The 9 Best Funds You Can Buy Today Of the 3,095 mutual funds in our performance report, these nine -- plus 21 runners-up -- are rated tops for today's stock and bond markets.
(MONEY Magazine) – Picking the most promising mutual funds can be about as difficult as forecasting the weather a year from now. However, it can often be done if you follow the clues buried in every fund's performance record. That's because a fund that has consistently excelled in certain economic conditions is likely to do so again when those conditions reappear. -- Thus to find great U.S. stock and income funds, we went back to periods when the economy most closely mirrored the moderate growth and rising interest-rate environment we see ahead. For example, we looked for domestic funds that flourished in previous economic expansions marked by rising short-term interest rates, as you find today. In the end, we settled on the nine terrific buys profiled in the following pages, along with 21 runners-up (a table with key data on each appears on page 146). -- Then, in our most comprehensive listings ever, starting on page 65 we introduce the 1994 Money rankings of 3,095 funds and the top-performing funds during the past one, three and five years. And that's not all. -- In the story on page 160, financial pros offer advice to investors like you about funds to buy, keep or dump. -- Finally, beginning on page 150, we tell you how to get the most out of a new cost-saving way to buy funds. Let the funds begin.
Use These Total-Return Funds to Earn Money Safely With investors pumping $3.6 billion a week into equity mutual funds in late 1993 seeking to boost their prots, it seems almost un-American not to join the parade. Yet there are reasons for caution: First, the average share in Standard & Poor's 500 index recently traded at a perilously high 23 times earnings -- almost double its average during the past 20 years. Second, recent economic strength has led some economists to predict that long-term interest rates could rise a percentage point or so over the next 18 months, and short- term rates could jump as much as 1.5 points. An increase like that could trigger the much anticipated 10% to 15% market tumble sometime within the next six months. This, then, is the perfect time to think defensively by considering the conservative income-generating stock funds known as total-return funds. Total- return managers invest in a solid blend of dividend-paying stocks and bonds. Their funds tend to hold up much better than aggressive funds in choppy markets, partly because of the cushion provided by a steady stream of income. A few total-return funds -- most notably, the two standouts and four runners- up cited below -- are especially known for their deftness in markets beset by rising interest rates. To select our defensive stalwarts, we asked the Venice, Fla. investment research firm Ned Davis Research to identify two periods during the past 20 years in which economic conditions and interest-rate moves closely resembled what many economists expect to happen in the next 18 to 24 months. The firm's answer: from January 1977 to May 1979 and September 1982 to September 1984. Both stretches coincided with growing economies, and in both periods, short- term rates rose much faster than long-term rates. Though the S&P 500 ended each period higher than it began (4.3% in 1977-79 and an impressive 53% in 1982-84), both stretches included setbacks. Stocks lost 7.2% in calendar year 1977 and 3.4% between November 1983 and June 1984. Having chosen our benchmarks, we then asked Chicago fund research firm Morningstar Inc. to identify total-return funds that excelled during these two periods. Overwhelmingly, the winners had taken a value approach to investing -- that is, their managers attempted to buy stocks at prices below what they perceived as the true worth of the companies' assets or earnings potential. Explains James Stack, editor of the investment newsletter InvesTech: "Value funds' approach tends to get them into beaten-down cyclical stocks (those whose profits rise and fall with the strength of the economy) at exactly the right time -- just before the companies reap the benefit of an expanding economy." For example, an ability to catch cyclicals on an economic rebound explains why $1.4 billion no-load Lindner Dividend outperformed all conservative funds in 1982-84 and all but five in 1977-79, and why we think it could beat most of its peers again. Recently reopened to new investors, the fund was run during the late '70s and early '80s by founder Kurt Lindner, who set the fund's