Further indications of an economic recovery and a prevalence of successful midcap and small-cap equity strategies surfaced in the third quarter in Morningstar Inc.'s separate account/collective investment trust database.
The median for the entire separate account universe as well as the average gross return for the top 10 managers continued to rise from previous quarters. The median for the year ended Sept. 30 was -4.81%, while the median for the year ended June 30 was -26.05%. For the year ended March 31, the separate account median was -36.92%.
The average one-year return of top 10 performers was 37.8% for the 12-month period ended Sept. 30, compared with one-year averages of 9.5% and zero, respectively, for the two quarters.
Steve Deutsch, director of separate accounts and collective investment trusts at Chicago-based Morningstar, said the number of midcap strategies in the top 10 overall list also was interesting. “Domestic midcap products held five of the top 10 overall one-year gross returns and four of the 10 overall five-year gross returns,“ Mr. Deutsch said. “The previous two quarters had more diverse categories represented in the top 10 overall list, with a tendency for large-cap products to appear in the top 10 overall one-year returns.”
Mr. Deutsch said the results this past quarter might indicate that portfolio managers had a bit of luck in their results. “It may not be driven by their skill, but by being in the right place at the right time,” he said.
Dennis Lynch, managing director and growth team leader at Morgan Stanley Investment Management, said the skill comes with picking the best stocks and populating the right portfolio based on market capitalization. Morgan Stanley's Mid-Cap Growth strategy was No. 1 overall for the year with a 51.3% return.Another portfolio he and the same team manage, the Morgan Stanley Small Company Growth, had the fourth best performance, with 38.25% for the year.
Mr. Lynch, who is based in New York, said portfolio managers are oriented toward the long term, both strategies have an average turnover of around 20% year to date, compared with average turnover of 100% for competing funds.In the small-cap strategy, Mr. Lynch said portfolio managers concentrate on companies that have unique business niches with little competition that help guarantee success.
“They have unique high quality business models,'' he said. One such company in the fund's portfolio, Blue Nile Inc., a direct seller of diamonds on the Internet, has a very strong cash flow because it keeps no inventory in stock. He said the company only buys diamonds from a distributor after a customer places an order, giving it a business model that traditional retailers like Tiffany's can't match.
He said the small-cap strategy has owned Blue Nile since 2004 and the stock was up 44% in the third quarter.
Another strong performer, Marvel Entertainment Inc., was able to rely on its vast collection of superheroes, the Incredible Hulk and Captain America, to leverage movie deals.
Mr. Lynch said the stock price was up 40% in the third quarter. But his team no longer holds the stock; because with the announced sale in August of the company to the Walt Disney Co., it no longer qualified as a small-cap holding.
A third equity pick, Lululemon Athletica Inc., a maker and retailer of yoga-inspired clothing, has seen a stock price increase of 70% in the third quarter, Mr. Lynch said. The Morgan Stanley team purchased the stock in mid-2007. He said company officials have positioned their retail stores reaching out to the local community and offering free in-store classes. “Their stores become the hub of the local yoga community,'' he said.
In midcap strategies, Mr. Lynch and his managers have put heavy reliance on Baidu Inc., which he called “the Google of China,'' and Tencent Inc., which provides instant messaging service in China. Both companies have experienced strong growth because of their market dominance in that country, he said.
In second place for the year was the Small/Mid Cap Core strategy of Pyramis Global Advisors, Boston, with 49.25%, followed by the growth strategy of Moloney Securities Asset Management, St. Louis, with 43.79%.
Ron Medley, who manages Moloney's strategy, said investments in two semiconductor manufacturers, ON Semiconductor Corp. and Entegris Inc., helped produce good results. He said both companies have a strong presence in Asia, whose economy is recovering quicker than the U.S.
“Electronics are becoming a bigger part of our life,'” he said. “It's like bandwidth length on the Internet; it keeps on growing.”
Confidential Management Advisors, Troy, Mich., was fifth for the year with its Multi-Cap Core Portfolio, which returned 35.25%. Jim Tassoni, the fund's portfolio manager, attributed the good performance to both positive sector and stock selection. “On the sector side, our overweights to the industrials and information-technology sectors vs. the Russell 3000 were our two biggest contributors,'' said Mr. Tassoni.
On the stock selection side, he said technology sector stock Garmin Ltd. was the best performer. He said the maker of personal GPS devices returned 58.44% for the quarter.
MicroStrategy Inc., also a technology stock, was a very positive contributor as well, he said.
The company provides businesses with integrated software solutions to more efficiently run their companies. “With businesses worldwide looking to run leaner more efficient models this stock was well positioned to meet those needs,'' he said. It rose 42.45% for the quarter.
For the five years ended Sept. 30, small- and midcap strategies again dominated with some exceptions. Insight Capital Research & Management Inc., Walnut Creek, Calif., was first with its Concentrated Growth portfolio with an annualized 33.34%. (All figures for periods of more than one year are annualized.)
AIS Capital Management LLC, Wilton, Conn., was second with 17.35% for its precious metals tactical asset allocation portfolio; Morgan Stanley's Mid-Cap Growth Strategy was third with 16.3%. The Pyramis Small/Mid Cap Core portfolio was fourth, at 15.99%; and the Moloney Securities' growth portfolio was fifth, at 15.96%.
The median gross result in the Morningstar database was 2.97%, while the Russell 3000 returned 1.56% for the same period.
In the collective investment trust universe, The Boston Co., Boston, was first for the year with 29.68% for its small-cap value strategy, followed by 19.67% for the small-cap value strategy of Donald Smith & Co., New York. A midcap value strategy by Boston Co. was third with 16.11%, and Cloud Neff Management LLC, Tulsa, Okla., was fourth with its large-cap value strategy at 8.31%. The CIT median for the year was -6.11%, and the Russell 3000 was -6.42%.