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Tweddell’s NewFund Focus Part 1 of 3 Issue # 32
April 2001
$6 per issue Prescription $72 When the market’s going
down, it’s not because you are stupid. And when it’s going up, it’s
not because you are smart. Ralph Wanger Recommended Funds Performance-Prices for week
ending Mar. 30, 2001 Recommended NAV When NAV
Gain (Loss)/
Funds Recommended 03/02/01 Holding Period Diversified Funds
Oppenheimer MnSt Sm Cap 10.00 Sell 12.92 + .83*
37.5 %
20 months Marsico 21st Century 10.00 7.29 (27.1)
% 13 months Janus Strategic Value 10.00 9.84 +
.25* 0.9
% 13 months Nationwide Value Opp 11.41 12.54 9.6 %
9 months Managers Small Co 9.98 7.59 (23.9) % 9 months AIM Small Cap Equity 10.00 8.45 (15.5) % 6 months Oppenheimer MnSt Oppty 9.81 9.50 ( 3.2) % 6 months Invesco Global Growth 10.17 5.81 (42.8) % 4 months Van Kampen SmCapGr 10.34 7.40 (28.4)
% 3 months Sector Funds – Technology MFS Technology 19.34 11.05
+ .50 (40.3) % 11 months Calamos Convert Tech 10.00 7.01 (29.9) %
6 months * Distributed gains Year-to-date Returns DJ Industrials: - 8.42 % S & P 500 - 12.11 % Nasdaq Comp – 25.51 % Russell
2000 - 6.82 % MCSI EAFE (Foreign stocks) – 14.03 % “New-Fund Effect” – Performance Report Last month a subscriber asked whether I could report some kind of a “new-fund index” – in other words, a report on performance. An index of my recommendations wouldn’t work, because while there were over 600 new funds last year, I recommended only a handful. Further, since the average holding period varies with performance and my comfort level, statistics would be misleading. There is also the real-life problem of whether when one or more funds is sold, do we invest all or part of the proceeds in the next one or two recommendations? And finally, studies of new funds – including my own - have concluded that, while growth funds benefit from the new-fund effect, it’s questionable whether value funds do. However, I struck a balance between value and growth recommendations because as I’ve repeated ad nauseam, sector strength dwarfs everything else. With that long introduction, below is a summary of all diversified new-fund recommendations, both realized and unrealized since NFF’s inception 32 months ago. The only reasonable approach, in my opinion, is to tally the return on all recommendations, assuming $10,000 invested in each. Other timing considerations such as reinvestment of sales proceeds, time held, etc., are not considered. Recommendations are shown using purchases, listed sequentially: NewFund Focus Diversified Fund Recommendations 9/98
to 4/01 Returns on a $10,000 Investment*
Fund Ending
Sum ($) Fidelity Advisor Small Cap
Fund 21,300 Invesco Endeavor 25,090 Long Leaf International 16,910 Acorn Twenty 15,560 Alleg Chicago SmCap Value 9,605 UAM DSI SmCap Val 9,403 Forward Hoover 14,940 GE Mid-Cap Value 8,750 Oakmark Global 9,010 H & Q IPO & Emerg Gr 12,080 Oppenheimer MS Sm Cap 13,750 Marsico 20th Century 7,290 Janus Strategic Value 10,090 Nationwide Value Opp’ty 10,990 Managers Small Company
7,606 AIM Small Cap Equity 8,450 Oppenheimer MS Opp’ty
9,684 Invesco Global Growth 5,713 Van Kampen Sm Cap Growth 7,157 Fidelity Adv Aggressive Growth 8,552 * Realized returns are italicized $200,000 Total Invested $231,930 Total Realized and Unrealized Gains Average ending
sum on each $10,000 investment: $11,596 – 15.9% Conclusions · Returns were good – particularly after the last 12 month’s bear market - the worst in over a decade. · What a difference a bull market makes! Most recommendations made as the market was rising were profitable – some startlingly so. Once the market rolled over, the new-fund effect was much less apparent – if at all. · Asset allocation still dwarfs all other considerations – the new-fund effect included. At NFF’s inception, value dampened returns while growth soared. During the last 12 months, value held its own while growth imploded. The performance of Janus Strategic Value, recommended very near the market’s peak, illustrates the point well. Some Janus funds (large-cap growth, heavily laced with technology) are down more than 50% - yet Janus Strategic Value is still managing to hold on to a slight gain. The lesson: Don’t get carried away by where the action is - it might be feet first. Keep a reasonable balance between value and growth. · Contrary to conventional wisdom, and the urging of self-serving industry pundits, carefully selected diversified new funds are not “very risky,” compared to older funds with long track records. This is not to be confused with buying new narrow sector funds, launched to take advantage of mania-driven investors – that remains one of the worst strategies conceivable. ·
The new-fund buy/sell discipline prevents
performance chasing. This is critically
important - industry cash
inflow/outflow statistics are showing that most – or at least far too many -
investors did just that and are now looking at big losses. A “Keeper” – Full Disclosure Establishing a discipline
and then violating it is self-defeating.
