NEW YORK (Money Magazine) -
After three years of pounding market losses you may be wondering if any fund can provide protection in bad times as well as the opportunity to profit when good times return.
That's the concern we had in mind when we set out to select our 10 Best Funds for 2003. We began by assembling a list of the top-performing stock and bond funds since January 1995 -- a period that includes the height of the bull market as well as the crash that followed.
|Also in the Mutual Fund Guide
To identify consistent performers, we eliminated funds that made the cut only because of one or two spectacular years. We also ruled out funds with above-average expenses and those with recent manager changes. In making our final selections, we sought funds that ranked in the top quartile of their category for most of the past three-, five-, 10- and 15-year time periods.
Of our 10 funds, three focus on large-cap stocks, two on midcaps and two on small-caps. One mixes stocks and bonds and two are pure bond funds. Among the equity funds, some buy stocks with strong growth potential, others look for undervalued shares and some blend the two approaches. That means you can use these funds to build a diversified portfolio or to fill the gaps in your current holdings.
|Fund ||Ticker ||3-year return ||Expense ratio |
|Fidelity Dividend Growth ||FDGFX ||-3.9% ||0.95% |
|Growth Fund of America ||AGTHX ||-9.4 ||0.75 |
|Thompson Plumb Growth ||THPGX ||6.6 ||1.2 |
|American Century Equity Income ||TWEIX ||9.1 ||1.25 |
|Calamos Growth ||CVGRX ||-1.5 ||1.5 |
|FPA Perennial ||FPPFX ||6.9 ||1.24 |
|Royce Total Return ||RYTRX ||10.8 ||1.24 |
|Van Kampen Equity & Income ||ACEIX ||2.5 ||0.82 |
|Dodge & Cox Income ||DODIX ||10.8 ||0.45 |
|Fidelity Spartan Investment Grade Bond ||FSIBX ||9.9 ||0.5 |
When you look at the veteran managers who run these funds, you'll find that they share more than consistent winning records. All pay close attention to controlling risk, whether by favoring dividend stocks, observing valuation guidelines, shrewdly mixing stocks and bonds or, in the case of the two pure bond funds, sticking with high-quality issues.
Another thing they have in common: These managers have shown that they can handle whatever the market throws at them, making them ideal choices for these uncertain times.
Here are our picks:
Fidelity Dividend Growth: Large-cap blend
As the son of a Merrill Lynch broker, Charles Mangum has always been fascinated by the market. At age 14, he bought a few shares of convenience-store chain Circle K and watched his investment double. "I thought, 'This is so much fun,'" says Mangum, now 38.
A few years later, he suffered his first loss when another of his picks, Nichols Oil, went bankrupt. Mangum was unfazed. "It didn't change my view of stocks," he says. "I knew I loved investing."
Since then, Mangum has clearly learned a thing or two about choosing stocks. As manager of $14 billion Fidelity Dividend Growth, he has posted 5.6 percent average annual returns over the past five years, topping 97 percent of the fund's large-blend peers.
Some 80 percent of the 100 stocks in the portfolio pay a dividend, even if it's a low one (recently the fund yielded a modest 0.83 percent). "Our dividend screen serves to help us identify more mature growth stocks," Mangum says. "These companies tend to be less risky and stronger financially."
When Mangum buys stocks that don't pay a dividend, he looks for firms with strong cash flow and the potential to pay a dividend, such as Microsoft and entertainment company Clear Channel. [Microsoft issued its first stock dividend Jan. 17, 2003.]
That emphasis on strong balance sheets kept Mangum largely clear of tech during the late 1990s. His portfolio is typically concentrated in health-care, consumer and financial stocks, mainly large-caps and midcaps such as longtime top holding Cardinal Health (CAH: Research, Estimates). But among his strongest 2002 performers was one of his few tech buys, Dell Computer (DELL: Research, Estimates).
While the stocks seem solid, this fund does take chances. Mangum makes concentrated bets -- his top 10 stocks account for some 40 percent of his portfolio -- and he'll scoop up troubled but financially strong companies.
Of course, not all of Mangum's bets have paid off. He holds Bristol-Myers Squibb (BMY: Research, Estimates), which plunged some 50 percent in 2002 on news of earnings shortfalls and accounting problems. "Our research got that one wrong," he concedes.