dual goals of high income (the recent yield was 6.5%) and capital appreciation from undervalued stocks and convertible bonds. Lindner retired in January 1993, leaving the reins to his protege, Eric Ryback, 41, a 12-year veteran of the fund. In the current recovery, Ryback is again betting on cyclicals, with 23% of the fund's assets in such industries as transportation (7% of the portfolio) and steel and other base metals (6.5%). "Our cyclicals should benefit from an expanding economy," says Ryback, "and to insulate the portfolio against rising interest rates, we've sold off preferred stock shares and shortened the maturities of our bonds." Ranked ninth among total-return funds in both previous rising-interest-rate periods, $6.6 billion no-load Fidelity Equity-Income emphasizes capital appreciation over income. Its manager of six months, Stephen Petersen, 37, keeps his yield only 20% to 40% above that of the S&P (currently the fund yields 3.4%). Instead, Petersen likes bargain-priced stocks that he believes will surprise Wall Street with improved earnings. Petersen trained with the now retired Bruce Johnstone, who was responsible for the fund's stellar performance in the rising-rate markets of the late 1970s and early 1980s. Petersen has partly insulated Equity-Income from the ill effects of rising U.S. interest rates by keeping 20% of the fund in foreign stocks and fixed- income securities. Domestically, however, Petersen prefers cyclicals (33% of the portfolio), and has major holdings in automakers and transportation companies, including the railroad CSX Corp. We think four other total-return funds deserve honorable mention. The most conservative is $4.2 billion, 4%-load Franklin Income, a high-yielder (recently 7.2%) that's only 55% as risky as the average total-return fund. Though $1.1 billion no-load Mutual Beacon did not become part of its current fund group until January 1985, it is now a virtual twin of $3.4 billion Mutual Shares, which ranked third and second, respectively, among total-return funds in 1977-79 and 1982-84. (Mutual Shares is now closed to new investors.) Both funds are run by the talented veteran Michael Price, 43, and both have returned 20% more than the average equity fund during the past three years with only about a third of the risk. Unlike our preceding value-oriented honorees, $190 million no-load Berger 101 co-managers Bill Berger, 68, and Rod Linafelter, 34, are confirmed growth jockeys, but they too are counting on cyclicals (21% of the portfolio). Like Berger 101, $1.5 billion, 5.75%-load Kemper Total Return is a growth fund by nature that currently has an opportunistic stake in cyclicals. Almost a sixth of its stockholdings are in industries such as railroads and chemicals. If history is any guide, that figures to be a winning formula for the next couple of years. -- Jerry Edgerton
Profit Big From Small Aggressive Stock Funds The interest-rate increase of up to one percentage point that Money forecasts during the next 18 months could be bad for stocks -- and devastating for aggressive stock funds. After all, when stocks in general fall in value, aggressive funds tend to plunge. Why on earth, then, would anyone risk getting aggressive now? Simple: By investing in such funds selectively, you stand to get the highest possible returns. Not all funds classified as aggressive growth and small- company funds are equally risky. History proves that some of these funds can be extraordinary performers, even when rates are on the rise. Had you scorned portfolios like Twentieth Century Select and Pennsylvania Mutual at the start of 1977, for example -- a period, like today, in which rates were climbing as the economy was expanding -- you'd have passed up gains of 85.9% and 68.1% respectively by the middle of 1979, compared with just 4.2% for the S&P 500. In previous markets that resemble this one, the top-performing aggressive ^ U.S. stock funds tended to invest in shares issued by small or medium-size companies, especially "value" stocks with relatively low price/earnings and price-to-book ratios -- measurements of how much investors are currently paying for a company's estimated future earnings and the value of its assets. The rationale is that rising rates often accompany quickened economic growth, which boosts small firms' earnings more sharply than those of big multinational firms. That's because big-corporation profits get cushioned during U.S. recessions by stronger overseas sales. The growth spurt is often strongest for companies in cyclical industries such as automobiles, machinery, steel and