Been Down So Long, You Call This Up?

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Been Down So Long, You Call This Up?

By KENNETH N. GILPIN, NY Times

January 5, 2003

The fourth quarter was a good one for stock mutual funds, but the market declined so sharply in the nine previous months that 2002 ended as the third consecutive miserable year.

"It was nice to see something go up, but compared to where we were three years ago, it was a drop in the bucket," said Russ Kinnel, the director of funds research at Morningstar Inc. "We are still looking at some pretty sizable losses in many areas."

Fueled by the rise in major market averages, which spent the first two months of the quarter rallying from lows set in early October, the average domestic equity fund gained just less than 6 percent in the quarter, according to Morningstar data. But that gain merely pared nine months' worth of

sizable losses: for the year, the average domestic equity fund lost more than 20 percent of its value.

The last 12 months were the worst year for stock funds since 1974 and contrasted sharply with the 1990's, when the group rose in 8 of the 10 years.

The 2002 declines were breathtakingly pervasive across the fund industry. Lipper Inc., which tracks fund performance, said 96 percent of equity funds finished the year in negative territory.

For the year, only two groups of funds had positive returns: precious-metals funds, up more than 65 percent, and real estate funds, up a bit more than 4 percent, according to Morningstar.

"Last year was about as bad as it can get," said Thomas M. McManus, the chief investment strategist at Banc of America Securities. "But the good thing about the sharp fall in stocks is that it makes the market more resistant to further declines.

"I suppose you could come up with some scenario in which people would want to sell stocks below their October lows," Mr. McManus added. "But we think the market is making a gradual recovery."

Those who did well in 2002 did so by "avoiding mistakes" in the stock market, said Thomas F. Marsico, the president and chief investment officer of Marsico Funds. "If you avoided Tyco, WorldCom and Enron, you outperformed the market," he said.

At the end of 2001, he said, he was wary about what might happen over the next 12 months. "A year ago, our portfolios were pretty defensive," he said. "We are now somewhat more optimistic."

It was a good quarter for natural-resources funds, which rode the sharp rise in the price of oil. The end of Brazil's two-stage election process, and the decisive victory of Luiz Inácio Lula da Silva in the presidential race, was a tonic to Latin American stocks. Emerging-markets funds in general did well, as did most funds that focus on foreign stock markets.

For bond funds, it was another good quarter — and a great year.

Aided by the Federal Reserve's decision in early November to cut short-term interest rates by half a percentage point, taxable bond funds gained 2.6 percent in the quarter, and more than 6 percent for the year.

The year was also the third in a row that bonds outperformed stocks. That had not happened since 1939-41, according to Lehman Brothers. Investors continued to pile money into bond funds, even as interest rates sank to their lowest levels in decades.

Robert Adler, president of AMG Data Services, which tracks mutual fund flows, said $125 billion to $130 billion poured into taxable bond funds in 2002, a record. "Investments in bond funds have been successful, and investors are not going to be willing to tamper with a winning formula until rising rates dictate another change," Mr. Adler said.

Since the shift to bond funds began, "investors have not yet suffered in a market of rising rates," he said, noting that as interest rates rise, prices of outstanding bonds fall.

Mr. Kinnel said he was not sure investors "realize the kind of haircut they are in for if rates go back up a percentage point or two." For much of 2002, gains in bond funds were largely relegated to ultrasafe investments like Treasuries and government-backed mortgage securities.

But as rates continued to fall in the fourth quarter, and the economy showed a few signs of stabilizing, investors began to buy high-yield, or junk, bonds. For the quarter, high-yield bond funds gained 5.8 percent, according to Morningstar.

Tom Soviero, who manages the $2.2 billion Fidelity Advisor High Income Advantage fund, said that if one event helped the high-yield market, it was the Fed's rate cut in early November.

"That was a statement that liquidity was going to be provided," he said. "Also, the equity market helped quite a bit, led by technology and telecommunications stocks."

Although High Income Advantage was up 15 percent for the quarter, it fell by more than 4 percent for all of 2002.

"It's been a tough year," Mr. Soviero said. "I'm not bragging. But I hope the recent trend continues."

It seemed to be a good quarter for technology and telecommunications stocks, which bounced sharply off what some analysts said were oversold levels. Still, many said fundamental indicators suggested weak demand for products from personal computers to fiber optic cable. The recovery, they argued, may be more technical than real.

Nevertheless, technology funds posted a gain of just under 19 percent in the quarter. And communications funds rose more than 16 percent, according to Morningstar.

But those gains did little to transform a horrific year for the sector.

For all of 2002, technology funds lost more than 40 percent of their value, according to Morningstar. Communications funds fell more than 34 percent.

Steven F. Crowley, co-manager of the Kopp Emerging Growth fund, one of the quarter's best performers, has about 90 percent of his fund's assets in health care, medical technology and technology stocks.

"In our opinion, these stocks went down to a valuation extreme," he said. "If the economy doesn't grow next year, you will be hard pressed to make the case that technology spending is going to grow."