But a similar bet on Merck (MRK: Research, Estimates) paid off. "Merck got extraordinarily cheap earlier this year -- it was trading at a 13 [price/earnings] multiple with a 4 percent yield," Mangum says. "We figured all the bad news was out." Over the past three months Merck has rebounded 22 percent.
Growth Fund of America: Large-cap growth
This $37 billion fund from the venerable American Funds group rarely shines brightest in a raging bull market, yet it stands out during the market's dark days.
During the go-go growth stock years of the 1990s, when some funds were posting triple-digit annual returns, Growth Fund of America, with its team of six low-profile managers and a highly diversified portfolio, may have seemed passe. But when many of its rivals stumbled, GFA proved its worth. Since the tech crash of 2000, GFA has fallen a total of 36.3 percent vs. a 52.9 percent loss for the average large-cap growth fund.
The fund's long-term success -- it ranks in the top 2 percent to 7 percent of its peers over the past three-, five-, 10- and 15-year periods -- can be traced to its cautious take on growth.
Its managers never roll the dice on shaky industries or desperate turnaround stories. Instead, they diversify across virtually every sector, loading up on steadily growing large-caps with moderate price/earnings ratios such as student-loan financier SLM (SLM: Research, Estimates) and drugmaker Forest Laboratories (FRX: Research, Estimates), both recent winners for the fund.
In an unusual move, last year the group scooped up a smattering of beleaguered bonds in companies like media leader AOL Time Warner (AOL: Research, Estimates) (MONEY's parent), carmaker Ford Motor Co. (F: Research, Estimates) and credit-card issuer Capital One (COF: Research, Estimates).
AOL's debt was trading for as little as 72 percent of the bonds' face value and paying a 12 percent to 13 percent yield, says manager James Rothenberg, making it a low-risk way to buy the company. "It was a bit of a surprise that overnight you had reasonable credits that traded like junk," he says. In recent months, those bond holdings have returned upwards of 25 percent, helping to temper stock losses.
Thompson Plumb Growth: Large-cap blend
In the world of investing, Madison, Wis., is about as far from Wall Street as you can get. Fortune 500 CEOs rarely come to the midwestern college town. If they do, joke the locals, it's probably time to sell the stock.
That's just fine with the father-and-son management team at the $515 million Thompson Plumb Growth. "I don't socialize with anyone in the industry," says John C. Thompson, 34, whose father John W., 59, co-founded the firm in 1984. "In key moments, you have to go against the grain."
Such conviction was tested in the late 1990s. Like many large-cap managers, the Thompsons had fallen hard for tech stocks. But unlike many of their peers, they began to pare back their exposure to high fliers like EMC and Intel when the P/E ratios for the tech sector topped 50. "Those valuations made me sick to my stomach," says John C. Thompson.
By early 2000, when the bear market began, the managers had cut the fund's tech stake sharply, moving into financial firms with strong earnings growth and solid balance sheets, such as Wells Fargo (WFC: Research, Estimates) and Associates First Capital. It was an unpopular move, even within the company, Thompson recalls.
In the new millennium, though, the duo has been vindicated. While the average large-cap blend fund finished in the red in both 2000 and 2001, Thompson Plumb Growth posted gains of 26 percent and 19 percent, respectively. The fund was down 21.5 percent in 2002 (through Dec. 27), in part because of disastrous bets on Qwest and Tyco.
But Thompson says the market is rife with well-priced blue chips like ChevronTexaco (CVX: Research, Estimates), Coca-Cola (KO: Research, Estimates) and General Electric (GE: Research, Estimates).
American Century Equity Income: Midcap value
American Century Equity Income is another fund that doesn't stray far from its heartland roots. The Kansas City, Mo., management team, led by Phillip Davidson, 47, and Scott Moore, 38, is made up chiefly of Midwesterners, and they invest with a conservative "show me" attitude.
"We have a healthy skepticism," Davidson says. "We might use Wall Street research and listen to what the companies are saying, but we do our own analysis."
That cautious strategy kept this midcap value fund largely clear of the dot.com meltdown and has helped to generate stellar returns.
The $1.3 billion American Century Equity Income fund ranks in the top 16 percent of its peers, with a 7.9 percent annualized return over the past five years. Davidson and Moore take a disciplined value approach, using quantitative screens to identify out-of-favor but financially strong companies with yields that are high compared with their histories. (Recently, the fund yielded 2.2 percent.)
