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Funds '01: Not so terrible
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January 2, 2002: 3:14 p.m. ET
The fourth quarter alleviated some of the pain for funds and offers hope for '02.
By Martine Costello
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NEW YORK (CNN/Money) - Stock mutual funds were walloped in 2001, with their worst losses in 30 years. It was the first time in history that they lost money two years in a row.
Indeed, the recession, a bear market and the Sept. 11 terrorist attacks left most funds in a state of shock, producing returns that were even more pitiful than those of 2000.
But woven into a terrible year were glimmers of good news that may portend better days ahead. In the last three months, the war in Afghanistan, the Federal Reserve's 11 interest-rate cuts and the government's plans for a multi-billion-dollar stimulus package helped fuel a powerful rally. It's lifted hard-hit sectors like growth and tech funds from having a monumentally dreadful year to having just a really bad year.
"The numbers would have been a lot worse if it weren't for the turnaround in the last three months," said Sheldon Jacob, a fund analyst and editor of the newsletter No-Load Investor. "The real losers of 2001 were big winners in the fourth quarter."
A year for the record books
While the final figures have yet to be tallied, U.S. domestic stock funds lost a record 11.37 percent in 2001, compared with a loss of 13 percent for the S&P 500, according to preliminary numbers from Morningstar, a Chicago fund-tracker. Out of 26 stock-fund categories tracked by Morningstar, only five had any gains. (Click here to see the full list of winners and losers).
Most of the winners were the niche players in the fund world, such as precious metals funds, up 20.19 percent. Small-cap value funds, wallflowers during the 1990s bull market, gained 17.44 percent. Real estate funds, a sector of safety, earned 9.31 percent. Small blend funds earned 8.28 percent, while mid-cap value earned 6.30 percent.
Bond funds also had a banner year for the second year in a row, rising an average of 5.43 percent. Among the top performers were long-term bonds, up 7.39 percent, and short-term bond funds, up 7.13 percent. Alan Papier, a bond analyst at Morningstar, attributes the strong returns to record interest-rate cuts and stock market volatility.
Emerging markets bond funds were another winner in 2001, up 8.45 percent, because most sidestepped the pain in Argentina.
Click here for the top five winners and bottom five losers in large-cap value, mid-cap value and small-cap value funds.
On the equities side of the Street, many funds suffered double-digit losses. Among the hardest-hit were tech funds, down 38.29 percent, communications funds, off 34.61 percent, and large growth funds, which lost 23.62 percent.
Big fund families like Janus took a big hit, with more than half of Janus' funds in the bottom of their categories, said Dan Culloton, another analyst at Morningstar. Vangard fired the outside managers at its struggling U.S. Growth Fund, Lincoln Capital, and Merrill Lynch fired star manager Jim McCall barely two years after the company lured him away from PBHG Funds, he said.
New fund launches also dwindled in 2001, Culloton said, dropping by more than 70 percent from 2000.
One of the few technology funds in the black this year, Seligman Communications & Information, succeeded in part by avoiding flameouts in networking and optical systems companies like Nortel Networks, Lucent Technologies and Cisco Systems, said manager Paul Wick.
Wick stuck with "fairly recession-proof" names like Symantec (SYMC: up $2.25 to $69.36, Research, Estimates), Lexmark International (LXK: up $1.42 to $61.17, Research, Estimates) and Microsoft (MSFT: up $2.19 to $69.23, Research, Estimates). Four of his holdings were also acquired in mergers, such as Galileo International by Cendant.
Click here for winning and losing funds in short-term, intermediate and long-term bonds, as well as multi-sector bonds.
Outside of the United States, international funds gave up an average of 16.85 percent, with Japan stock funds off 30.35 percent and Europe stock funds down 20.97 percent.
It was a rare year in which global recession also brought down virtually every international stock-fund category, said Andrew Clark, an analyst at Lipper. The losses, in fact, negated the benefit of diversifying overseas. "Normally everything doesn't go into the dumpster at the same time," Clark said.
Damage that's hard to measure
There was also the psychological toll of the terrorist attacks in the heart of New York's financial district. Among the victims in the World Trade Center were David Alger, a star manager who perished along with more than two dozen fund managers and research analysts at Fred Alger Management.
Alger's Spectra Fund was the top-performing growth fund of the 1990s, and he managed or co-managed about 16 other funds, according to Morningstar. He was also a mentor to many top managers, including Janus veterans Helen Young Hayes and Warren Lammert, as well as Tom Marsico, a former Janus heavyweight who founded Marsico Capital Management, Culloton said.
"It's absolutely impossible to quantify the impact of Sept. 11," Culloton said.
The underlying good news
Still, for all the tragedy that took place in September, it also marked a turnaround for mutual funds. When markets reopened on Sept. 17 after a four day halt in trading, managers like Seligman's Wick and Robert Rodriguez of the FPA Funds started buying.
"It was a tale of two periods -- before Sept. 17 and afterwards," Rodriguez said. He did so much buying that the cash weighting in FPA Capital Fund dropped from 10 percent of the portfolio to 3 percent in a single week.
Rodriguez increased his exposure in the energy sector to 8 percent from 1 percent by Sept. 24, buying shares in natural gas companies Ensco International (ESV: down $0.34 to $22.79, Research, Estimates), Patterson-UTI Energy Inc. (PTEN: down $0.32 to $22.61, Research, Estimates), and National Oilwell (NOI: down $0.69 to $19.05, Research, Estimates), which have all risen at least 100 percent since then.
Rodriguez also added to his retailing stake, and was one of the biggest buyers of Zale Corp. (ZLC: up $0.39 to $41.34, Research, Estimates) , which increased to about $41 a share from $24 on Sept. 17.
In fixed income, Rodriguez took a more cautious stance in late September and October by investing in shorter-term bonds. Earlier in 2001, the age of the bonds in the fund had been a little over 3 years, but by fall dropped to 2.2 years. Bonds in the fund's benchmark, the Lehman Government Corporate Index, have an average age of 5.2 years. "September 11 did have an effect on how we thought about things," he said of his more cautious stance.
The well-timed purchases pushed FPA Capital to fifth-best performer among small value funds, earning 38.13 percent. FPA New Income is also a top performer, fourth on the list of intermediate-term bond funds with returns of 2.33 percent.
Good news in the fourth quarter
The early part of 2001 was so bad that many fund analysts seemed to have a hard time assessing the rosy returns of the past three months. Large growth funds gained 14.81 percent in the fourth quarter, while technology gained 36.75 percent and mid-cap growth moved up 19.64 percent.
The fourth-quarter pickup has also helped the industry stem the exodus of money out of mutual funds that happened after Sept. 11. Overall, funds have seen net new inflows of $444 billion through October, compared with $302 billion in the same time period last year, according to the Investment Company Institute. Combined assets in funds at the end of November stood at $6.93 trillion, compared with $6.96 trillion in the same time in 2000.
Click here to see winners and losers in communications, health, and world stock funds.
Still, few, if any, analysts are willing to say whether the latest figures represent the start of a new bull market for U.S. stocks -- and what that means for funds in 2002. The moral of the story, however, is that diversification will be an important theme for individual investors.
"If anything, these last two years have taught us that we should temper our expectations," said Morningstar's Culloton. Many leading fund managers, like PIMCO's Bill Gross, Legg Mason's Bill Miller and retired Vanguard founder Jack Bogle have all predicted mid- to high-single digit returns for growth stocks next year. 
* Disclaimer
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