consumer appliances, which are largely dependent on domestic economic strength. These firms, in turn, tend to be among the favorite investments of value fund managers. If this economic and investment pattern holds, one of the most promising funds for today's market figures to be $682 million no-load Twentieth Century Heritage Investors; it specializes in dividend-paying, midcap companies with a median market value of around $1.3 billion. Like all eight stock funds of the 35-year-old Kansas City-based firm Twentieth Century (total equity fund assets: $20 billion), Heritage is run by a management team (pictured on page 62). Their computers scan corporate data for 7,000 U.S. and 3,500 foreign firms for signs of accelerating earnings or revenue growth. While the firm's investment style is growth, this fund is currently loaded with cyclicals that are just beginning to benefit from the economy's newfound strength -- including retailer Dollar General, carpet manufacturer Shaw Industries and auto-parts maker Federal-Mogul. "We look for any sharp change in earnings," explains chief investment officer Robert Puff Jr., 48. "Even a company that normally grows at 5% a year will catch our attention if it starts growing at 10%." Another favorite, $43 million no-load Royce Premier (one of our "Six Little Funds That Could Win Big," November 1993), is a fund with champion bloodlines. Co-manager Charles Royce, 54, is one of the fund industry's most accomplished small-company value investors. His $1 billion no-load Pennsylvania Mutual fund outperformed every other small-company fund in the 1982 to 1984 rising- interest-rate market and beat all but four competitors in the 1977 to 1979 period. Penn Mutual is now closed to new investors, but Royce and co-manager Tom Ebright, 49, follow the same investment approach with two-year-old Premier. Says Royce: "We like to buy strong companies whose stocks have fallen because of temporary trouble."One such issue is Grey Advertising, which Royce believes will profit from higher advertising spending by companies looking to increase recognition of their brand names. In addition to those two top picks, seven other aggressive funds look especially promising -- two small-cappers, four midcaps and a large-cap fund. The 20-year-old, $1.4 billion no-load Lindner Fund, co-managed by Eric Ryback, 41 (who also runs Lindner Dividend), and Robert Lange, 49, focuses on companies with potential capital gains -- with less concern for dividend yield than its sibling. Lindner (whose median market capitalization is $735 million) recently had 27% of its stocks in industrial companies, such as Birmingham Steel and General Motors. The most volatile of our picks is $809 million no- load Vanguard Explorer, partly because the fund specializes in the smallest of small-cap stocks; its median market value is just $200 million. Explorer nevertheless outperformed the average equity fund in the two rising-rate periods we examined. The four midcap selections prefer more established companies, which tends to make their shares rise steadily but also offers investors less potential for explosive gains. Recently, no-load Evergreen Fund manager Stephen Lieber, 68, moved 17% of his $630 million value-oriented portfolio into battered health- care stocks such as Merck and Johnson & Johnson. Despite the $31 billion mountain of assets it has under management, Fidelity Magellan's holdings have a medium-size median market value of $2.9 billion. Although manager Jeff Vinik, 34, has never led the 3%-load fund through a rising rate market, he was trained at Magellan by 1980s star Peter Lynch, who has. Manager Robert Salomon Jr., 57, combines elements of both value and growth investing in $105 million no-load Salomon Bros. Capital. Lately he has steered the fund into automobile- parts suppliers that he believes will continue to have strong sales. At the low-risk end of the midcap spectrum is $3.1 billion no-load Nicholas Fund. Manager Albert Nicholas, a 24-year fund veteran who follows strict value guidelines, recently had 35% of the portfolio in retailing and consumer and industrial products. The only large-cap fund on our list of seven honorable mentions is $4.7 billion, 5.5%-load AIM Weingarten, run by a team led by Jonathan Schoolar, 32. Two of their current favorite stocks: Motorola and American Express. Like virtually all funds that relied on big-company stocks last year, Weingarten's performance was underwhelming; in fact, it barely broke even last year. Yet its proven ability to spot companies on a hot streak should make the fund a star. -- J.E.
