Funds ride bull market rebound, and then some
As a historic stock market rally reaches its second anniversary, investors in US mutual funds have been among the biggest winners.
By Mark Jewell, The Associated Press
The pain of the stock market meltdown is becoming a more distant memory thanks to the stunning rebound of mutual fund returns.
An extreme example: Since the market bottomed in March 2009, real estate mutual funds have risen an average 195%, according to Morningstar. They invest primarily in real estate investment trusts, which were lifted by improving prospects for the income-producing commercial properties that REITs own. A $10,000 investment at the market's low has swelled to nearly $29,500. Investors in the top-performing Pimco Real Estate Real Return Strategy fund (PETAX) saw an equal investment grow to nearly $42,000.
Investors can't expect to latch onto a rising market at just the right time. Yet the gains have been so large across the board that virtually anyone who didn't give up on stocks has seen a big payoff. The average returns for 16 of Morningstar's 21 domestic stock fund categories were greater than 100% through last week, beating the 95% return of the Standard & Poor's 500 Index. Even the two categories with the smallest returns -- utilities funds and health care funds -- are up more than 60%.
"The categories that have done the best over the last year or two are the ones investors should be more cautious about," Morningstar fund analyst Ryan Leggio says. "They don't offer the same risks and rewards as they did a year ago, when they were much cheaper to buy."
Most of the top-performing funds in this bull market specialize in unusually volatile stocks. So it's important to note that they fell more steeply than the 57% drop in the S&P 500 from its October 2007 peak to March 2009. That means they had a bigger pit to climb out of to get investors back to where they started a goal many of the recent hottest funds have yet to achieve.
In fact, nine of the top 10 individual stock funds over the past 24 months have bottom-rung 1-star ratings on Morningstar's 5-star scale. That system measures past returns, while also considering how much risk a fund took to achieve them.
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Still, their supersized gains since the market turned the corner offer a reminder that the best short-term opportunities can often be found in the hardest-hit areas. That was a tough move to make in early 2009, when it seemed the market's free-fall might not end.
But when prospects brightened that spring, the stock funds that had lost the most "just snapped back really hard," Leggio says.
One example of how volatile the top-performing funds have been: Ariel Fund (ARGFX) is up 229% since the market bottom. That surge came after the fund lost 55% from the market's peak-to-trough, compared with the 45% average decline for its mid-cap blend fund peers.
A look at a few of the top-performing domestic stock fund categories since the market bottom, and the outlook for the market segments they specialize in:
Real estate: Although the recovery of the housing market remains stalled, the outlook for REITs has been improving. Their fortunes have little to do with single-family home price trends. Instead, REITs are all about the commercial and industrial property markets, which are being lifted by the economic recovery.
One reason these funds have recently been popular is that investors, especially income-seeking retirees, are drawn to the fact that REITs are required to pay out most of their operating income as dividends.
With yields for 10-year government Treasury bonds around 3.5%, REITs' average 4% dividend yields look attractive. Historically, REIT dividend yields have averaged around 6%.
REITS were offering investors almost 10% yields in March 2009, when their prices became so cheap that their yields surged (prices and yields move in opposite directions). But if 10-year Treasury yields keep rising, as they have this week, REITs could look less attractive, sending REIT stocks down.
Industrial: Mutual funds specializing in industrial stocks such as manufacturers and chemical companies have been the second-strongest domestic stock category, with an average 162 percent gain. Most indicators suggest an economic recovery will continue, so the outlook for these funds remains good. However, it's open to debate whether stock prices already reflect those expectations.
Small companies: Small-cap funds, which specialize in stocks of companies valued at less than $2 billion, ranked high. They posted an average gain of about 140%.
Small companies are typically more dependent on borrowing and near-zero short-term interest rates have lifted their stocks. Although rates have nowhere to go but up, few economists expect a sharp rise anytime soon.
However, because small-caps have fared better in the bull market than large-caps, the situation could reverse itself. Typically, large-caps regain the lead as a bull market begins to lose momentum.
Financial: Funds specializing in stocks of banks and other financial companies have risen an average 133%. They were helped as the credit troubles that sent these stocks into their 2008 tailspin eased.
Like industrials, financial stocks often move closely in synch with the economy, so they could continue to rebound. But credit issues vary widely from bank to bank, so generalizations are tough to make.
Technology: These mutual funds, up an average 133%, are an exception among the bull market's top-performing categories. The others rebounded from unusually sharp drops during the meltdown.
Tech funds have been faring relatively well all along, and have the best 3-year record among all domestic stock fund categories. Their average annualized gain is nearly 10%. Credit consumers' insatiable demand for gadgets, which withstood the recession, has buoyed these funds, and that demand shows little sign of slowing.