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Style Universe: A Year of Rational Pessimism

Small-value and real-estate funds stand out in otherwise dismal year.

Morningstar Analysts, 12/28/2001

<P>Small-cap value managers are whistling a happy tune, as dirges play for many Internet funds that launched just before the technology-stock bubble burst in 2000.</P> <P>This year's bear market was grisly for once-high-flying growth funds, which focus on quickly growing companies with high price/earnings ratios. Among domestic-stock funds, technology funds were the big losers this year, with a 37.70% year-to-date loss through December 27, followed closely by communications, with a 35.36% loss, and large growth, with a 23.14% loss.</P> <P>As Morningstar's Investment Radar map indicates, the small-value category was the top performer for the year--it managed to post a 17.48% gain for the year to date through Thursday. Small-value offerings prefer small-cap stocks that look cheap relative to earnings, cash flow, or other fundamental measures. The second-best-performing category in Morningstar's database was real estate with a 8.74% gain for the year. The small-blend and mid-value categories also managed to stay in the black, with 8.61% and 6.26% returns, respectively.</P> <TABLE cellSpacing="0" cellPadding="0" width=422 border="0" > <TD><IMG height=224 src="http://im.morningstar.com/im/SU_122801_1.gif" width=422></TD> "How the Style Universe Works"</FONT></A>.</FONT></TD></TABLE> <P>A slowdown in information-technology and telecommunications capital spending severely impaired tech and communications fund results as well as the large-growth funds that favored those sectors. The worst-performing large-cap growth fund for the year to date through Thursday, Merrill Lynch Focus 20 <?XML:NAMESPACE PREFIX = MSTR /?><MSTR:SECURITY>MBFOX</MSTR:SECURITY>, posted a painful 69.94% loss. To make matters worse this concentrated fund, which picked about 20 stocks on the basis of their earnings momentum, also lost its manager, Jim McCall, who quit in November. McCall kept most of the fund in tech stocks during his tenure, even as the fundamentals of tech companies continued to deteriorate and many other growth managers reduced their exposure to the sector, Morningstar fund analyst Dan Culloton wrote in a recent analysis. Top holdings like telecom-equipment supplier Sonus Networks <MSTR:SECURITY>SONS</MSTR:SECURITY>, and optical-networking equipment makers ONI Systems <MSTR:SECURITY>ONIS</MSTR:SECURITY> and Ciena <MSTR:SECURITY>CIEN</MSTR:SECURITY> hurt the fund, falling more than 80% this year. </P> <P>Specialty-communications fund Firsthand Communications <MSTR:SECURITY>TCFQX</MSTR:SECURITY> gave up more than 61% of its value this year. Manager Kevin Landis focuses primarily on smaller-cap equipment and infrastructure providers and kept more than 70% of its portfolio in tech. The fund offers exposure to innovative communications technology firms, but its narrow focus makes it extremely volatile, and it suffers when tech is out of favor. Top holdings Vitesse Semiconductor <MSTR:SECURITY>VTSS</MSTR:SECURITY>, network-equipment maker Extreme Networks <MSTR:SECURITY>EXTR</MSTR:SECURITY>, and Ciena have each lost more than 65% this year.</P> <TABLE cellSpacing="0" cellPadding="0" width=422 border="0" > <TD><IMG height=224 src="http://im.morningstar.com/im/SU_122801_2.gif" width=422></TD> <TD height="1"0></TD> (1)</FONT> Merrill Lynch Focus 20, <FONT color=#ff3300>(2)</FONT> Firsthand Communications, <FONT color=#006600>(3)</FONT> Kensington Strategic Realty, <FONT color=#006600>(4)</FONT> Spirit of America Investment, <FONT color=#006600>(5)</FONT> Alpine U.S. Real Estate Equity, <FONT color=#006600>(6)</FONT> Boston Partners Small-Cap Value II, <FONT color=#006600>(7)</FONT> Aegis Value. </FONT></TD></TABLE> <P>Within the real-estate category, real-estate investment trusts (REITs) have attracted mutual fund managers because they performed relatively poorly in 1998 and 1999 and the stocks looked undervalued in 2000, said Morningstar analyst Alan Papier. Investors looking for a strong dividend yield and relative safety from the reeling stock market jumped into REITs, helping them post gains in 2001 even as most stock market segments tanked, Papier says. Specialty-real estate offerings Kensington Strategic Realty <MSTR:SECURITY>KSRAX</MSTR:SECURITY>, Spirit of America Investment <MSTR:SECURITY>SOAAX</MSTR:SECURITY>, and Alpine U.S. Real Estate Equity <MSTR:SECURITY>EUEYX</MSTR:SECURITY> all managed to post gains of 25% or more this year.</P> <P>Small-value offerings' strong returns in 2001 attracted assets and made several of them ask if their fatter asset bases would hamper future performance. In many cases, the answer was yes. Thus, many successful small-value offerings have closed their doors to new investors this year, including Berger Small Cap Value <MSTR:SECURITY>BSVIX</MSTR:SECURITY><FONT size=2>, </FONT>Wasatch Small Cap Value <MSTR:SECURITY>WMCVX</MSTR:SECURITY>, American Century Small Cap Value <MSTR:SECURITY>ASVIX</MSTR:SECURITY>, and Boston Partners Small Cap Value II <MSTR:SECURITY>BPSCX</MSTR:SECURITY>. </P><FONT size=2></FONT> <P>Small-value funds Boston Partners Small-Cap Value II and Aegis Value <MSTR:SECURITY>AVALX</MSTR:SECURITY> have racked up 47.24% and 41.58% returns, respectively, for the year to date. Boston Partners Small-Cap Value uses a broad style to find bargains in several industries, said Morningstar senior fund analyst William Samuel Rocco. Holdings include pharmaceutical products provider Option Care <MSTR:SECURITY>OPTN</MSTR:SECURITY>, up more than 211% year to date, and specialty retailer Pier 1 Imports <MSTR:SECURITY>PIR</MSTR:SECURITY>, up more than 68%. In addition, risk-conscious fund manager David Dabora holds more than 100 names and keeps their weightings in the portfolio small. </P> <P>With a mere $50 million in assets, Aegis Value has achieved a great record using a "patient deep-value strategy," says Morningstar Director of Fund Analysis Russel Kinnel. "Grungy" stocks such as uranium supplier USEC <MSTR:SECURITY>USU</MSTR:SECURITY> and tobacco processor Standard Commercial <MSTR:SECURITY>STW</MSTR:SECURITY>, up more than 84% and 138%, respectively, for the year to date, have boosted returns this year, writes Kinnel in a recent analysis. The fund has achieved a stellar three-year record, but for most of that time its asset base was less than $10 million in assets. It remains to be seen if they can produce similar returns with more money to invest, Kinnel said. </P>

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