Sail Past Rising Rates in These Bond Funds With the economic forecasters predicting a rise in interest rates over the next 18 months (see page 60), income investors could be in for rough seas. Reason: When interest rates climb, the price of bonds -- and the share value of funds that invest in them -- can capsize or sink. That doesn't mean that every income investment will suffer in '94, though. Certain segments of the bond market, notably municipal and high-yield corporate bonds, will be largely insulated from rising rates and the damage they can cause. If you place your bets carefully, you can reap total returns of 5% to 9% in the outstanding bond funds cited in this story -- not bad for a year when stocks are forecast to advance only about 4% to 8%. You should avoid Treasuries and investment-grade corporates, however. The expected one-percentage-point gain in long- and intermediate-term rates would carve 10.5% out of the price of a 20-year T-bond and 7% from that of a 10-year issue. That's enough to cancel out their yield over the 18-month period. Moreover, you can't escape the damage by fleeing to shorter maturities. With short-term rates forecast to climb by an even steeper 1h percentage points, 4% of the value of a three-year bond could disappear -- that's roughly equal to its payout too. Fortunately for investors, prices and yields on tax-free municipal bonds are likely to hold steady, thanks to a unique supply-and-demand situation. Investors are flocking to such issues to beat the new higher tax rates -- assets of tax-exempt funds rose 26% during the first 10 months of 1993 -- and that trend figures to continue as high-bracket taxpayers recoil from the sticker shock of their '93 returns. Yet the supply of new bonds is shrinking: Only $179 billion in new issues is expected this year, compared with some $290 billion in 1993, mainly because many municipalities have finished taking advantage of today's low rates by refinancing their older, high-rate debt. Thus for investors in the 28% federal tax bracket or higher, funds that invest in munis offer an attractive combination of total return and acceptable risk. One top choice is $1.8 billion Dreyfus Intermediate Municipal. This fund, which, like all the ones in this section, imposes no sales charge, is currently paying a 4.6% yield. But since that yield comes tax-free, it is equivalent to a taxable 6.4% for people in the 28% federal tax bracket, 6.7% for those in the 31% band and 7.2% for those in the 36% bracket -- all higher than the 5.1% being paid by comparable taxable funds. Manager Monica Wieboldt has shown a talent for profiting in good times and limiting the damage in bad. During the three years to Jan. 1, for example, when rates trended generally downward and most funds enjoyed capital appreciation, her fund averaged an annual total return of 10.4% -- well ahead of the 9.4% gain of the average intermediate muni fund. Yet in 1987, when the yield on 10-year bonds jumped by two percentage points in just nine months, the fund lost only a third as much as the average tax-exempt fund (for more details on this and other bond funds, see the table on page 146). So even if munis prove more vulnerable to rate rises than the experts predict, this fund is well positioned to avoid losses. The intermediate-term issues (current average weighted maturity: 9.9 years) that it holds are now paying as much as 90% of the yield of longer-term bonds yet would lose much less of their value if muni yields do climb along with other rates. "We've been in an attractive part of the yield curve,"she says, "and we expect it to stay attractive." Moreover, Wieboldt is well stocked with high-quality issues that are more liquid and thus more stable in price: 94% of her assets are in bonds rated BBB or above by rating services such as Standard & Poor's. Fund investors who are loath to take on even an intermediate-term dose of interest-rate risk can get a surprisingly strong yield and the price stability, almost, of a money fund with Vanguard Municipal Short-Term. This fund's ultrashort maturity is currently just 15 months -- compared with a maximum of 12 months for money funds and about three years for the average short-term bond fund. Equipped with this conservative time frame, the fund has been able to stay afloat during periods of rising rates; in 1987 it enjoyed a positive return of 4.1%. Co-managers Ian MacKinnon and Chris Ryon were recently posting a yield of 2.8%, equivalent to a taxable 4.1% for investors in the 31% bracket (short-term taxable funds are paying 4%). "This is an ideal choice for investors ready to take a baby step forward from bank certificates of deposit and money-market funds," says Robert Tracinski, a bond fund analyst at Morningstar. Like munis, junk bond funds are also likely to shrug