When funds age beyond the “ideal” 18
months, I eliminate them from the recommended list (I did stall on a few while
the market was rising), no matter how much I like the fund. However, although Oppenheimer Main Street
Small Cap Fund is a “sell” this month, I am keeping a personal position,
because I view it as one of the best small-cap funds. The quickest way to double
your money is to fold it over And put it back in your
pocket. Will Rogers
Are there glimpses of the beginning of the end of the bear market? One of the things to look for is bad news and the March 30 issue of the Wall Street Journal had plenty: During the first quarter, the Nasdaq had its worst performance ever and the Dow’s had its worst quarter in 41 years. In February, investors who discovered 25-year old index funds only a few years ago, were backing out, making net withdrawals for the first time in seven years. For the first time since August 1998, investors took more money out of all stock funds than they put in (net $3.07 billion withdrawals); a year earlier (the month before the market peaked), net cash into fund was over $53 billion. The Journal’s “Performance Yardstick” table, showing historical returns for the major Lipper categories shows why they are disillusioned. As you’d expect, year-to-date, four-week and one-year returns were negative, but what must be really discouraging are the three-year returns. Of twelve diversified stock fund categories, the highest average annual return was 5.49% (Mid-Cap Core) and the average return was a passbook savings-like 3.05% - pretax! Proving once again, it ain’t what you make, it’s what you keep. |
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Since she could have made more money in CDs, the average fund investor must be wondering whether there might be a better way to invest – and that’s one of the ingredients needed to end a bear market. Are we there? Probably not - historically, it’s still early and past bear markets usually end when discouragement finally morphs into despair. But it is beginning to feel as if we’re closer to the end than the beginning – for sure on the “Naz,” lurching into the 1800s, where it’s impossible to lose another 3300 points. After months – that seemed like years - of drooping prices, the idea that stocks go up may sound fanciful, because we tend to think in a linear fashion, believing that whatever has been happening is most likely to continue happening – and the longer it endures, the more convinced we become. The number of pundits on CNBC who are predicting more of the same – sagging prices – is growing. In a way, it’s not much different than a year ago; except then, they were forecasting higher prices. While linear reasoning is fine for predicting sunrises and choosing a dry cleaner, it’s a lousy way to invest because markets are cyclical. Ralph Wanger reminds us that, “In bleak periods falling stock prices are not part of the problem. They are part of the solution.” So if the end is months, not years away, now is the time to prepare – to plan on where to be as stocks go up the other side. Where will the solution lie for fund investors this time – in what sectors? Sector selection is critical; there is nothing more frustrating than getting into stocks or funds after a big drop and having the market go up around you. Usually, “new” stocks lead a new bull market. If you get the sectors right, good things happen; get them wrong, and nothing goes right, as technology and large-cap growth fund investors have learned this past year. Wagner’s music is
better than it sounds
Mark Twain Which brings me to small-cap stocks. While investors may be vaguely aware that they have been outperforming large-caps recently, few seem to really care. In talking to folks and meeting with new clients and prospects, most are small-cap indifferent. Most are preoccupied with what to do with what they already own – typically, oversized positions in large-cap growth and technology funds – not what they might own. While you’d expect assets of small-cap funds to be much smaller than large-cap, the difference is still huge: small cap funds hold assets of a little over $200 billion compared to almost $2.5 trillion in large-cap funds – Vanguard’s S & P 500 Index Fund alone, has assets of $500 billion. The small-cap stock sector (that now includes many former large-cap stocks) looks promising for a number of reasons. Ted Theodore, Vice Chairman of Avatar Associates, in a piece in Avatar Advisor (March 2001) titled “Great Expectations,” pointed out some of them: A change of
potentially great importance for the stock market seems to be taking place
quietly among financial analysts. For
the first time in more than five years, earnings expectations for smaller
companies are greater than their larger brethren. Actually, a trend toward this result had been brewing for about a
year…earnings in 1999 were far superior for the big cap companies of the S
& P 500. The margin got much smaller
last year and, now, analysts see a complete reversal from two years ago…The
stock market has not ignored these developments. Various measures of the market show the beginnings of much better
price performance in the small-caps, regardless of what is happening among the
large caps. We have often argued that
the relative performance swings between capitalization tends to result
in a trend which can go on for five to ten years. The evidence from the market seems to be
confirming the fundamental earnings picture that we are entering such a
