THE BEST MUTUAL FUNDS IN A ROUGH PERIOD FOR STOCKS, PUNCTUATED BY THE CRASH AND THE KUWAIT INVASION, BOND FUNDS WERE WINNERS.
By JOSHUA MENDES REPORTER ASSOCIATE Rahul Jacob

(FORTUNE Magazine) – SALMON swimming upstream to spawn face the same kind of challenge as stock pickers in the three years through August 31, 1990. Though it soared to new highs in early summer, the market finished downhill from where it started, moving from a lofty pre-crash level to a humbler post-Kuwait one. Not only did most classes of stock funds trail the total return on Standard & Poor's 500- stock index, which is not unusual, but the typical return was also miserable in absolute terms as well. All the more remarkable, then, that a few standout stock funds rang up impressive annual returns. Strong salmon, those.

The lists that begin on the next text page -- compiled for FORTUNE by Morningstar Inc., a mutual fund rating service based in Chicago -- show the top-performing mutual funds in each of 13 categories during this period. The rankings are based on capital gains plus dividends or interest. The categories are generally arranged in descending order of risk, within several broader groupings. Displayed first is the most nail-biting category of all, aggressive growth stock funds, which often use such techniques as shortselling and high leverage in the hope of winning big. At the other end of the spectrum are staid Treasury bond funds. In between come hybrid funds appealing to middle-of-the- road temperaments, namely balanced funds holding both stocks and bonds, and convertible bond funds. There are also specialty categories, such as funds investing in small companies, municipal bonds, and international stocks and bonds. When it came to average performance by category during the three-year period, the race went to conservative funds that took few chances. International bond funds, roaming the globe for the best interest rates and helped by a general rise in foreign currencies against the dollar, did best. The ace in this group was Paine Webber Master Global, with an average yearly return of 14.7%. The best-performing fund of all, however, was a stock fund that triumphed despite the period's handicaps. Gabelli Growth scored a 16.3% yearly return, miles ahead of the 1% average for all growth funds. Meanwhile, Kaufmann Fund grew at a respectable 10.4% clip even though aggressive growth funds were losing money at an average 2.3% a year. (To learn how the managers of Kaufmann and other top funds are investing now, see the interviews that follow.) Not all mutual funds were considered in these rankings. To make the cut, they must be diversified geographically and by industry. Thus, the Japan Fund and other single-country funds do not qualify, nor do sector funds that concentrate on one industry. Another requirement: The fund must have been managed by the same person during the entire three-year span. For funds with multiple managers, at least one must have stayed around. Finally, the fund must be open to new investors. STELLAR PERFORMANCE is a powerful reason to invest in a fund. But you should also carefully consider costs, which are shown in the rankings along with other important data. Some funds charge a front-end sales load, not reflected in the performance figures on the lists, which can run as high as 8.5%. Investors in funds that bested the market, such as Templeton Foreign and Oppenheimer Global, more than recouped this charge. But when the fund performs poorly, the sales load adds insult to injury. A handful of funds have no - front-end load but levy a charge when you exit. Every fund has annual expenses -- management fees, and in some cases, ''12b- 1'' promotional fees allowed by the Securities and Exchange Commission rules. Together these average around 1% of assets, even in no-load funds. But the fees, which are accounted for in the performance data, can be as high as 3.5% at small funds with few investors. Often disregarded by investors, but extremely significant, is a fund's portfolio turnover. This is a measure of how often a fund buys and sells stocks. For instance, a fund with 100% turnover changes its stock holdings completely over the course of a year. The brokerage commissions, not included in management fees, can nibble at a fund's performance. Worse, the investor can be hit with sizable taxes on capital gains distributions if the winnings are big. More attractive are funds like Pasadena Fundamental Value, which has achieved outstanding gains primarily on paper while holding its turnover to 24%. Finally, you should examine the fund's level of risk. In measuring this, Morningstar looks at the variability of a fund's performance. If the monthly return often lags behind the return on 90-day Treasury bills, the fund is considered high risk. This does not necessarily mean that the fund is a bad investment -- it may have roared past T-bills -- but that it gives a bumpier ride. Because Morningstar watches fluctuations over several years, junk bonds don't yet show up as high risk despite their recent troubles, but only ''above average'' in most cases. If you like to sleep soundly, you may want to limit your selection to mutual funds with ''low'' or ''below average'' risk ratings. Still another option is to abandon the idea of trying to beat the market at all. Vanguard Index 500, a no-load fund managed by Vanguard Group in Valley Forge, Pennsylvania, and not on these lists, is designed merely to shadow the S&P 500. Its three-year average return of 2.5% trailed the index a bit, but a minuscule management fee -- most recently 0.21% -- accounts for most of the discrepancy. The risk level is just what you'd expect: ''average.''

CHART: NOT AVAILABLE CREDIT: SOURCE: MORNINGSTAR INC. CAPTION: AVERAGE ANNUAL RETURN -- LAST THREE YEARS As a group, international bond funds led the mutual fund parade in the three years through August 31, while aggressive growth stock funds came in last. Stock funds Hybrid funds Bond funds

CHART: NOT AVAILABLE CREDIT: SOURCE: MORNINGSTAR INC. CAPTION: THE TOP FUNDS BY CATEGORY AGGRESSIVE GROWTH STOCK FUNDS GROWTH STOCK FUNDS GROWTH & INCOME STOCK FUNDS EQUITY INCOME STOCK FUNDS SMALL COMPANY STOCK FUNDS INTERNATIONAL STOCK FUNDS BALANCED FUNDS CONVERTIBLE BOND FUNDS JUNK BOND FUNDS MORTGAGE-BACKED BOND FUNDS TREASURY BOND FUNDS MUNICIPAL BOND FUNDS INTERNATIONAL BOND FUNDS