This love affair had to cool down, even if it’s just a momentary lull. Assets in U.S. diversified stock funds rebounded to $3.4 trillion from $2.99 trillion during 2010, and the number of funds climbed to 8,061 from 7,964. Capping a 17.14% gain for the year with an 11.41% increase in the final quarter, these equity funds beat the Standard & Poor’s 500, which posted solid gains of 15.06% and 10.76%, respectively.
Although the average long-term domestic fixed-income fund had a respectable 8.01% return in 2010, it rose just 0.11% in the last quarter, as worries about Federal Reserve policy and mounting European debts rose. For the first time in two years, investors pulled money out of bond funds in the fourth quarter and, on balance, put cash into stock funds.
A number of analysts expect the craving for bonds to resume shortly. “Sustained risk aversion and insatiable need for current income suggest inflows in bonds will resume in 2011,” says Avi Nachmany, of the consulting firm Strategic Insight.
While others might debate that point, the trends in 2010’s equity-fund markets were pretty clear: Small did better than large, growth trounced value and domestic beat international.
Overall, small-cap growth was the leader, ending the year 27.64% higher. The funds jumped 16.58% in just the last quarter. It wasn’t a landslide victory over value. Small-cap value climbed 26.02% during the year and 15.91% in the quarter.
Despite all the hoopla about the costs involved, smaller-cap equities actually have benefitted from the discipline Congress’ Sarbanes-Oxley Act has brought to the sector in recent years, according to Tim Holland, who co-manages Aston/Tamro Small Cap (ticker: ATASX), which was up 31.26% for the year. The measure was aimed to prevent the kind of accounting scandals that rocked Enron and other companies earlier this decade.
“A lot of the weaker players had to beef up their controls if they wanted to stay public,” he says, adding that his fund was overweight consumer-discretionary stocks and underweight financial equities.
Smaller, nimbler companies’ ability to move quickly in overseas markets also helped, according to Michael W. Cook, manager of SouthernSun Small Cap (SSSIX) fund, which returned a whopping 48.83% for the year, leading the whole small-cap value category.
“We have observed that, for a variety of reasons relating to technology and operating sophistication, a growing number of small- and mid-cap U.S. businesses are able to access faster-growing economies in emerging markets around the world, and we have constructed our portfolio with this in mind,” he says.
Mid-cap growth funds jumped 25.87% for the year and 14.21% in the quarter. Mid-cap value funds were up 22.35% and 12.79%, respectively.
Chris Retzler and John Barr, co-managers of Needham Growth (NEEGX), up 31.37% for the year and 16.75% for the quarter, credit their strong performance to investing in companies that make equipment used in cloud computing, like Brocade Communications Systems (BRCD), and communication devices, such as Apple (AAPL).
They plan to continue to suss out the next big thing. They have their eyes on Entropic Communications (ENTR), which makes semiconductors for MoCA (Multimedia Over Coax Alliance), the standard chosen by the satellite, cable and telecommunications industries to integrate electronic networks within the home, and Entegris (ENTG), which produces equipment used to make semiconductors and flat-panel displays.
Large-cap growth funds did well, but not nearly as well as their smaller counterparts. They gained 14.8% for the year, strongly aided by the final quarter’s 11.42% rise. Large-cap value funds returned 12.96% for the year and 10.55% for the quarter.
Equity funds that invest in emerging markets gained 6.97% in the final quarter, and 19.54% for the year. Latin American funds picked up 9.68% in the final three months and 19.97% over the course of 2010. World equity funds rose 13.67% in 2010 and 7.83% for the fourth quarter. Despite the sovereign-debt problems in Greece, Ireland and several other countries in the region, European funds managed to post a 6.03% gain for the quarter and a 7.64% rise for the year. Asia did better. Pacific Region funds were up 9.11% for the quarter and 16.87% over the last year, as China’s volatile markets cooled. After tough going early in the year, Japanese funds soared 12.73% in the final period, giving them an average return of 12.43% for the year.
ALTHOUGH BOND RETURNS FELL off their pace in late 2010, high-yield was a bright spot. “Rates backed up as growth expectations increased, so it’s positive for high-yield as credit risk improves and spreads tighten,” says Jim Keenan, manager of BlackRock High Yield Bond Fund (BHYAX), which was up 4.53% for the quarter and a healthy 17.96% for the year.
The bond market’s missteps also weighed on one of the mutual-fund world’s giants. All of the 25 largest mutual funds had positive returns for the year and, with one exception, for the quarter. Pimco Total Return (PTTAX), a huge magnet for assets in recent years, $240 billion in all, was down 1.3% for the final period.
The average world-income fund rose by 8.02% for the year, though it was down 0.66% during the quarter. Investors in some sectors did far better than others. “Emerging-market countries offer plenty of attractive local-currency investment opportunities,” says Mike Cirami, manager of Eaton Vance’s Emerging Markets Local Income fund (EEIAX), which was up 13.81% for the year and just about flat in the quarter.
SOME OF THE SAME FACTORS that hurt bonds, including worries about inflation and the possibility of sovereign defaults, helped send prices of precious metals such as silver soaring. The leveraged ProShares Ultra Silver (AGQ) fund skyrocketed 82.54% in the final quarter to make it the top performer for both the year and the quarter.
Among the very largest funds, the $57 billion SPDR Gold exchange-traded fund (GLD) was the top performer for the full year, up 26.81%, while it gained 7.43% in the quarter, as the price of the metal jumped to $1,422.60, continuing its decade-long ascent.
However, Darwei Kung, who runs the DWS Enhanced Commodity Strategy fund (SKNRX), thinks gold is looking pretty expensive and sees far more opportunity in other commodities.
“We favor global industrial commodities like base metals and crude oil, which will benefit from further global growth, and we continue to like agricultural commodities, although more cautiously, as some have had large price moves,” Kung says. DWS Enhanced Commodity, which moves in and out of a variety of commodities, climbed 15.04% in the quarter and 18.80% in 2010.
Real-estate funds, aided by a 7.02% gain in the final quarter, climbed 27.6% for the year. And despite the sturm und drang around housing and high vacancy rates at malls, the top-performing fund for the trailing 15 years is Ken Heebner’s CGM Trust Realty fund (CGMRX), up an average of 17.25% per year.
There is still some upside. “We expect well-capitalized REITs to deliver higher dividends as billions of dollars in real-estate debt mature in the coming years,” says Brian Jones, who co-manages the Neuberger Berman Real Estate fund (NBRIX), up 31.1% for the year and 6.27% in the quarter.
With so many funds sporting double-digit gains in 2010, were there any slackers? Not many. The uncertainty generated by Obamacare had health-care and biotechnology funds near the bottom of the heap, up 9.87% for the year and 6.36% for the quarter. It helped if you could go short, which Michael Gregory at Highland Long/Short Healthcare (HHCAX) could. The fund was up 14.04% for the year. As it happens, he sees better times ahead for health care under the new laws, which he doesn’t believe will be repealed despite Republican threats.
“THE HEALTH-CARE SECTOR is at the early stages of a consolidation trend. Top-line growth pressures will force companies to look to acquisitions as a way to grow earnings. This comes at a point when health care is extremely undervalued,” he says. He expects lots of mergers in life sciences and tools, specialty pharmaceuticals and services businesses such as hospitals.
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