Technology, growth funds move to front

Growth and technology portfolios dominated the list of top-performing domestic equity strategies for the year ended Dec. 31, according to data from Morningstar Inc.'s separate account database.

Five growth and three technology strategies were among the top 10, a change from the previous quarter in which nine of the top spots were filled by real estate strategies and utilities.

"It was sort of a return to the common themes of the last couple of years, growth stocks and tech stocks did well. It was interesting that small caps slightly edged large caps, and some small-cap managers had a pretty good year, which was a little bit different from the large-cap growth story of the last couple of years," said Tony Thomas, senior manager research analyst for equity strategies at Morningstar in Chicago.

"Health care did well in the fourth quarter, and I would add that to the mix. Apple had a great fourth quarter, but UnitedHealth Group gained 36% in the quarter and that was a little bit better than Apple. So in that growth space, while people do predominantly think of it as tech, you could put some health names in there and some consumer cyclical names to explain why some growth managers did well last year."

Mr. Thomas said the easing of trade tensions might have benefited some companies that had been held back by uncertainty about trade issues.

"While the actual deal wasn't signed until January, I think it became clear as the year came to a close that things had stabilized on the trade front," Mr. Thomas said.

Mr. Thomas also said several cuts to the federal funds rate in 2019 might have reinforced confidence in the U.S. economy in a way that favored growth stocks.

For the period ended Dec. 31, the median one-year return for domestic growth equity strategies in Morningstar's universe was 32.54%; the S&P 500 total return index was up 31.48% for the year; the median return among all domestic equity categories was 27.61%; domestic value strategies had a one-year return of 25.97%.

Glen Allen, Va.-based Elemental Capital Management LLC's Small and Mid-Cap Growth strategy led the overall domestic equity category for the year ended Dec. 31, with a gross return of 56.33%.

"First and foremost, we're bottom-up fundamental investors," said Michael Grizzard, founder, managing member and chief investment officer.

"We're not trying to tactically or strategically allocate to sectors or industries. We're really building the portfolio on a company-by-company basis, and we consider ourselves to be business analysts. We spend most of our time evaluating and learning about individual companies."

Mr. Grizzard said the portfolio's key selection criteria include finding companies with the ability to generate more cash than is required to run the business and the ability to consistently earn a high return on capital.

"Other tailwinds we like to see are companies that are serving a massive, growing market or a consistent, recurring market opportunity. Within those two areas, we want them to be companies that provide a superior service, product, or have some sort of dominant mind share among their customers or clients," he said.

Mr. Grizzard said the firm's careful selection criteria mean the portfolio remains concentrated, with typically 10 to 20 holdings. He said Roku Inc., AppFolio Inc. and Yeti Coolers LLC were three standout performance drivers for the portfolio's 2019 return.

Nicholas Investment Partners LP's NicHealth strategy was in second place with a gross return of 54.54%; Taylor Frigon Capital Management LLC's Israeli Innovation strategy followed in third place at 50.68%; fourth on the list was Ivy Investment Management Co.'s Science & Technology Model Portfolio at 49.35%; and Westfield Capital Management Co. LP's Select Growth Equity strategy rounds out the top five, with a gross 48.95% return for the year ended Dec. 31.

Technology-related strategies also dominated Morningstar's five-year list of domestic equity separate accounts, holding six of the top 10 spots, and ARK Investment Management LLC's ARK Next Generation Internet strategy led the list for a second consecutive quarter with a gross annualized return of 28.14%. All multiyear returns are annualized.

Kayne Anderson Rudnick Investment Management LLC's Small-Cap Sustainable Growth strategy followed ARK in second place with a 22.98% return; Columbia Threadneedle Investments' Global Technology Growth strategy followed in third place at 21.6%; Janus Henderson Investors' Global Technology strategy was fourth with a 21.1% return; and Victory Capital Management Inc.'s RS Science And Technology composite was in fifth place with a gross 20.93% return.

The median five-year annualized return for domestic growth strategies in Morningstar's equity universe was 12.01%; the median among all domestic equity strategies was 9.62%; and the S&P 500 returned 11.68% for the five years ended Dec. 31.

Long-duration bond strategies filled nine of the top 10 spots on Morningstar's fixed-income list for the year ended Dec. 31, with corporate bonds displacing the long-term government strategies that occupied the top five spaces for the year ended Sept. 30.

"The U.S. Treasury long index, that's an index looking at Treasuries with maturities of 10 years or longer, is used as a proxy for a safe-haven holding area, for a risk-off sentiment," said Gabriel Denis, analyst, fixed-income strategies at Morningstar in Chicago. "Overall, the index had its best year since 2014 but at the end of the fourth quarter 2019, it was one of the worst-performing sectors. Just for the fourth quarter, the long Treasury index underperformed and dropped 4%."

The Bloomberg Barclays U.S. Long Credit index gained 23.36% for the year, the Bloomberg Barclays U.S. Long-Duration Government/Credit index returned 19.59% and the Bloomberg Barclays Long U.S. Treasury index returned 14.83% for the year ended Dec. 31.

