British naturalist Charles Darwin traveled to the Galapagos Islands off the coast of Ecuador and many other remote locales to gather specimens for developing his theory of evolution.
Investors searching for the fittest mutual funds have a much easier task: They can travel back a short time to the extraordinary 24 months in the U.S. stock market that ended in March.
Like remote islands that nurture their own life forms uninfluenced by larger populations, the two-year period from March 1999 through March 2001 will long be studied by market researchers for its unique perspective on many investment species.
Typically, two years’ worth of performance is too short a period to judge fund results. But the extraordinary boom and bust in technology stocks from March 1999 through March 2001–marked by as much as a 130 percent gain for the Nasdaq composite index between 1999 and 2000, followed by a 2000-2001 plunge that reached 65 percent–revealed more than just bulls and bears.
In January, mutual fund critic Roy Weitz, publisher of the popular FundAlarm.com Web site, noted that investors would have achieved nearly identical returns from January 1999 through November 2000 by buying shares in several pairs of hot and cold mutual funds.
For example, $10,000 invested in the ProFunds Ultra OTC Investors fund and Longleaf Partners Small Cap fund produced exactly the same result over the 23-month period he tracked–$10,573 (before tax effects, if any).
ProFunds Ultra OTC achieved its performance by posting a 233 percent return in 1999 and a 68 percent loss in the first 11 months of 2000. Longleaf, by contrast, scored a 4 percent return in 1999 and a 1.6 percent return in the 2000 period.
“Without consistency, even spectacular annual returns can be of little benefit,” Weitz wrote in his report. “The flip side, of course, is that even modest returns, without large losses, can provide a significant boost to your balance sheet.”
But with the benefit of hindsight from the dramatic 24-month cycle ended March 30, even more striking evidence emerges.
An investment of $10,000 in ProFunds Ultra OTC over that period would have left investors with just $2,747–a 251 percent gain followed by a 92 percent loss. Longleaf Small Cap yielded $12,119.79–a 1.8 percent gain followed by a 19.1 percent gain.
Using data from Chicago-based portfolio trackers Performance Analytics and Morningstar, the search for topsy-turvy results can be conducted among Chicago-based mutual funds.
For example, Oakmark Fund, the flagship fund of Harris Associates, flipped from an 18 percent loss in the 12 months ended March 2000 to a 32 percent gain in the 12 months ended March 2001.
Conversely, the Kemper Technology fund flopped from a 126 percent gain to a 55 percent loss.
A reasonably constructed fund portfolio might contain both funds in the name of diversification.
Diversification a plus
“You had a classic 180 degree turn in the two primary modes of behavior–greed and fear,” said William Lowery, executive vice president of Performance Analytics.
“One is not better than the other, but this underlines the importance of why you want to have both of these elements,” Lowery said.
But the data reveal evidence of another species, sometimes called tortoises.
These funds outperformed the historical annual return on stocks–about 12 percent–in both periods and crawled through the boom and bust unscathed.
For example, Chicago-based Keeley Small Cap Value Fund returned 12 percent in the 12 months ended March 2000 and 16 percent over the next 12 months.
As a result, Keeley beat the Oakmark Fund and Kemper Technology fund over the two years. A $10,000 investment turned into $13,016 at Keeley, versus $10,794 at Oakmark and $10,142 at Kemper.
Chicago-based UAM FMA Small Company fund did even better, turning $10,000 into $13,653.50 over the 24 months ended in March. A 17 percent return in the first 12 months was followed by a 16 percent return in the second 12 months.
Over the five years ended last March, the fund’s annual return was 13 percent.
On a calendar year basis, “1999 was a challenging year,” said Kathryn Vorisek, chief investment officer at Fiduciary Management Associates, the adviser to the fund. The fund declined nearly 9 percent that year, compared with a 20 percent advance for the benchmark Russell 2000 small-company index.
“You do get pressure to keep up with the indexes, but people hired us to be a small-cap value manager,” Vorisek said.
Timely sale
A timely sale of technology stocks in March 2000 prompted results to improve, she said. The fund redeployed money into financial services, just in time for a substantial rally in bonds. “2000 played out almost perfectly for us,” Vorisek said.
“We have a strict focus on valuation and search for a catalyst that’s going to change the rate of earnings growth,” she said. The tech wreck was a catalyst for gains by less-glamorous sectors.
Currently, Vorisek’s team has cut the fund’s position in financial services in favor of health-care and consumer products companies, including Steris, United Stationers, Bally Total Fitness and Alberto-Culver.
Robert (Tad) Carr, chairman of Fiduciary Management Associates, said a key to surviving exaggerated market swings, such as the 24 months ended last March, is the relatively small amount of money the fund manages.
With $1.2 billion under management overall and just $300 million in the small-cap value category, “One advantage is our size,” Carr said.
Many studies have demonstrated that smaller actively managed funds can reposition themselves more nimbly than giant funds during volatile periods.
Should investors diversify funds at the extremes or pick from the middle of the road? Some roller-coaster funds proved their worth in the 24 months of this study.
For example, the Chicago-based Driehaus Emerging Markets Fund turned a $10,000 investment into $23,630 in the 12 months ended March 2000. A 40 percent drop in the next 12 months still left investors with $14,119, beating Keeley and FMA Small Company.
“It would depend on your appetite for risk and volatility,” Vorisek said. “That’s an individual decision.”
Putting the numerous varieties of mutual fund results from the March 1999-March 2001 period under the microscope provides one of the best opportunities in decades to find the bulls and the bears, the rabbits and the tortoises.
Dumb questions: Many companies are issuing more shares of stock to offer more shares to key employees. What does this do to my shares of stock?
In a word–dilution. Unless by some miracle stock giveaways to insiders make them work harder on your behalf (there is no general evidence that this happens), whatever profits the company makes are divided among more shares, meaning less for you.
Why are capital gains treated as a negative when describing the performance of a mutual fund?
Capital gains are the name of the game for most investors. Without them, you’d be left with dividend and interest income.
But for taxable investors, capital gains taxes paid later are always better than taxes paid sooner.
That’s why investors with taxable accounts–as opposed to those with tax-deferred retirement accounts–prefer that fund managers let their winners ride and, when they sell, offset capital gains with capital losses.
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In the belief that there is no such thing as a dumb question, send your queries to me at 435 N. Michigan Ave., Chicago, IL 60611; phone 312-222-3599; my e-mail is webarnhart@aol.com or bbarnhart@tribune.com.