off an interest-rate rise, but for a different reason. The performance of low-rated bonds depends mostly on the issuer's financial strength, and as the economy gradually improves, these companies find it easier to pay off their debts. Of course, even with such improvement, junk still carries a much higher risk of default than high-grade munis do. So stick to high-quality junk funds invested in issues paying around 9%, rather than far chancier 14% bonds. That's the tack taken by Bill Veronda, manager of $304 million Invesco High Yield (recent yield: 7.6%). Only 4% of his assets are in issues rated lower than B, compared with an average of 20% for all junk funds. In addition to the three picks above, here are four more that could shine in '94. Both Vanguard MunicipalPIntermediate Term (4.6%) and Scudder Medium- Term Tax Free (4.6%) resemble the Dreyfus fund in holding top-quality, middle-of-the-maturity-road issues. Nicholas Income (8.2%) is another fine junk option. And for people who don't need a tax break and are wary of junk, T. Rowe Price's GNMA fund (5.9%) could be a good defensive pick, since mortgage-backed securities have historically done better than Treasuries when rates climb. They lost only 2.9% in the rate run-up of '87, for instance, while Treasury prices sank by 8.5%. -- Carla A. Fried
Go for Growth in the Right Overseas Funds These days it's hard to beat the allure of foreign shores. We're not talking about ancient ruins or exotic cuisines. We mean the phenomenal stock market returns found abroad. The average -- not the exceptional -- U.S.-based international fund soared 37.5% in '93. Compare that with 12.9% for domestic equity funds, and you can see why some fund companies report their international funds are drawing 80% of investors' new cash. If you missed the boat in 1993, don't fret -- you still have time to sign up for a global tour. Though foreign markets are unlikely to sustain the torrid pace of last year's gains, investment analysts still expect them to outpace the U.S. market this year, thanks to falling interest rates in recession- wracked Europe and above-average growth in the budding economies of Southeast Asia and Latin America. Most forecasters figure world markets will gain an average of 10% in 1994, vs. just 4% for blue-chip U.S. shares, and top foreign funds should gain far more. "Even though foreign stock prices rose substantially last year, they still are not high relative to U.S. stock prices, by historical standards," says Earl Osborn of the San Francisco investment advisory firm Bingham Osborn & Scarborough. "I would expect overseas returns to run ahead of U.S. returns for the next couple of years." To cash in on these superior results, and to increase the diversification of your portfolio, analysts recommend that you steer as much as 25% of your holdings into international funds. However, picking the right funds can be tricky. Since the majority of the 182 overseas funds available today are less than five years old, comparing performance records is not much help. To identify promising funds, investment pros focus on managers with proven international experience. They also favor funds that invest in many markets, because single-country funds leave you too vulnerable to unanticipated problems in one economy. Here's a rundown of the two funds our experts liked best and six other first-class tickets: Warburg Pincus International Equity is the top choice of Ken Gregory, editor of the newsletter No-Load Fund Analyst. This $570 million fund has posted a 32.6% average annual return since it was launched in 1989. And though the fund is only 4h years old, it is managed by Richard King, 49, who spent nearly a decade analyzing investments in Hong Kong. Not surprisingly, King tilts the portfolio toward Asia, planting 51% of the fund's assets in Pacific Rim nations. Economically shaky Japan, however, accounts for less than a third of that Asian stake, a relatively small portion considering that the Tokyo market is nearly 10 times the size of Hong Kong's, the region's next largest. Roughly a third of the 100 stocks in the fund are in emerging markets -- generally, nations with gross domestic product of less than $10,000 per capita, vs. more than $20,000 for the U.S. -- such as Korea, Mexico and Turkey. Most of these countries are likely to enjoy rapid growth of as much as 7% a year through 1999, while more mature economies lumber along at an annual pace of 3% or less. King favors companies that stand to profit from what he calls "once in a lifetime" changes in a nation or industry. One example: Inchan Iron & Steel, which controls 70% of the Korean market for heavy construction beams. King expects the continuing migration from Korea's rural areas to its cities to set off a building boom. In emerging markets, he