Economic and geopolitical conditions made many investors more optimistic about risk assets during the fourth quarter, Mr. Denis said. The Federal Reserve signaled the federal funds rate would be kept on hold through 2020, barring significant economic changes, and earlier concerns about an inversion of the U.S. Treasury yield curve abated when the Treasury curve uninverted and steepened in the fourth quarter. Globally, there was perceived momentum toward a phase-one trade deal between China and the U.S. and a decisive election win in the U.K. relieved some uncertainty about Brexit.

"We use the Bloomberg Barclays U.S. Aggregate Bond index as a sort of barometer for the entire U.S. investment-grade fixed-income market, as a way to see general market sentiment," Mr. Denis said. "Its return at the end of 2019, for the fourth quarter, was only 0.2%, which is good but it's not anything too flashy. But if you look at the return overall of 2019, it was nearly 9%, which is the best return in almost 10 years, the best year since 2011. So fixed-income markets did extremely well, as a whole, over 2019. But there was a little bit of a shift in which ones did better at the end of the year."

The Bloomberg Barclays U.S. Aggregate Bond index returned 8.72% and the Bloomberg Barclays Global Aggregate Bond index returned 6.84% for the year ended Dec. 31.

The median one-year return for long-duration strategies in Morningstar's universe was 19.92% and the median return for Morningstar's entire domestic fixed-income universe was 8.39%.

Columbia Threadneedle Investments' Long Duration Investment Grade Corporate Fixed Income portfolio topped Morningstar's list for the year ended Dec. 31, with a gross return of 25.48%.

"This strategy is managed against the long component of the Bloomberg Barclays U.S. Corporate index, with a very bottom-up, credit-intensive research focus," said Tom Murphy, senior portfolio manager and head of investment-grade credit at Columbia Threadneedle in Minneapolis. "There are 2,122 securities in the long corporate index. We have 150 in the fund. So you can call us a lot of things, but we're not closet indexers. What's reflected in the portfolio are the best ideas from our research staff."

The strategy's security-by-security selection process is finding that the majority of the best relative-value opportunities are in the BBB market, Mr. Murphy said, while duration and curve risk are kept neutral relative to the portfolio's long-duration benchmark.

"Duration was a tailwind last year, when you had rates go down anywhere from 90 basis points in two years to 60 basis points in 30 years," Mr. Murphy said. "We're not dismissing that, but our job is to beat our long-duration benchmark. This is a strategy that speaks to the asset-liability management plans of pension funds and the long-duration strategies of sovereign wealth funds and other long-term investors."

BNY Mellon Investment Management's Standish Long Corporate strategy was in second place with a gross return of 24.7%; Pacific Investment Management Co. LLC's Long-Term Bond-Long Credit strategy followed in third place at 24.65%; fourth on the list was PineBridge Investments' U.S. Long-Duration Credit Bond strategy, with 24.49% for the year; and First Trust Global Portfolios Ltd.'s Taxable Closed-End fund was in fifth place with a gross 24.4%.

Miami Beach, Fla.-based Thomas J. Herzfeld Advisors Inc.'s Fixed Income composite topped Morningstar's five-year fixed-income list for the sixth consecutive quarter, with a gross annualized return of 9.86%.

The strategy is in Morningstar's high-yield bond category and Erik M. Herzfeld, president and portfolio manager, said collateralized loan obligations were one of the portfolio's key performance drivers for the period ended Dec. 31.

"If you recall the end of 2018, we saw the leveraged loan market have a mini blowup," Mr. Herzfeld said. "In 2019, going into the end of the year, it was literally the opposite. We saw the leveraged loan market perform strongly and, in the fourth quarter, we were happy to have our positioning in lower-rated 'junk' debt. We felt that the Fed provided an incredible tailwind with their easing posture so we positioned ourselves accordingly, specifically in CLO equity."

The Federal Open Market Committee made a third consecutive 25-basis-point cut to the federal funds rate in late October and then left the rate unchanged at a range of 1.5% to 1.75% at its December meeting.

Mr. Herzfeld said the strategy will continue to take advantage of growth opportunities in lower-rated short-duration debt, while positions in longer-duration inflation-protected U.S. government bonds balance the portfolio against the potential for rising inflation in 2020.

"We feel that there's going to be a slowdown in Asia with regard to the (coronavirus)," Mr. Herzfeld said. "We think China will inevitably have a bad quarter, GDP wise. Their factories are not running at capacity. There's a lot of slack and there will be a lot less goods coming over from China. That might cause a shortage on the U.S. side, which may lead to inflation. So we think that will be a good environment for inflation-protected notes. They provide better credit quality, as well as protect against inevitable inflation pressure."

The Select High Yield composite from MacKay Shields LLC was in second place on the fixed-income list with a gross annualized return of 8.87% for the five-year period; Artisan Partners' High Income strategy followed in third place at 8.2%. Two strategies that also appeared on the one-year list were close behind, First Trust Portfolios LP's Taxable Closed-End fund was in fourth place with 8.04% for the five-year period and PIMCO's Long-Term Bond-Long Credit strategy rounded out the list with a 7.67% return.

The Bloomberg Barclays U.S. Aggregate Bond index returned an annualized 3.05% and the Bloomberg Barclays Global Aggregate Bond index returned 2.31% for the five-year period ended Dec. 31.

The median annualized five-year return for high-yield strategies in Morningstar's universe was 5.94% and the median return for Morningstar's entire domestic fixed-income universe was 3.41%.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Feb. 5.