If the managers like a company that does not pay a dividend, they might pick up its convertible or preferred shares instead -- lately such holdings made up about 30 percent of fund assets.
Classic value fare accounts for the bulk of the 70-stock portfolio, especially energy, financial and utility companies. Top holdings recently included a Union Pacific preferred issue, Piedmont Natural Gas and British Petroleum. Last year, Davidson and Moore added more Kimberly-Clark, which had fallen on concerns over a disposable-diaper price war with Procter & Gamble (PG: Research, Estimates) and now yields 2.3 percent.
Davidson and Moore's strict value approach leads them to sell as soon as their stocks become too richly priced, which has produced relatively high turnover in the portfolio -- typically they hold their stocks no longer than four months -- and may generate a lot of capital gains for investors.
Calamos Growth: Midcap growth
When John Calamos started his fund company in 1977, his focus was on convertible securities. Using quantitative screens, he developed a method for choosing convertibles based on company balance sheets as well as macroeconomic themes.
Over the years, Calamos Asset Management has branched out into fixed-income and equity funds, including $2.3 billion Calamos Growth, which has returned a superb average annual 17 percent over the past 10 years, ranking No. 1 in its category.
Moreover, those returns have been remarkably consistent; in each of the past seven years, the fund has ranked in the top 25 percent or better in its group.
That success is a family affair -- Calamos, 62, runs the fund along with his nephew Nick Calamos, 40, and son John Jr., 37. Like many growth investors, the managers look for small-cap and midcap stocks that are likely to beat Wall Street's earnings expectations. But they refine this hunt with many of the quantitative techniques developed for their convertible fund.
For example, relying on balance-sheet and credit analysis, they will scoop up less traditional growth fare such as beaten-down but financially strong companies with improving returns on capital. And if their valuation models show that a sector is becoming high-priced, they will quickly get out.
By getting rid of tech early in 2000, the managers managed to end that year up a hefty 26.6 percent; in 2001 the fund fell only 7.7 percent vs. a 20.9 percent loss for the average midcap growth fund. Last year, when the fund fell 15.9 percent vs. a 22.6 percent average loss for the category, the managers chose to double the fund's tech stake to 23 percent of assets.
Among their favorites: Amazon (AMZN: Research, Estimates) and eBay (EBAY: Research, Estimates). "We see these companies as the Wal-Marts of the Internet," Calamos Sr. says. The bulk of the 100-stock portfolio is in consumer-services companies; the fund's largest holding, at 2 percent of assets, is Apollo Group (APOL: Research, Estimates), which provides higher education courses. Up 47 percent last year, it was recently added to the S&P 500.
Once the team finds a company it likes, it may not hold that stock for long. Turnover has exceeded 200 percent in some years. Still, Calamos Sr. notes, "we trade with an eye to tax efficiency." Indeed, thanks to its matching of gains and losses, the fund ranks in the top 1 percent of its category for tax efficiency.
FPA Perennial: Small-cap blend
The FPA family is best known as the home of superstar manager Robert Rodriguez, who runs the small-cap FPA Capital and the FPA New Income bond fund.
But the Los Angeles firm houses another topnotch small-cap offering, $71 million FPA Perennial, which boasts a five-year average annual return of 10.2 percent that outpaces Capital's by nearly two points -- and places the fund in the top 6 percent of all small-cap blend portfolios.
Managed since 1995 by Eric Ende, 58, and Steven Geist, 48, Perennial never had a losing year on their watch until 2002, when it fell 10.9 percent.
The secret of the pair's success is an intense focus on a company's financials and a stock's valuation. They favor industry leaders that generate enough cash to buy back shares, make acquisitions or pay a dividend. Another key financial measure is return on capital.
They recently loaded up on Renal Care Group (RCI: Research, Estimates), an operator of kidney dialysis centers, which has no debt and a return on capital that tops all its major competitors. They expect the company to increase earnings by some 15 percent a year by scooping up competitors, repurchasing shares and opening new locations.
Ende and Geist buy the companies they like only when the stock is selling at a discount to its historic highs or to the market's P/E. That discipline has served them well during this bear market -- the fund is up 18.4 percent since March 2000 -- but didn't hold them back in the bull market. In 1999, for example, Perennial gained more than 25 percent, four percentage points more than the S&P 500.
