2012 Mutual Fund Rankings

By the editors of Kiplinger's Personal Finance

published 9 August 2012

It was a mediocre year for the U.S. stock market and U.S.–oriented stock funds. But it could have been worse. In fact, it was a lot worse—overseas. With concerns growing about the health of the global economy, investors concluded that the U.S. was the best block in a bad neighborhood and nudged Standard & Poor’s 500-stock index to a 5.5% total return over the 12-month period that ended June 29 (that figure reflects a 9.5% gain in the first six months of 2012). But as the European debt crisis and the possible breakup of the euro zone took center stage, and as growth slowed in China and other emerging nations, investors abandoned foreign stocks in droves. The MSCI EAFE index, which tracks performance in developed overseas markets, plunged 13.4%, and the MSCI Emerging Markets index sank 15.7%.

The past year also marked the growing prominence of what has become known as the risk-on/risk-off trade—that is, the tendency of all sorts of markets to move in lock step depending on the mood of investors on a given day. The phenomenon made it excruciatingly difficult for traditional stock pickers to excel. Over the past year, for example, only 11% of actively managed stock funds that focus on large U.S. companies beat the S&P 500.

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This was the best-performing category over the past year, but it basically won by default. Named for a New Testament parable about investing, Matthew 25 is a concentrated fund managed by Mark Mulholland. His top holding, Apple, boosted results. Apple’s 75% rise over the past year also explains the success of the funds that track the Nasdaq 100; it accounts for nearly one-fifth of the index. Donald Yacktman, a seasoned bargain hunter whose eponymous funds rank at or near the top of the list of winners for the five- and ten-year periods, says he has never seen such high-quality businesses selling so cheaply. Fidelity Contrafund has delivered superior returns since the estimable Will Danoff took over as manager in 1990. Danoff looks for growth wherever he can find it and isn’t particularly concerned about a stock’s price.

Over time, stocks of midsize companies tend to be more volatile than those of large firms, but they typically return more. That was not the case over the past year, however. Funds in this group lagged their large-company counterparts by an average of five percentage points. Akre Focus, a member of the Kiplinger 25, invests in firms that can produce high and sustainable returns on equity (a measure of profitability) and generate earnings growth of at least 15% annually. Wells Fargo Advantage Discovery and Fidelity Low-Priced Stock are also in the Kip 25. Low-Priced Stock buys high-quality, growing companies trading at bargain valuations—and at prices of $35 or less. The Wells Fargo fund, which is more growth-oriented, seeks midsize companies than can beat Wall Street’s earnings forecasts over the next 12 to 18 months.

With investors shying away from risk, most small-company funds got swamped over the past year. But several swam against the tide and posted above-average gains with below-average volatility. Consider T. Rowe Price New Horizons, the granddaddy of small-cap funds. Under manager Henry Ellenbogen, who took over in 2010, the fund continues to excel by finding good companies with sound business models and talented executives. T. Rowe Price Small-Cap Value, a member of the Kiplinger 25, is run by Preston Athey, who has a knack for navigating rough markets. The fund’s 20-year returns are socko, but it’s also done well, relative to its peers, more recently. And then there’s Homestead Small Company Stock, another Kip 25 fund. It’s run by three managers who seek out-of-favor companies that have a catalyst to spark a turn of fortune.

When it comes to balanced funds, which typically hold a mix of stocks and bonds, much hangs on a fund’s asset allocation. So it’s no surprise that Vanguard Wellesley Income, with its hefty 62% stake in Treasuries, corporate bonds and other debt, posted good results over the past year. This group also includes more-exotic fare. For example, FPA Crescent, a member of the Kiplinger 25, has built a winning long-term record by buying anything that offers the best value at the moment. The fund may invest in stocks and bonds, engage in short selling, hold real assets, or sit on its cash if manager Steven Romick sees few opportunities. Contrast that flexibility with Permanent Portfolio, which holds fixed allocations to gold, silver, Treasuries, the Swiss franc, and shares of natural resources and other companies.

Shares of large companies from developed nations have royally disappointed investors in recent years. But if you smell opportunity in those stinker returns, you can choose from several excellent selections among value-focused funds. Harbor International, a member of the Kiplinger 25, seeks undervalued firms with strong earnings potential and recently had 70% of its assets in Europe. The nine managers who run Dodge & Cox International, another Kip 25 pick, follow a disciplined, stock-by-stock approach to identifying companies that sell at discount prices. Tweedy, Browne Global Value’s approach to value investing à la Benjamin Graham has led it to food giant Nestlé and liquor producer Diageo. Among more growth-oriented funds, Artisan International, run since 1995 by Mark Yockey, is a solid choice.

