12 Stock Funds Set to Score in '94 Investing will be no Sunday in the park next year, but these picks can blossom anyway.
(MONEY Magazine) – Despite the storm gathering over U.S. markets, this is no time to abandon stocks. True, most analysts, including MONEY's Michael Sivy, regard a retreat of 10% to 15% by early next year as increasingly likely. The average stock now trades at three times the value of its company's assets and about 35 times its dividend -- the priciest levels since just before the 1987 market crash. Even so, you can't afford to bail out of stocks, as long as you have investment goals more than five years away -- say, paying your kids' college bills or financing your retirement. History shows that the market eventually will reward you handsomely for hanging in there. In the past 67 years, for example, stocks have fallen at least 10% in the space of a month seven times, only to rebound 20% or more within six months, according to Ibbotson Associates, a financial information services firm. Moreover, even in a sinking market, savvy investors can find plenty of opportunities to make money. Three types of mutual funds look especially promising next year: value funds, which invest in out-of-favor businesses with as-yet-unrecognized potential; domestic growth funds that have shored up their portfolios against a market downturn; and international funds that can capitalize on fast-growing economies in Asia or the anticipated economic recovery in Europe. We name a dozen funds below that will enable you to ride these three themes. You'll find the funds' performance records, phone numbers and investment styles in the table on page 60. (If you prefer to invest in individual stocks, see the box on page 54 for five that analysts expect to thrive no matter what happens to the overall market in '94.)
A GREAT YEAR FOR VALUE Stock pros figure that in 1994 value funds will outperform growth funds, which buy stocks with rapidly expanding earnings. Chief reason: Because value portfolios hold stocks that many investors have already given up on, the funds typically fall 33% less than the average growth fund when the market sinks, according to the Boston research firm Trinity Investment Management. Value investors' favorite stocks come in all sizes. One fund feasting on the giants among them, $2.8 billion T. Rowe Price Equity-Income, has returned 13.8% so far this year. Managed for eight years by Brian Rogers, 38, the fund is heavily invested in such wounded behemoths as $27 billion American Express, whose share price plunged 48% in the two years to December 1991. The financial services giant is now massively remaking itself, having sold its brokerage unit, Shearson Lehman, to Primerica and its trust company, Boston Co., to Mellon Bank. By mid-November of this year, the stock had rebounded 55% from its low. Rogers expects the tough '94 market to force many other ailing companies to go through similar makeovers to pump up their stock prices. "Shareholders and boards have become less tolerant of poor performance," he says. "That trend should be good for the types of companies we invest in." Rogers also likes a number of limping drug stocks, including Bristol-Myers Squibb, Eli Lilly, SmithKline Beecham, Upjohn and Warner Lambert. He thinks their prices, driven down 30% to 40% on average from their highs over the past two years, will rebound in 1994 when the market's panic about health-care reform is proved to be unfounded. Other fund managers search for undervalued shares among small companies -- those with fewer than $500 million worth of shares on the market. MONEY expects small stocks to outperform blue chips next year, as they often do in economic recoveries. However, the small fry typically fall farther and faster than large stocks in market setbacks, so following a value approach to small stocks can dampen what would otherwise be bone-jarring spills. Two disciples of the small-stock value philosophy, Charles Royce, 53, and Tom Ebright, 46, have managed the top-performing Pennsylvania Mutual fund to a 12.9% compound annual gain over the past 10 years. That fund is closed to new investors, but Royce and Ebright follow the same investing style with their two-year-old Royce Premier fund. The $28 million portfolio currently owns 50 stocks, compared with the 450 held by Pennsylvania Mutual. "Of the small - companies that we own, these are the ones we are most confident will realize above-average returns," says Royce. One example: Willis Corroon Group, an insurance broker in London that has swelled its revenues almost 26% to nearly $1.1 billion over three years by expanding market share in Europe and in the Far East. "We're convinced this is going to be one of the top three global insurers in profitability," Royce says. Ferreting out values that other investors have overlooked requires down-to- the-bedrock analysis of a company's earning prospects and true asset value. Few fund managers are better at this than Mario Gabelli, 51. His $883 million Gabelli Asset fund specializes in stocks with unrecognized earnings potential as well as those selling cheap relative to the value of their assets. The fund has returned 22% this year, thanks largely to gains among the 69 stocks that Gabelli jokingly calls his Gabelli Interactive Couch Potato portfolio (telephone, cellular, cable, broadcast, entertainment and publishing companies), now 34% of the fund's assets. Looking ahead to 1994, Gabelli thinks a stronger economy could lead to comparable gains in the fund's 60 industrial companies, such as Caterpillar, General Motors and Navistar. As a group, such companies make up 24% of the fund's assets. Another small-stock connoisseur, Mark Tincher, 38, of $960 million Vista Growth & Income, is not strictly a value investor. Instead, he takes an eclectic approach that measures both values and earnings momentum and singles out whatever shares, growth or value, appear to be the most promising. The fund's disciplined approach partly explains its enviable consistency. Every year since the fund's launch in 1987 (Tincher took over in 1991), it has never ranked below the top 4% of funds in its growth and income category. Vista's 29% annual compound return over the period is better than twice that of Standard & Poor's 500-stock index.
