Beneath market turmoil, new mutual trends arise

By Bill Deener / The Dallas Morning News <br><br>The stock market was filled with a lot of sound and fury in the third quarter, but most mutual fund investors will find that it signified ... not much.

Monday, October 2nd 2000, 12:00 am

By: News On 6

By Bill Deener / The Dallas Morning News

The stock market was filled with a lot of sound and fury in the third quarter, but most mutual fund investors will find that it signified ... not much.

Investors probably would have slept better holding a safe, sedate certificate of deposit. Instead, they took a ride on one of the most volatile stock markets ever, and by the time the quarter ended Friday the average large-cap growth fund, the largest mutual fund category, posted a 0.8 percent loss according to Lipper Inc., a mutual fund tracking service.

"With the exception of August, it has just been a real sluggish quarter," said Bob Shoss, portfolio manager of the Aim Large-Cap Growth Fund. "Rising interest rates and oil prices were very negative for stocks and caused a lot of uncertainty."

Investors were whipsawed this quarter as the major stock indexes, such as the Nasdaq composite index and the Standard & Poor's 500, first fell sharply in July, made a dramatic recovery in August and then collapsed in September.

However, beneath all the market turbulence some positive trends have begun to develop, and at least some investors are being rewarded. For example, those lucky enough to invest in the financial services and biotechnology areas were treated to double-digit quarterly returns.

Return to value

Investor sentiment continued to shift away from growth funds and into value funds, and that means this long-suffering sector is finally showing signs of life.

Growth fund managers invest in fast-growing companies â€“ primarily technology â€“ that are expected to increase earnings by at least 15 percent a year. Value managers look for slower-growing, so-called cheap stocks, often in ignored areas of the market, such as in the industrial or consumer products sectors.

The average small-cap value fund rose 6.5 percent in the quarter, one of the best performers among the diversified U.S. stock funds.

"Value is really picking up, and I'm delighted to see it," said Ted Aronson, portfolio manager of the Quaker Small-Cap Value Fund. "Over the past five years, the small-cap value was the worst performing sector by far."

For example, for the two-year period ending March 31, small-cap value had gained 3.8 percent, compared to the 42.3 percent gain of the average diversified stock fund.

The turn toward value stocks actually began in the spring after the Nasdaq dropped 37 percent from its record March 10 high of 5,058, Mr. Aronson said. Before the sell-off, the stock prices on many of the high-flying growth stocks had soared beyond rational levels, he said, while the prices on value stocks had remained stagnant for much of the last five years.

"The market became saner," said Mr. Aronson. "Investors finally said these technology shares are at exaggerated levels. I just believe that value funds will shine for awhile."

Sector funds win

Value funds, however, didn't take all the spotlight in the quarter. In fact, the quarter's best performances were turned in by two of the so-called sector funds, which focus on one specific area of the market.

Financial services funds, which invest in banks, brokerages and insurance companies, soared to a 21.8 percent gain, topping all other fund categories, according to preliminary data from Lipper. Shares of companies in this sector were pushed higher by the generally held belief among economists that the Federal Reserve has finished raising short-term interest rates for a while, said Anna Dopkin, portfolio manager of the T. Rowe Price Financial Services Fund.

The Fed has raised rates six times over the last 15 months in an effort to slow the booming U.S. economy and curb inflation. Financial services companies are sensitive to interest rate moves because as rates move higher demand for loans decreases, Ms. Dopkin said.

This sector was also helped along this quarter by several merger announcements, which typically push up the share prices of the companies being acquired.

"I had four takeovers in the companies that I hold in my portfolio," said Ms. Dopkin. "These stocks did well, and that also helped other financial service companies as people speculated over who might be next."

Shares in one of her holdings, U.S. Trust Corp. doubled in value after the announcement that it would merge with Charles Schwab & Co.

The other sector fund that did well specialized in health/biotechnology stocks. This sector rose 12.1 percent â€“ on top of a 17.6 percent gain in the second quarter. Much of this upward momentum is coming from a number of biotechnology companies that have presented promising clinical data at various conferences, said John Schroer, portfolio manager of the Invesco Health Sciences Fund.

For example, shares of IDEC Pharmaceuticals Corp. have risen from $60 a share to more than $170 a share after it presented some promising information about one of its anti-cancer drugs at the May meeting of the American Society of Clinical Oncology. The company introduced a drug â€“ Rituxan â€“ that has potential for treating non-Hodgkin's lymphoma.

"There is just a lot in the pipeline that is coming out of these biotechnology companies," said Mr. Schroer.

Not all positive

But as good as these returns were, investing in sector funds â€“ because they aren't diversified across several industry groups â€“ is not for the faint of heart. Funds that specialize in telecommunications stocks, for example, dropped 5.9 percent in the quarter, making it the worst-performing sector among all domestic fund categories, according to Lipper.

Investors are now beginning to question whether all the money spent building out the wireless networks will ever pay off, and stiff competition among the long-distance service providers has hurt those companies, said Michael Gallipo, portfolio manager of the Monument Telecommunications Fund. Shares of the long-distance service providers have been especially hard hit in recent months as they have trimmed revenue and profit growth estimates.

Shares of WorldCom Inc., AT&T Corp. and Sprint FON Group are all down more than 50 percent from their yearly highs.

"I actually think the market has overreacted," said Mr. Gallipo. "We are still optimistic about the potential of wireless, and still highly recommend stocks like Nokia."

While the performance of U.S. stock funds was sluggish, at least most of the categories posted positive gains. The average overseas fund was down 3.2 percent in the quarter, and some of the sectors suffered much heavier losses.

Funds that specialized in Pacific region countries lost 12.7 percent, China funds were off 9.6 percent and European funds took a 5.8 percent hit, according to Lipper. All these regions are in the midst of what has become a painstakingly slow process of restructuring their economies to become more competitive in the global marketplace, said Michael Lipper, chairman of Lipper Inc.

That means ridding themselves of much of the cronyism and government intervention of the past and allowing companies to rise and fall based on their own merits. Japan in particular seems to be stuck in an economic netherworld where it hovers just above recession with interest rates close to zero.

But Mr. Lipper said those problems are being addressed "and I wouldn't be negative on a long-term basis investing outside the U.S."