Cautiously optimistic about tech and telecom, Ende and Geist currently have 15 percent to 20 percent of the fund's assets in those sectors. "Tech valuations are wildly volatile," Ende says. "They're kind of scary. We're interested in companies with highly established business models, leading technology and fortress balance sheets giving you downside protection." Recent picks that meet those tests include computer storage maker SanDisk and telecom-equipment maker Advanced Fibre Communications.
Finally, fund investors looking for a tax break might consider Ende and Geist's other portfolio, FPA Paramount. Since taking over the lagging fund in early 2000, they essentially have made it a carbon copy of FPA Perennial. Its dreadful long-term record means that the fund should have enough stored-up losses to avoid a capital-gains distribution until at least 2009.
Royce Total Return: Small-cap value
At age 63, small-stock maven Chuck Royce has more experience than any three typical fund managers put together. A classic value investor, he began running his first fund, Pennsylvania Mutual, back in 1973, and today manages or co-manages nine small-stock funds.
Of those, Total Return is a low-risk choice for today's dicey market. Over the past five years, the fund has gained an annual average 7.6 percent, ranking it among the top 9 percent of its small-cap value peers -- and with only half the volatility of the average small-cap fund.
Following the Royce fund playbook, Total Return is highly diversified: Its $882 million portfolio is spread among more than 300 stocks. More than 80 percent of those holdings pay a dividend. Investors frequently overlook the fact that some 2,000 small stocks pay dividends, Royce notes, adding, "In the small-stock dividend-paying universe, where the yields are often under 3 percent, buyers often don't factor the dividends into the price, so we often get that yield for free."
Financial services companies and industrial firms usually make up the bulk of assets. Top holdings include Alliance Capital, insurance broker Arthur J. Gallagher and building-maintenance provider ABM Industries, which formerly served the World Trade Center and saw its stock fall from a high of $18 to $13 after Sept. 11. "We believe this is a superb company that will bounce back," Royce says. The stock recently traded at $15.50 with a yield of 2.4 percent.
Over the past year, Royce has uncovered some dividend-paying bargains among utility stocks, which he doesn't normally buy. "Because Enron tarred the whole industry, we did find a few opportunities," Royce says. Among his buys: DQE, yielding 10.3 percent, and Hawaiian Electric, yielding 5.8 percent.
Royce's firm was acquired by brokerage Legg Mason in 2001. But the deal leaves his funds' management, as well as its expenses and no-load status, unchanged. Royce has lost none of his enthusiasm. "I love what I do, and I have no intention of stopping," he says. "Just as the '90s were the large-cap decade, the next 10 years will be the decade of small-caps."
Van Kampen Equity & Income: Domestic hybrid
In 2002 James Gilligan, the lead manager of Van Kampen Equity & Income since 1990, set an impressive mark: His 8.9 percent annual loss beat the typical hybrid (stock and bond) fund's 10.2 percent loss -- and put him in the top half of his category for the 12th straight year, something few, if any, managers have achieved.
Gilligan's streak translates into an impressive long-term return: Over the past 10 years, the $5.1 billion fund has returned an average of 11.9 percent annually, putting it within the top 10 percent of all stock and bond funds.
Gilligan, 44, spices up his portfolio with a healthy dose of convertible bonds -- they typically make up 10 percent to 20 percent of fund assets. Gilligan and his team see convertibles, which pay a yield but also capture some of the company's stock price appreciation, as a less risky way to play the equity market.
When the managers believe a company is a good buy but they're not sure how long it will take for the market to recognize its value, he explains, a convertible lets them collect a yield while they wait for the stock price to rise.
It's been a winning approach. In 1997 he picked up the convertible of then-distressed Laboratory Corp. of America, which conducts medical diagnostic testing. With Medicare reimbursements down, Lab Corp. stock had plunged more than 60 percent.
Gilligan, noting an uptick in revenue and margins, saw an opportunity. And his bet paid off: While the stock rose almost 700 percent in three years, Gilligan picked up the convert's 10 percent yield and a significant portion of the price gain. Today he's eyeing energy service as well as health-care convertibles.
Gilligan is equally risk-conscious about his equity choices. Employing a mix of value and growth styles, he and his team look for companies with low valuations (relative to their historic range) and improving earnings, such as beaten-down drugmaker Bristol-Myers Squibb and insurer Allstate.
