Looking at the past year’s returns, you’d think we would all be feeling a little sunnier about stocks. Most stock-fund categories posted double-digit gains, and if you held the best-performing funds, which you’ll find in the lists of small-company, emerging-markets and sector funds, you could have earned 50%. Maybe it’s Greece’s debt woes, the persistently high unemployment rate or the whispers about a possible double-dip recession, but whatever the reason, we’re betting the past year’s numbers don’t give you that much comfort.
Longer-term results show just how uneven stock returns have been in recent years. Every major stock-fund category posted negative returns over the past three years (stocks were near record highs three years ago, but the 2008 plunge was broad and deep). And over ten years, with the exception of relentlessly rising emerging-markets stocks, returns in most categories have been flat to middling.
Long term, returns have behaved more predictably. Over the past 20 years, funds that invest in large U.S. companies returned an average of 7.2% annualized. That’s not dazzling, but neither is it unexpected after two disastrous bear markets (since 1926, U.S. stocks have returned 10% annualized). Small-company stocks outpaced large-company stocks, and traditional stock funds beat funds that focus on alternative investments, such as commodities, or employ short-selling strategies. But after the travails of the ’00s, many advisers are recommending alternative investments for their clients.
Kiplinger’s believes you can expect to earn 8% a year from large-company U.S. stocks over the next decade. It might be a lumpy 8%, but stocks should have little trouble beating Treasury bonds (if you buy a ten-year Treasury today and hold it to maturity, you’ll earn roughly 3% a year). Take more risk by investing in small companies or emerging markets and you should do even better.
To see which funds topped their categories and which we think will perform well in the future, read on. -- Elizabeth Ody
LARGE-COMPANY STOCK FUNDS
Leverage wins short term, smart management long term
You’ll notice a large dichotomy between the winners over one year and longer periods. Several of the short-term champs employ leverage. When the stock market sinks, these kinds of funds will fall hard. Some of the long-term winners have been run for many years by the same managers using the same investing style. For instance, Will Danoff has piloted Fidelity Contrafund (FCNTX) with a deft hand for 20 years. Mason Hawkins has been at the helm of Longleaf Partners (LLPFX) since 1987. Contrafund favors stocks of growing companies; Longleaf has more of a value tilt. Don Yacktman has managed the eponymous Yacktman Fund (YACKX), a concentrated portfolio of blue-chip stocks, since 1992. Bruce Berkowitz’s idiosyncratic Fairholme (FAIRX), which holds some bonds along with stocks, has shined ever since its inception in 1999.
MIDSIZE-COMPANY STOCK FUNDS
A fund run by one of our columnists hits the top of the charts
This category includes not just funds that invest in midsize companies but also funds that invest in firms of all sizes. For example, Tilson Focus (TILFX), which is co-managed by Kiplinger’s columnist Whitney Tilson, can invest in everything from blue chips to tiny start-ups, as long as he believes the stock is cheap (he doesn’t manage Tilson Dividend). Similarly, managers of the Appleseed Fund (APPLX), which invests only in companies that pass certain ethical screens, care not one whit about a company’s size in their quest for value. Fidelity Low-Priced Stock (FLPSX), a member of the Kiplinger 25, follows an odd strategy: Manager Joel Tillinghast buys mainly stocks that trade for $35 or less. Rick Aster, who has run Meridian Growth (MERDX), another Kiplinger 25 member, since its 1984 launch, invests in fast-growing midsize companies.
SMALL-COMPANY STOCK FUNDS
Coming off a bang-up year
It’s no surprise to see Aegis Value (AVALX) at the top of the charts. Manager Scott Barbee excels at spotting hidden value among small companies that other managers have missed. However, the types of stocks Barbee favors (the average market value of Aegis’s holdings is a mere $255 million) can be extremely volatile, and the fund took a big hit during the 2007–09 bear market. Royce is also a familiar name in the category -- the family boasts a roster of fine funds that focus on small, undervalued companies. To invest in Royce Select I (RYSFX), you need to pony up at least $50,000. Veteran manager Preston Athey, who runs T. Rowe Price Small-Cap Value (PRSVX), a member of the Kiplinger 25, has nearly 20 years with the fund under his belt. He holds a widely diversified portfolio of about 300 stocks and holds on to a company for an average of ten years.
Balanced, asset-allocation and convertible funds are the main players
The best of this group protect capital in bear markets. What’s remarkable about Permanent Portfolio (PRPFX) is the simplicity of its approach. For nearly 30 years, Permanent has essentially maintained a fixed allocation to six different asset classes, including precious metals, Treasuries, Swiss francs and stocks. The strategy aims to provide protection against both deflation and inflation. Hussman Strategic Total Return (HSTRX), managed by economist John Hussman, similarly invests in multiple asset classes but with a far more active approach. Steve Romick, manager of FPA Crescent (FPACX) also has an eclectic bent, but his yen is to roam a company’s capital structure, from bank loans to bonds to common stock, in search of the best value. Vanguard Convertible Securities (VCVSX) invests in a truly hybrid product -- convertible bonds are part bond, part stock.
INTERNATIONAL DIVERSIFIED LARGE-COMPANY FUNDS
A break-even decade ends with a decent year
Any diversified overseas fund that hugs its benchmark will have close to two-thirds of its assets in European stocks. That would not have been a good thing in the first half of 2010, when falling share prices and a strengthening dollar walloped many of these funds. Our top pick in this category is Harbor International (HIINX), a member of the Kiplinger 25. Its managers look for strong, stable businesses with growth potential, such as Petrobras (PBR), the Brazilian oil giant, and ABB (ABB), a Swiss maker of power-transmission systems. Another worthy fund, with a much different philosophy, is Oakmark International (OAKIX). Managers David Herro and Robert Taylor look for undervalued -- even scorned -- sectors that they expect to rebound in due time. A big bet on consumer stocks that cratered in 2008 paid off in the past year.