is partial to banks, believing that rising national incomes increase the demand for checking accounts, car loans and home mortgages. That's the reasoning behind the fund's 2% stake in Bancomer, one of Mexico's largest banks. Our other top choice for international investors is Montgomery Emerging Markets, a favorite of Michael Stolper, publisher of the newsletter Mutual Fund Monthly. This $591 million fund -- a rare no-load in the category -- has returned 28.9% annually since its inception in March 1992. Co-managers Josephine Jimenez and Bryan Sudweeks, both 39 and five-year veterans of emerging markets, oversee an eclectic portfolio of some 200 stocks in 25 countries; their largest stakes are in Mexico, Brazil and China. They spend 20 weeks yearly overseas looking for promising companies. They also recruit investment analysts worldwide to study at Montgomery's San Francisco offices. After returning home, these pros alert their former hosts to local corporate standouts. One stock they found that way was Pakistan's Adamjee Insurance, whose share price rose more than 125% in 1993. Jimenez and Sudweeks divide their dollars between established firms and promising newcomers, or as Sudweeks says, "blue chips and jewel boxes."In Thailand, for instance, the fund owns both the giant Bangkok Bank and Wongpaitoon Footwear, a small manufacturing partner for U.S. athletic shoemaker Reebok International. Several other international funds get high marks from experts. Among them are two granddaddies of the field: $2.1 billion Scudder International, launched in 1953, and $3.7 billion T. Rowe Price International, founded in 1980. These no-loads boast 10-year average annual returns of 16.5% and 17.4%, respectively. And emerging market fans might look at $1.1 billion Templeton Developing Markets (5.75% load). Well-regarded manager J. Mark Mobius, 57, has 10% of the two-year-old fund's assets in telephone companies such as Philippine Long Distance Telephone, which he thinks will profit from that nation's rapid industrialization. If you are convinced that markets in a particular area of the world are poised for an especially strong year, consider regional funds. In Europe, Sheldon Jacobs, editor of the No-Load Fund Investor, recommends $312 million Invesco European, which has 27% of its assets in Germany and France, where falling interest rates are expected to boost stock prices over the next 18 months. In Asia, $448 million Merrill Lynch Pacific A (6.5% load) boasts an impressive average annual return of nearly 20% since 1983. Finally, to diversify your portfolio -- and boost its yield -- some financial pros suggest putting up to 40% of your international stake into foreign bond funds. But the near-term outlook for these funds is dicey. This year the German mark and other leading currencies are expected to decline in value another 10% against the U.S. dollar -- on top of last year's 2.8% dip -- taking a big bite out of foreign bond returns. Southfield, Mich. financial planner Ron Yolles steers foreign-yield seekers to $1.4 billion Scudder International Bond (5.1% yield); its manager, Larry Teitelbaum, 42, uses currency futures to protect the portfolio against a rising dollar. -- Gary Belsky
CHART: NOT AVAILABLE CREDIT: Source: Morningstar Inc. CAPTION: 30 Great Funds to Buy Now The three tables below give you all the vital statistics on what we believe will be 30 of the most profitable funds to own over the next 18 to 24 months. Included in the 30 (24 no-load funds and six load funds) are the nine first- string choices that seem poised to post truly outstanding returns; they're distinguished by the stars before their names. Since we sought out funds that are well suited for current economic conditions (marked by a likely rise in U.S. interest rates and rapid expansion abroad), it's not surprising that certain investment styles predominate among our choices. For example, except for Kemper Total Return, all of our other 14 domestic equity funds follow either a value-oriented investment approach or one that blends value and growth. All seven fixed-income funds lean toward intermediate- and short-term bonds, which are less interest-rate sensitive than long-term bonds. Indeed, the longest average maturity among these fixed-income picks is Dreyfus Intermediate Muni's 9.9 years. Among our 30 choices, the best performers in 1993 were the internationals, led by Templeton Developing Markets and Montgomery Emerging Markets, which rode rallies in Latin America and Asia to gains in excess of 58%. According to our data supplier, Morningstar, Japan is the largest holding of four of our eight global portfolios. Although Merrill Lynch Pacific has a 73% stake in Japan, the other funds' 15% to 28% holdings are hardly votes of confidence in that recession-wracked market.