holdings were biotech stocks. Gilead Sciences Inc. and Neurocrine Biosciences Inc. were among the biotech winners, and Mid Atlantic Medical Services Inc. did well in health care.
Other winners in the portfolio include retailers Ann Taylor Inc. and Christopher & Banks Corp., and education services firm Apollo Group Inc.
A key to the fund's success relative to its peers, said Mr. Laporte, is its longer-term view of the market. This strategy results in a lower turnover ratio than most small-cap growth funds, about 30%. "We don't churn the portfolio," said Mr. Laporte. "We look to stay with good growth companies for a number of years."
No. 4 for year
The Oakmark Select Fund, managed by William Nygren, was the fourth best-performing fund for the year ended June 30, with a return of 7.4%. The Fidelity Aggressive Growth Fund, managed by Rajiv Kaul, ranked fifth for the period, with a return of 6.7%.
Ranking eighth for the year was the Janus Mercury fund, at 5.6%, managed by David Corkins. He took over as lead manager in February after Warren Lammert resigned and gives most of the credit for the fund's performance to Mr. Lammert. Mr. Corkins said the "eclectic mix" of stocks in the portfolio, from technology firms such as Nokia Corp., to financial services firm Berkshire Hathaway Inc., to midcap names such as Caremark Inc., a health care service firm, have served the fund well through choppy markets. "We're looking for well-managed companies of all market caps," said Mr. Corkins, who also manages the Janus Growth & Income Fund and who assisted Mr. Lammert on Mercury for four years.
Mr. Corkins has made some changes to the fund, however. He added more midcap stocks, like Caremark, and has focused on firms with better business models.
Two stocks that he sold off were information technology firms Infosys Technologies Ltd. and AmerisourceBergen Corp. New stocks added include Citigroup Inc. and Dell Computer Corp. Mr. Corkins said the idea is to find companies that have cash flow and earnings potential and look poised to grow. With more volatility in the stock market expected and a less than clear view of what the economy will do going forward, the job of picking the winners from the losers won't be easy. "It's a stock-picker's market," he said.
Cut and dried
In the fixed-income universe, the key to success has been more cut and dried over the last few quarters. Of the top 10 fixed-income funds, the majority are high yield.
The best-performing fixed-income fund for the year ended June 30 was the Fidelity Capital & Income Fund, managed by Mr. Glancy. The fund, a high-yield bond fund, returned 42.8% for the one-year period.
Fidelity also held the second and third spots, with the Fidelity New Markets Fund, an emerging market debt fund, at 34.7%, and the Fidelity High Income Fund, a high-yield fund, with 26.7%.
The high-yield market has benefited from corporate America's greater focus on balance sheets, said Fred Hoff, manager of the High Income Fund. It has managed to weed out a lot of bad debt that shouldn't have been issued in the first place, and now, with an economy that is improving, Mr. Hoff predicts continued strength. While high-yield managers may not see the same type of returns that they have seen over the last six months, Mr. Hoff believes they will outperform investment-grade bonds and Treasuries over the next few years.
A move into utilities and energy bonds in the middle of 2002 helped drive performance over the last 12 months, as both of those sectors have come back strong in 2003, Mr. Hoff said. Among the portfolio's winners in the energy sector were CMS Energy Corp. and El Paso Energy Corp.
Gains from two areas
American Funds' American High Income Trust was the fourth best-performing fund for the year ended June 30, with a return of 25.5%. The Federated Strategic Income Fund, managed by Joseph Balestrino, came in fifth for the period, with a return of 20.6%.
Much of the gains over the last 12 months came from two areas, said Mr. Balestrino: high-ield and emerging-market debt. High yield makes up about 41% of the portfolio, and emerging-market debt, about a third. The rest is in investment-grade bonds and developed international debt. The concentration of high-yield and emerging-market debt is as high as it' s ever been in the portfolio, said Mr. Balestrino. While he has already started reducing emerging market debt to some degree, he is maintaining his potion in high yield, as he expects significant outperformance over high quality bonds. "We're committed to the idea that the economy will not go backwards into a double-dip recession," he said.
After a five-year bear market for high-yield bonds, Mr. Balestrino thinks the fledgling high-yield run still has legs.