Although he's willing to pay more for companies with strong returns on capital or high gross margins, he remains leery of chasing hot stocks. "Buying the favorites is a loser's game," Gilligan says. "You have a higher potential for disappointment."
Dodge & Cox Income: Intermediate-term bond
Talk about a class act. Dodge & Cox Income, which buys high-quality, mainly intermediate-term government and corporate bonds, has made a specialty of delivering safe, steady returns.
Over the past 10 years, the $1.9 billion fund has gained an annual average 7.9 percent, placing it among an elite 6 percent of intermediate-term bond funds. Its worst one-year performance, a modest 2.9 percent loss, came during the rate shocks of 1994.
And all this comes at a low price. Its expense ratio of 0.45 percent is less than half of the 1.11 percent average for taxable bond funds. The fund recently yielded 5.3 percent.
Credit for the fund's superb performance goes to Dodge & Cox's team of 11 managers, led by Dana Emery, 41, head of fixed income. During the Internet bubble, the team's skeptical value-oriented style kept the fund clear of tech disasters.
The bulk of the fund is stashed in safe issues, with roughly two-thirds of assets in government or top-rated bonds. But lately the team has sampled corporate bonds that have fallen to just below investment grade. "We don't typically buy below-investment-grade issues," says manager Thomas Dugan, 37. "But as we've sifted through the residue of the meltdown, we've seen some compelling opportunities."
Among them: the debt of Xerox and Dillard's Department Stores.
Once the Dodge & Cox managers find a bargain, they stick with it. In November 2001 the fund purchased BBB-rated five-year AT&T bonds yielding 6.5 percent. Over the next six months, as AT&T bond prices fell, they sold the five-year issue and bought longer-term AT&T bonds that at the time yielded more than 10 percent. "We believe that the telecom industry will not evaporate," Dugan says, "and that AT&T will be one of the survivors."
Given the prospects for flat or rising rates, the team has loaded up on mortgage securities, mainly 15-year mortgage pass-throughs -- loans that are largely paid down and therefore less subject to prepayment or deferred-payment risk. Says Emery: "In a rising-rate environment, pass-through bonds offer stable income over the long term." That remains the hallmark of Dodge & Cox.
Fidelity Spartan Investment Grade Bond: Intermediate-term bond
The $456 billion Fidelity family of equity funds is the largest and most renowned in the nation. But just 55 miles from its Boston headquarters, amid the pine forests of New Hampshire, you'll find the lesser-known side of Fidelity and one of the best-kept secrets in the bond industry -- the $125 billion Fidelity bond shop.
If you're looking for a core fixed-income holding, the group's $2.6 billion Fidelity Spartan Investment Grade Bond, which recently yielded 4.6 percent, shouldn't be overlooked.
Over the past 10 years, the intermediate-term bond fund not only has beaten its benchmark Lehman Brothers aggregate bond index but also has ranked in the top 8 percent of its category. Helping to ensure that success are low annual expenses: just 0.5 percent vs. the taxable bond fund average of 1.11 percent.
In its bucolic setting, Fidelity's bond operation is both high-tech and hands-on. Manager Kevin Grant's team sits together on the trading floor rather than in offices, shouting out orders and sharing research.
Yet powerful computers link the team to the full resources of Fidelity, including reports from 41 credit analysts and 350 equity analysts and managers. "We have the nimbleness of a boutique money manager but the resources of Fidelity," the 42-year-old Grant says.
Fidelity's truth-in-labeling policy means Grant buys only paper rated BBB or better. He avoids betting on the direction of rates and instead aims to beat his benchmark by identifying sectors and bonds that he believes can outperform. "Our weightings are driven by where we see opportunity," he says.
Earlier this year, with the corporate market hurt by blowups like Qwest and WorldCom, the fund's large stake in Treasurys and mortgage-backed securities helped buoy performance. Today Grant likes corporate debt, including telecom, as well as mortgages.
Low rates and record refinancings have flooded the mortgage-backed market, driving down prices and pushing up yields. Investors who are not ready to pony up the $25,000 minimum initial investment for the fund should check out Grant's other portfolio, Fidelity Investment Grade Bond, which has a $2,500 minimum (albeit somewhat higher expenses).