Lipper Research Analyst Don Cassidy on KTLK AM-760
Thursday, July 1, 2004
Q. Don, here we are at midyear already(!). What are the major trends yousee in how mutual funds investors have fared?A. Yes, and happy third quarter!
Value beat growth, by about +6% to +2% at the small-cap end, and byabout +3% to +1% at the large-cap end.
Mid/small beat large-cap, by about +4% to about +2% overall
Real estate was still above average despite its severe drop in April,netting roughly a 5% average gain at midyear. People DO like their currentincome stream! And a rising economy helps REITs unless inflation becomessevere.
Natural Resources was the best sector, gaining about 8% after a smallslide the past couple of days. Obviously reflecting oil prices andoutlook.
Q. How did some of 2003's favorite fund types do in the first half of2004?
A. I always like to look back, because it so often reminds us NOT to chasethe big recent winners! Gold, which was a huge winner in 02-03, was theworst type of fund to own in the first half of 2004, with about an 18%average loss. Domestically, technology, which was up over 50% last year,was just about break-even in the latest 6 months. Probably it had gottenahead of itself late last year, anticipating the economy rebounding. Andbonds, which were a big favorite in 2001 until late last year, went flat.They lost about 1.5 or 2% on an NAV basis, which pretty much cancelled outthe current income you received.
Q. Are there clear patterns of kinds of funds that have tended towin/lose?
A. It was a generally choppy market for the past 5 months, but a fewthings did stand out. With great uncertainty and no particular big storiesto move investors to strong action, value continued to do better thangrowth. It would not surprise me if that continued through the elections,again because of the uncertainty. It is also pretty clear that the worldeconomy IS moving ahead and it looks like some of the banking reforms inJapan are taking hold, so their stocks and funds were the best (!), up 11%so far. I think they will continue to recover. China's economy is roaringalong, with growth in the upper single digits, but it looks like ourtechnology funds area, where things were so hot that they needed to rest.Those funds were down about 5 or 6% in the first half but long term,although volatile, they should be winners for those with patience andfortitude.
Q. What about the dollar and its effects?
A. We had a dollar rally in the first half but it may be over now. Thatimplies still holding some international funds. It looks like the Europeantheatre will grow the slowest, so keeping a representation elsewhere andespecially including some emerging markets funds would seem a good idea.
Q. Also, what about bond funds? People put a lot of money there in2002-03...
A. It was a pleasant ride while it lasted. But we think returns therewill now be negative for perhaps the next 2-3 years. And we say this notjust because the Fed has officially started raising rates. The Fed isusually a follower, reflecting actual trends. The domestic and worldeconomies have been expanding for over a year now, and that means risingdemands for capital and higher long-term rates. Even without big federaldeficits!
Q. How were bond returns in the first half?
A. About zero net, plus or minus a tiny amount. You got your interest butlost roughly the same amount in principal. And we think it will get morenegative looking out ahead.
Q. So how do people who want income invest now without losing theircapital?
A. It will be difficult. You need to go to shorter-term bond funds, toladdered funds, to flexible bond funds, to TIPs funds, and even to thosefairly new "inverse" bond funds, which move in the opposite direction ofbond prices. These can be used to hedge, or to seek capital gains as ratesrise.
Q. What if people own utilities or REIT funds?
A. If the inflation and the rate rise prove small and gradual, those fundsmay get a small benefit. But you need to be sure they are invested incompanies that RAISE their dividends, so your income stream is offsettingthe rising rate capitalization pull. Or you could look at naturalresources funds, at limited partnerships investing in energy, or maybe atroyalty trusts. You can invest in equities and slice off part of capitalto live on, rather than expose your principal to decline as rates rise!
Q. What do you think investors should do for second half?
A. First, stay diversified and flexible. Don't have too much bet on anyone theme. Lighten your bond fund positions. Stay international as wellas domestic. Try to think in advance how the elections may turn out, andwhat the implications would be. Act in advance rather than react with thecrowd after the fact. Major areas of difference are energy, theenvironment, health care, and tax rates. We think a mix of growth andvalue funds still makes sense. We also think that the small-cap side hasbeen played out for a long time and that at some point the bull market willbe led by large-caps, so we would own some of those kinds of funds.
Q. How can investors do their own homework?
A. We of course favor the free www.LipperLeaders.com website, whichanalyzes funds on five different scales to match investor preferenceblends. That could shorten the shopping list that you then take closerlooks at.
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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).
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