SMALL- AND MIDSIZE-COMPANY INTERNATIONAL FUNDS
Foreign stocks with a little extra spice
These funds can invest in any foreign market, and those that preferred Asian firms had an edge in recent years. Wasatch International Growth (WAIGX) transplanted its expertise in picking small, U.S. growth companies to investing in small, fast-growing foreign companies, mainly in the Far East. Not surprisingly, the fund is volatile. On the other side of the philosophical spectrum is Oakmark International Small Cap (OAKEX). Run by Oakmark’s longtime foreign-stock maven, David Herro, the fund invests in small, undervalued companies, especially in Europe, a region that Herro favors. Less than 5% of assets are in emerging markets. We also like T. Rowe Price International Discovery (PRIDX), the only fund in this category that has been around at least 20 years. The fund holds a balanced mix of stocks from Europe and the Far East.
GLOBAL STOCK FUNDS
Their managers can roam far and wide
Great managers can find attractive investments in any market -- and these winners show how it’s done. Clyde McGregor and Robert Taylor, managers of Oakmark Global (OAKGX), look for beaten-down stocks from all over the world. They have 18% of the fund’s 41-stock portfolio in Japanese stocks. Peter Doyle, manager of Kinetics Paradigm (WWNPX), makes large bets on sectors he thinks have the most-intriguing prospects. Half of Paradigm’s portfolio is in financial stocks. Some funds that levy sales charges stand out in this category. Michael Avery, manager of Ivy Asset Strategy (WASAX), has skillfully cut his fund’s risk during bear markets. BlackRock Global Allocation (MDLOX), run by Dennis Stattman, has consistently beaten its peers. You can read more about the fund and its sponsor in Great Days at BlackRock.
DIVERSIFIED EMERGING-MARKETS FUNDS
The top category over the past decade
Although this category lost money in the first half of 2010, returns for the previous six months were so strong that the one-year numbers rock. James Donald, manager of Lazard Emerging Markets (LZOEX), goes his own way: In the past year, Donald made outsize bets on stocks in Turkey and South Africa compared with the fund’s benchmark. Meanwhile, the fund held only 3% of its assets in China because Donald thinks that market is expensive. Driehaus Emerging Markets Growth (DREGX) practices momentum investing, looking for companies with rapid earnings growth and strong share prices. T. Rowe Price Emerging Markets Stock (PRMSX), a member of the Kiplinger 25, missed the winners lists, but we like its prospects. Manager Gonzalo Pangaro favors Brazil and China because those countries have healthy fiscal and trade balances.
Editor's Note: Wasatch Emerging Markets Small Cap fund (WAEMX) was mistakenly omitted from the tables in the September issue of Kiplinger's Personal Finance. The fund should have been the top performer based on one-year returns among diversified emerging-markets funds. For more on this fund, see FUND WATCH: This Emerging-Markets Fund Wins Big with Small Companies.
REGIONAL AND SINGLE-COUNTRY FUNDS
Emerging markets dominate the list
Funds that invest in Russia, India and China dominate the charts in this category. As you look at these funds’ scintillating one-year returns, just remember that even a diversified emerging-markets fund is plenty volatile -- singling out a region or country adds to the risk. Matthews Asia Dividend (MAPIX) is a fine choice. By investing in dividend payers, the fund limits itself to higher-quality companies, which hold up better in a rout. Matthews Pacific Tiger (MAPTX) is another standout from the same family; its managers scour Asia, excluding Japan, for firms with the best growth prospects. Over the long term, European stocks have been rewarding. Although the continent’s prospects currently look shaky, T. Rowe Price European Stock (PRESX), which focuses on companies with competitive advantages, is a good choice if you want to bet on a rebound.
A fabulous ten years for gold funds
You might be surprised to see so many real estate funds topping the charts in this category. But remember, many real estate stocks were priced for disaster when the market bottomed in March 2009, so they had plenty of room to run over the past year. Pimco RealEstateRealReturn Strategy (PETAX) takes an unusual approach: Manager Mihir Worah uses derivatives to track the performance of an index of real estate investment trusts and invests the collateral for the derivative positions in a portfolio of bonds (the fund’s Class D shares are available without a sales fee). Most gold funds, such as Tocqueville Gold (TGLDX), hold only a small portion of assets in metal; instead, they invest mostly in gold-mining stocks. Mining stocks are almost always more volatile than bullion, so expect a turbulent ride if you invest in a gold fund.
Stuff that won’t (or at least shouldn’t) behave like the rest of your portfolio
This group includes things outside the traditional categories of stocks, bonds and cash. Pimco CommodityRealReturn Strategy (PCRDX), run by Mihir Worah, provides protection against inflation by owning a basket of commodity futures contracts, as well as Treasury inflation-protected securities. Stock-market bears may enjoy Pimco StocksPlus Total Return Short Strategy (PSSAX). The fund uses derivatives to short-sell Standard & Poor’s 500-stock index; Pimco maestro Bill Gross invests the collateral in bonds. Arbitrage Fund (ARBFX), a member of the Kiplinger 25, invests in takeover targets after the deal is announced. It profits as a deal stock rises from the post-announcement price to the consummation price. Merger arbitrage doesn’t correlate strongly to either stocks or bonds, making Arbitrage Fund an excellent portfolio diversifier.