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New fund winners in 2Q
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June 30, 1999: 11:19 a.m. ET
Large growth funds take a back seat to small cap, Asia and energy funds
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - Listen to Chuck Royce talk about Marshall Industries and you can see how sweet the second quarter must be for small cap managers.
Marshall's stock surged 80 percent this week after Avnet Inc. announced plans to buy the electronics distributor. And Royce's seven small cap funds, which own about a 10 percent stake in Marshall, will earn 10 to 20 percent in the second quarter alone.
"The small cap world is full of takeover stories," said Royce, president of Royce Funds. "The advantage really is these stocks have been depressed for three years. It's an area where there's tremendous opportunities."
This is payback time for all of the beaten-down fund categories that watched large growth funds steal the show in 1998 and the first quarter of 1999.
Preliminary figures through June 21 show that Asia and Japan funds, small- and mid-cap funds, Europe stock funds and even natural resources funds are leaping to the top of the performance charts, according to Chicago fund-tracker Morningstar.
Large cap growth funds, meanwhile, are down an average of 0.55 percent for the quarter through June 21, Morningstar said.
What a difference a quarter makes
"It's a classic rotation away from everything that did well in 1998 and the first quarter of 1999," said Christine Benz, an analyst at Morningstar. "Everything that did lousy in that time has picked up."
Why is everything changing? For one, the world economy has recovered from assorted fiscal crises, said Kevin Rendino, portfolio manager of the $12.7 billion Merrill Lynch Basic Value Fund, which is part of another category that has turned around.
Asian markets show promise, and Brazil weathered its devaluation without a meltdown. Last year, investors were too nervous to own anything but the top stocks -- the so-called "Nifty Fifty."
"It was the 'haves' and the 'have-nots' last year," Rendino said. "A lot of stocks were obliterated to almost stupid valuations."
Now, managers who looked beyond the glamour names of Microsoft (MSFT) and Cisco (CSCO) are getting rewarded, Rendino said. For example, he's owned IBM (IBM) since 1991. Rendino bought the stock at 25 when the company was floundering amid a reorganization. He's made $540 million on that investment since then.
Likewise, Rendino bought 2 million shares of Novell Inc. (NOVL) for another fund while the stock was trading at 8. Now, Novell is trading at 27, and he's made a $20 million profit.
"The playing field has gotten a lot more level," Rendino said.
Another sector that's come back from the dead is natural resources, thanks in part to a change in investor sentiment, said John Segner, manager of the Invesco Energy Fund. The fund is one of the top winners in the category, up about 33 percent as of Monday, according to Morningstar. Last year, it lost 27.83 percent.
"These stocks were grossly oversold last year and the first quarter of 1999, to be perfectly frank," Segner said. "People were too negative and they were throwing out the fact that we do need energy in our society."
Segner said even last year, oil demand grew by 1 percent. Oil demand is about 75 million barrels a day, compared with 58 million barrels a day 10 years ago.
"Energy demand world-wide is growing," Segner said. He predicts a significant increase in earnings in oil companies by 2000.
"I'm very optimistic for the next 18 to 24 months," Segner said.
The dogs of 2Q
At the other end of the spectrum, every category of bond funds except emerging markets lost money through June 21.
Benz, of Morningstar, attributed the downturn to rising interest rates. (The Fed was expected to raise interest rates Tuesday). The biggest loser was long government bonds, off 3.92 percent.
Emerging markets bond funds were up 4.95 percent in the second quarter, but Benz said those funds are more like equities since they are so tied to the performance of those economies.
Investors felt more comfortable with the state of the economy that they didn't mind moving away from large growth stock funds, Benz said.
"A lot of the large growth stocks are taking a breather," Benz said.
Large cap growth fund losses also mean that managers overall are having an easier time beating the S&P 500, Benz said. In 1998 and early 1999, a few big names led the market. So managers had a hard time beating the benchmark unless they owned big stakes in stocks like Microsoft, Dell (DELL) and Pfizer (PFE). Now, there are other paths to good returns since more stocks are doing well.
While statistics for the entire second quarter aren't available, consider these numbers, Benz said. Through May 31, 888 funds out of 2,587 beat the S&P 500. During the same period of 1988, only 389 funds beat the benchmark.
"This shows that now there are other ways to beat the index, Benz said.
What should you do?
But before you start selling your second-quarter losers, consider this: Financial planners say the best approach is a diversified portfolio.
Remember that in 1998 some people said you didn't need to buy anything but large growth stocks. That you didn't need to invest overseas because you could get international exposure through U.S. multinationals. That value and small cap stocks -- even diversification -- were dead.
Above all else, the second quarter returns prove that diversification, despite what some people said last year, is very much alive, said Harold Evensky, a financial planner at Evensky, Brown & Katz of Coral Gables, Fla.
"Last year people said it was a 'new era,' " Evensky said. "If anything, the 'new era' is dead."
For example, some of Evensky's favorite recommendations in previously beaten-down categories are doing great this year. The Matthews Pacific Tiger Fund is up 59 percent year to date as of June 25, while the Undiscovered Managers Behavioral Growth Fund, a small cap fund, is up 11.7 percent in the same time and the Oppenheimer Real Asset Fund, in the natural resources category, is up 12 percent, he said.
Evensky recommends people take their time developing an asset allocation plan and stick with it. If they do anything at all, they should only be trimming around the edges.
"I'm not surprised by the turnaround," Evensky said. "I was only surprised that large caps beat everything else for so long."
A sweet success story
Royce, of the Royce Funds, has certainly been finding a path to success besides Microsoft. While his funds fared better than their peers in 1998 by delivering positive returns, they all had single-digit losses in the first quarter of 1999, he said.
He bought Marshall Industries (MI) for seven small cap funds and four other funds because he thought it was an undervalued company with strong management and promising earnings.
But Royce never imagined the stock would soar 80 percent on Tuesday when Avnet (AVT) announced plans to buy it for $830 million in stock, cash and debt.
Royce sees equally good potential -- though not necessarily takeover possibilities -- in companies like insurer Zenith Insurance (ZNT), clothing retailer Charming Shoppes (CHRS) and energy company Denbury Resources (DNR).
"These stocks could move 50 percent to 100 percent in the next couple of years," Royce said. "The market cycle we're in will be led by small caps over the balance of this year." 
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