favorable period for small caps. (Emphasis added) Another view comes from Charles Albers, mentioned often here. For over a quarter century, at the helm of Guardian Park Avenue Fund and more recently managing the Main Street Funds at Oppenheimer, Albers has beaten the S & P 500 consistently. He starts with black-box quantitative measures that point to attractive sectors and industries and then uses more traditional fundamental analysis for stock selection. We’ve benefited from Albers’ acumen – last year, NFF subscribers harvested a 113% profit from his Oppenheimer Main Street Small Cap Fund. Even after the market’s recent miseries, at the end of February (latest figures available), his Oppenheimer Main Street Opportunity since-inception five-month return was down only 1.54% compared to a loss of 9.14% for the Russell 2000 Index and 8.44% for its Lipper category. Because Albers is deft at sector navigation, his current analysis and thinking is of more than passing interest. Excerpts of his recent memos to the folks at Oppenheimer: …our cap
size prediction models now suggest that the five-year (1995-1999) cycle of
superior performance by mega-cap stocks has played itself out. Now, the probabilities point to superior
performance from mid-caps and small-caps in the year ahead. This assessment considers 1) relative
valuations, 2) historic patterns of relative price performance, and 3) evidence
from the bond and money markets. In another memo: Our size
prediction models are heavily in favor of small caps and have been for some
time, so we feel that there is little chance of this being a false signal…
We…predict that small cap stocks will lead in the market recovery when it
comes. Further, once the market comes off a bottom, it’s hard to imagine performance- chasing investors doubling up on the very sectors that eviscerated them – usually the healing process takes more time. Typically, if they’re going to invest more money, it will be in something “new.” While Cisco Systems and EMC – the companies - will probably do fine as the economy recovers, their stocks are unlikely to attract many “own it any price” investors - in the next cycle, anyway. Then there is valuation. Last month I included a table showing year-end price/earnings and price/book ratios of the major Morningstar fund categories. While all sectors were high by historical standards (less so now), small-caps were much cheaper than mid- or large-cap stocks. It wasn’t always so – in decades past, small-cap stocks sold at the highest relative valuations because prevailing wisdom held that petite, nimble companies could grow much faster than big lumbering corporations. In the 60s, my graduating class of rookie brokers believed to our post- adolescent cores that only dullards and lazy over-the-hill types bought blue chip stocks - investors who lacked the energy, ambition and imagination to do anything else. The real action was in small-cap stocks and, in fact, they worked pretty well until 1973 – 4, when things got so bad that market makers in many of our OTC favorites stopped answering their telephones. Sweetest
Small-cap Spot? Barron’s Rhonda Brammer (2/19/01) thinks the real sweet spot in the small-cap sector is value. In the February 19 issue she points out: Arguing in favor of small-cap value continuing to outperform growth are
two things. First, while SmallCap
Growth’s (Standard
& Poor’s/Barra’s indexes) return on
equity and assets are less than twice those posted by SmallCap Value, the
Growth index sells at three times the multiple of price-to-book. Second, while the historical growth rate is
11.2% a year for the SmallCap Growth Index and 10.6% for SmallCap Value, the
price-to-earnings ratio of SmallCap Growth is 23.5 versus 12.5 for SmallCap
Value. Small-cappers of all stripes are encouraged by history. After recessions and bear markets, small-cap stocks have tended to lead all stocks in post-slump rallies – after 1974, it was particularly dramatic. The small-cap story is a good one: · Higher earnings growth projected versus other sectors. · Quantitative models favoring small-cap vs. large-cap. · Significantly lower relative valuations vs. large-cap. · Small-cap funds “under-owned” by the average fund investor. · Small-caps’ historical tendency to lead the market after recessions. · Lastly – and importantly for our self-serving purposes - studies of the new-fund effect have shown that it most potently boosts small-cap fund returns. If you like the story, and have had a reasonable allocation strategy, your portfolio already includes small-cap funds; consider increasing your small-cap allocation. If, as seems quite common (an exception being NFF investors), you have little or no small-cap stake, consider the following funds:
Small-cap Blend FundsTo avoid getting marooned at the wrong end of either the growth or value spectrum, or if you have limited capital to allocate to the sector, the “safest” way to invest is in the small-cap blend category. Four candidates:
(800) 435-4000 schwab.com
Small-cap Value FundsIf you want to make the value bet, two candidates:
“Over-owned” technology Funds? “Under-owned” value funds?“Diversification is an old song, but many still don’t sing it…technology sector funds still hold more assets than mid-cap and small-cap value funds combined.” Mutual Funds magazine May 01 Small-cap Growth FundsIf growth is your objective:
(800) 421-5666 vankampen.com
A new fund recommendation is attached. The last three recommendations have been growth funds and as investors’ love of growth turned into hate, they were punished accordingly. This month’s recommendation, a value fund, will help balance the two sectors. April 3, 2001 Copyright 2001 |
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