BUSTED GROWTH STOCKS WILL BOUNCE BACK With stocks at risky heights, does it make any sense to invest in a growth fund? The answer is yes, since a diversified portfolio ought to include funds that follow a variety of investing styles. The problem is that investors' rosy expectations for the most popular growth companies -- chiefly technology, telecommunications and gambling firms -- have pushed their share prices to dizzying heights. If earnings fall short, a distinct possibility in the slow- growth, rising-interest-rate economy that MONEY foresees for 1994, the stocks could be clobbered. As a result, the best growth funds of 1994 will probably be those that possess unusually big cash cushions or own growth stocks that have already taken a pasting and are now on the mend. Jim Craig, 38, steward of the Janus Fund, has adopted both defensive strategies. "Three years is old for a bull market," he explains. "And with so many smart people in the market, it's picked over." Accordingly, Craig is keeping 23% of the fund's $9 billion of assets in cash, up from 20% at the beginning of the year. Besides serving as a buffer against a market tumble, the cash allows him to pick up first-rate growth stocks if their prices drop to more attractive levels. Another 18% of his portfolio is in foreign stocks. That way, a full 41% of the fund's portfolio is not exposed to U.S. stock market risk. Among U.S. stocks, Craig has repurchased Wal-Mart and Gillette, two 1980s meteors that he sold before they fell to earth in 1993. He also owns telecommunications stocks with a twist. While other pros are chasing the latest media merger or small companies with breakthrough technologies that may quickly become obsolete, Craig owns long-distance carriers AT&T and MCI Communications. "Most people don't realize that half the price of a long- distance call goes to pay for access to the regional carriers," says Craig. As technology improves, he says, "the cost of obtaining that access will go down big time, and AT&T's and MCI's profit margins will expand." While the most popular growth stocks trade at record levels, stock market investors have dumped traditionally steady growers, such as name-brand food and health-care stocks, because of jitters over consumers' increasing price consciousness and worries about health-care reform. That gives fund investors a rare opportunity to buy well-run funds loaded with temporarily depressed stocks. For example, Parker Hall, 60, and David Fowler, 43, managers of the $1.8 billion Vanguard U.S. Growth Portfolio, held on to ex-earnings machines like Wal-Mart and WMX Technologies after they stalled out in 1993, as well as depressed drugmakers like Pfizer and Abbot Laboratories. As a result, the fund, which returned 47% in 1991, is down 3% this year. "Our big growth stocks have underperformed recently," admits Fowler, "but we're encouraged that they've been driven down to historically low prices compared with the market." Another star manager down on his luck, Roger Engemann, 53, runs Pasadena % Growth fund. The fund returned 68% in 1991 but has fallen 7.5% this year, its worst showing since an 11% loss in 1987. The fund buys shares of companies that are growing about twice as fast as the average company in the U.S. and stays with them until their growth rates slow. Three-quarters of the fund's assets are in what Engemann considers high-quality growth companies, such as Coca-Cola and Wal-Mart, whose share prices fell as the market favored cyclicals over growth stocks during the economic recovery in 1993. (Cyclical stocks' earnings vary with the fortunes of the economy; growth stocks tend to provide consistently rising profits every year.) "My stocks had a rotten year," admits Engemann, "but their earnings are growing 15% annually, and they're selling at market price-to-earnings multiples." In effect, he says, buyers like him are getting some of the best companies in America at also-ran prices. In contrast to a classic growth investor like Engemann, Mark Goldstein, 47, manager of $530 million Neuberger & Berman Manhattan, leavens his approach with elements of value investing. Goldstein figures that his stocks' earnings will grow about 25% in 1994, yet their P/E multiples average only 16.5. By comparison, earnings of the companies in the S&P 500 are expected to increase around 14% next year, and they are trading at an average P/E of 17 on estimated '94 earnings. Goldstein's portfolio includes health-care providers and drugmakers (again Pfizer is a favorite), gaming companies (top choice: Circus Circus) and retailers such as Tops Appliance City, a $400-million-a-year appliance discounter in metropolitan New York. "The company enjoys the highest sales per square foot of any discounter," he says, "and it plans to double the number of its stores to 10 over the next 18 months."