What the markets giveth, the markets also taketh away. A year ago, funds in this group were riding high, with an average return of 36% in the 12 months that ended in June 2011. But the euro-zone crisis and slowing growth around the world caused investors to dump riskier stocks, including those of small foreign companies. Westcore International Small Cap has been on a roll lately. The fund, which invests in fast-growing companies, has risen to the top of the charts each year since 2009 (it earned 13% in the first half of 2012). As with most funds in this category, Westcore holds stocks you’re unlikely to recognize. The top three: Australia’s Credit Corp. Group and Cardno Limited, and Hong Kong’s Xtep International Holdings. Other good choices are Wasatch International Growth and T. Rowe Price International Discovery.

You’ll find the funds in this category appealing if you want to give a manager the freedom to invest in the best companies, no matter where they’re based. Wasatch World Innovators scours the globe for companies experiencing growth spurts, although its top holdings include such U.S. household names as Apple and Google. The managers of First Eagle Global, which may be available without a sales fee through advisers, seek shares of firms trading at big discounts to their underlying value. The fund’s long-term record was largely built under the esteemed Jean-Marie Eveillard, who stepped aside from day-to-day duties in 2009. Pimco All Asset All Authority invests in a basket of other Pimco funds and recently held significant stakes in emerging-market debt and commodities (note that Pimco’s Class D shares don’t levy sales charges).

Another year, another brutal outcome: As bad as the past year was for developed markets, emerging markets fared even worse. The turmoil in Europe is hurting China, where growth is slowing. Because China has a voracious appetite for natural resources, that, in turn, is hurting Latin America, including Brazil (China is its biggest trading partner). Picking through the wreckage of the past year’s leaders is no fun. But we’re keeping an eye on Forward Select Emerging Market Dividend. The year-old fund is off to a good start and boasts a 4.6% dividend yield. Otherwise, our money’s on Causeway Emerging Markets. It invests in growing companies trading at value prices. In many cases, the managers will consider the health of a country’s economy, as well as the outlook for certain industries, before investing. The fund yields 3.9%.

The narrower a fund’s focus, the more extreme its results are likely to be, as the funds in this category prove. Over the past year, regional and country funds lost an average of five percentage points more than the typical diversified overseas stock fund. So use funds in this group to add spice to a portfolio, not as core holdings. The standout in this category is Matthews Asia Dividend, a member of the Kiplinger 25. Managers Jesper Madsen and Yu Zhang invest in both emerging and developed nations, seeking companies they think will boost dividends in each of the next three years. European stocks are bruised and battered, and they require a credible resolution of the euro-debt crisis before they can embark on a sustained rally. Consider Fidelity Canada for a play on our northern neighbor’s rich natural resources.

Change at the top of this group comes with the velocity of a Stephen Strasburg fastball. Energy and natural-resources funds led the short-term winners’ list a year ago, and real estate funds were in ascendance the previous year. Health funds starred over the past year, as investors rotated into firms seen as capable of withstanding a weak economy. Vanguard Health, run since 1984 by Edward Owens, is a longtime favorite. Because of their high yields, real estate investment trusts are attractive. Pimco RealEstateRealReturn Strategy gets exposure to REITs by buying derivatives, then invests the collateral used to back those instruments in inflation-protected debt. Those bonds helped results big-time over the past year. For a more traditional property fund, consider Fidelity Real Estate Investment and T. Rowe Price Real Estate.

Funds in this category aim to zig when the market zags. Market-neutral funds sell short a basket of stocks, hoping to profit from falling prices, while holding an equal measure of shares the traditional way. In theory, the strategy should cancel out the influence of market movements and let specific stock picks drive returns. Funds that engage in merger arbitrage, such as Kiplinger 25 member Merger Fund, invest in acquisition targets after a deal has been announced, in a bet that the merger will be completed. Over the past five years, the fund has been less than one-fourth as volatile as the S&P 500. The ride at Pimco CommodityRealReturn Strategy, which shed 44% in 2008, isn’t as smooth. Yet we recommend Harbor Commodity Real Return Strategy, a clone of the Pimco fund, for its inflation-hedging properties.

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