Don’t look for huge gains in U.S. stocks in 2016. Nearly seven years into a bull market, stocks are on the pricey side, so focus on reducing your risks. There’s no shame in lagging the market benchmarks in a bull market; bear markets are when you want to top the indexes.
Over the past six years, U.S. growth stocks have shellacked undervalued domestic stocks (those that are cheap in relation to profits, revenues and other measures). But based on how their valuation parameters have stacked up over time, growth stocks still look more attractive than value stocks. Meanwhile, small-capitalization stocks, after lagging large caps over the past five years, are finally cheap enough to warrant your attention.
The news flow from overseas remains terrible. But remember that current share prices already reflect what’s in the news. Stocks are cheaper overseas than in the U.S., and they border on being dirt cheap in emerging markets.
With that in mind, here are my six favorite no-load stock funds for 2016.
Vanguard Primecap (VPMCX), launched 31 years ago by former managers at the outstanding American Funds group, has one of the best long-term records in the business. Over the past 15 years, Vanguard Primecap has returned an annualized 7.2%—an average of 2.4 percentage points per year better than Standard & Poor’s 500-stock index. Vanguard now runs two Primecap funds, but both are closed to new investors. (All returns are through December 8.)
However, Primecap Odyssey Growth (POGRX) is still open—and it’s a terrific fund. Start with low costs. The fund charges 0.63% annually. Add a team of managers who are skilled investors and have a deep understanding of technology and health care, two sectors the managers believe offer extraordinary opportunities. The fund has about two-thirds of its assets in those sectors. Over the past 10 years, Odyssey Growth has beaten the S&P 500 by an average of 2.1 percentage points per year.
It’s hard to get excited about a fund that’s run mainly by a computer. But T. Rowe Price Diversified Small Cap Growth (PRDSX) has produced some pretty exciting numbers. Since Sudhir Nanda became manager in late 2006, the fund has beaten the average return of its small-cap-growth rivals in every calendar year, including 2015 so far. It has likewise topped the Russell 2000 Growth index, which tracks small-cap-growth stocks, every year. Since Nanda took over, the fund returned an annualized 10.7%, an average of 2.1 percentage points per year better than the Russell index.Nanda’s quantitative strategy is valuation-sensitive—that is, his computer models look for statistically cheap stocks with consistent earnings growth. The fund owns about 300 stocks, none of which makes up more than 1% of its assets. Nanda and his team of analysts get plenty of input from T. Rowe price industry analysts. Diversified Small Cap Growth is a member of the Kiplinger 25, the list of our favorite no-load funds. Expenses are 0.85% annually.
Vanguard is, in my opinion, the best no-load fund company in America. But its expertise runs far beyond index funds, which it is best known for in the public’s mind. Vanguard’s low costs give it just as big an advantage in actively managed funds. Plus, Vanguard outsources almost all its stock fund investing and does a first-rate job of hiring and monitoring its fund managers.
Vanguard Dividend Growth (VDIGX) is, in my estimation, Vanguard’s single best stock fund. The fund, run by Wellington Management’s Don Kilbride, has beaten the S&P 500 by an average of 1.6 percentage points annually over the past 10 years and has done so with about 25% less volatility.
Kilbride buys large companies with a top-notch record of hiking dividends and the ability to continue raising them. The fund, another member of the Kiplinger 25, has about one-third of its assets in defensive consumer-staples and health care stocks. The fund yields just 1.9%, about the same as the overall stock market. But for good total returns and an ability to best the averages in bear markets, Dividend Growth is tops. Annual fees are just 0.32%.
Jed Weiss, manager of Fidelity International Growth (FIGFX) since its inception in 2007, started investing in stocks as a boy with money he earned cutting grass and shoveling snow. That early start has paid off. His fund has beaten the average large-company foreign growth-stock fund every year except 2009. Since its inception, it has returned an annualized 2.3%, beating the MSCI EAFE index, which tracks foreign stocks in developed countries, by an average of 3.0 percentage points per year.
Weiss looks for companies with sustainable competitive advantages over their rivals, but he’ll only buy them when they’re trading at reasonable prices relative to their earnings. Pharmaceutical firm Novartis and food giant Nestlé are typical holdings. Annual expenses are 1.04%.
FPA Crescent (FPACX) lost 1.5% over the past year, a disappointing performance for a fund that has a record of excelling in rough markets. But Steven Romick has done a fine job piloting the fund since its inception in 1993. Over the past 15 years, Crescent returned an annualized 10.7%, compared with 5.7% for the S&P 500. The fund did especially well during the two big bear markets of the first decade of the 21st century, gaining 35.3% during the 2000-02 downturn and losing a relatively modest 27.9% during the 2007-09 conflagration. By contrast, the S&P 500 plunged 47.4% and 55.3%, respectively, during those two bear markets.
Crescent’s current portfolio suggests that it’s loaded for more bear. It has 35% of its assets in cash and 10% in bonds. Not that Romick and two comanagers who came on board in recent years are totally averse to taking prudent risks: They recently upped the fund’s stake in emerging-markets stocks to 8%. The fund is loaded with “old tech” stocks, such as Cisco Systems (CSCO), Microsoft (MSFT) and Oracle (ORCL).
Bottom line: Crescent is an ideal fund for the latter stages of a bull market—and it will shine even brighter in the next bear market. My major misgiving: Expenses, at 1.11% annually, are too high.
Warren Buffett said it best: “Be fearful when others are greedy and greedy when others are fearful.” Nowhere does the second half of that aphorism better apply today than to emerging-markets stocks. The MSCI Emerging Markets index has declined in four of the past five years, including an 14.7% plunge so far this year. Nobody wants these stocks.
But emerging-markets stocks currently trade at just 11 times next year’s estimated earnings, making them just about the cheapest stock sector in the world. And they are just too inexpensive to ignore. Harding-Loevner Emerging Markets (HLEMX) invests in high-quality companies, an approach that has enabled the fund to best the index by average of 2.5 percentage points per year over the past five years.
Rusty Johnson, who has been at the helm since the fund’s 1998 launch, and four comanagers are bullish on Eastern European stocks but hold below-average stakes in China. They have big positions in financial, technology and consumer stocks.
Harding-Loevner, also a member of the Kiplinger 25, charges 1.45% annually for expenses. As with FPA Crescent, I think that’s too high. Unfortunately, I don’t see any better actively managed emerging-markets funds that are cheaper and have reasonable investment minimums.
As far as allocation, I’d put 25% in Vanguard Dividend Growth, 20% each in Primecap Odyssey Growth and FPA Crescent, 15% in Fidelity International Growth and 10% each in Harding-Loevner Emerging Markets and T. Rowe Price Diversified Small Cap Growth.
Steve Goldberg is an investment adviser in the Washington, D.C., area.
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