FOREIGN MARKETS WILL SHINE While domestic funds compete to squeeze profits out of the perilous U.S. stock market, the year's most successful portfolios may be those that invest outside the U.S. The Pacific Rim economies, for example, are growing furiously, while Europe, just now beginning to beat back a pervasive recession, is a value investor's paradise. And in Latin America, where markets have been euphoric over the U.S. Congress' endorsement of the North American Free Trade Agreement, daring investors can cash in on newly liberalized economies that offer some of the most attractive growth prospects in the world. One of the best of the foreign funds is $675 million Acorn International, managed by Gary Greenberg, 40, Leah Zell, 44, and her husband, stock-picking wizard Ralph Wanger, 59. (Wanger also manages the top-performing Acorn Fund, which invests mostly in the U.S.) Zell crisscrosses Europe, and Greenberg covers the Pacific Rim, Latin America and South Asia, while stay-at-home Wanger oversees the troika's investment strategy from the fund's headquarters in Chicago. Launched in September 1992, Acorn International rose 39.1% in its first year, vs. 24.1% for its peers. Acorn International's managers are betting on companies that can profit from consumers' desire worldwide to improve the quality of their lives. One top pick, Tanjong, a $529 million Malaysian conglomerate, makes wireless terminals for off-track betting. "These are incredibly popular because of a unique cultural twist," says Wanger. "Malaysia is a nation of Muslims, and gambling is against their religion. These hand-held terminals allow people to play anonymously." Acorn's managers also like $20 million SensoNor, a Norwegian electronics company, and $30 million Tele 2000, a Peruvian cellular-telephone and cable-TV firm. Both companies figure to grow in excess of 20% for the next five years, says Wanger. Acorn International has 31% of its assets in the Pacific Rim. A purer play on booming growth in the Far East is $300 million Newport Tiger, which returned 22% in 1992 and 48.6% through October of this year. Nearly half the portfolio, managed by Jack Mussey, 52, is in 17 companies listed on the Hong Kong stock exchange. They include $2.8 billion Hong Kong Telecom and Bank of East Asia (assets of $7.9 billion). Both companies are poised to take advantage of the tremendous boom in mainland China. While the Hong Kong stock market has had a stunning 131% run in the past two years, Mussey thinks the rally will go on for at least another 18 months as Hong Kong companies continue to grow at 15% to 20% annual rates. Moreover, he adds, as investors become more confident that the British colony will keep on booming after it is absorbed by mainland China in 1997, he expects the market's P/E to rise from 12.5 to 15 in the next 18 months. The end of the cold war has unleashed a free-market free-for-all throughout the world, not only in the Far East but also in Mexico and Latin America, the Middle East and even Africa. The premier fund manager in these financially uncharted areas is Mark Mobius, 57, of Templeton Developing Markets Trust. The $927 million fund currently has 33% of its assets in modernizing European ; countries such as Portugal, 45% in the Pacific Rim and 20% in Latin America. Started in October 1991, the portfolio is up 49.9% this year. "The outlook for these markets is extremely bright over the next several years," says Mobius. "As investors realize their potential, the markets will expand tremendously." If the idea of international investing makes you nervous, Tweedy Browne Global Value is one global fund that won't have you reaching for the Tagamet. The management team of Chris Browne, Will Browne, John Spears and James Clark Jr. -- all between the ages of 46 and 55 -- invest wherever they find good companies selling cheap in relation to earnings or assets. And when they say cheap, they mean it. Fully 35% of the $120 million portfolio is invested in stocks selling at less than half the value of their assets. More than 80% of the portfolio is invested in Europe. The reigning pessimism has created bargains in stocks such as $140 million Franco Tosi, an Italian manufacturer of paper and plastic packaging material. By Clark's calculation, the stock is selling at 59% of the company's net assets of about $23 a share and about 10 times earnings. Furthermore, Franco Tosi's dividend yield exceeds 5%. Clark expects the firm to recover as the recession eases. Despite rebounds in some markets, European stocks remain far less expensive than American ones, says Will Browne. "Europe's markets remind me of the United States in 1973-74 and 1982, when everyone was depressed," he says. An investor who bought at the end of those down years would have posted 12-month gains of 37.2% and 22.5%, respectively. In what figures to be a lean year for investors, any fund that can give you that kind of return is definitely a keeper.
CHART: NOT AVAILABLE CREDIT: Sources: Morgan Stanley, Morningstar Inc. CAPTION: A defensive dozen for 1994's challenging market Investment advisers expect these 12 top-performing funds, listed within their categories by 1993 returns, to excel next year. The growth picks lagged the others in '93, but the pros predict that they will rebound in '94.