Here's what has worked, and what hasn't, so far in the year to date.
Amid persistent volatility, the path to relative success so far in 2012 has generally led through the market's more growth-oriented areas. Among Morningstar's diversified domestic-equity categories, large-growth funds have fared best as a group for the year to date though July 9. Further down the market-cap spectrum, mid-cap growth and small-growth funds have, on average, bested their blend and value-focused counterparts, too.
The performance advantage that growth has enjoyed in the year's first half is apparent at the sector level as well. Two large-growth focused SPDRs, Technology Select Sector SPDR XLK and Consumer Discretionary Select Sector SPDR XLY, have led the way, with each exchange-traded fund enjoying double-digit gains on the year. At the other end of the performance spectrum are the market's more value-focused areas. While SPDRs tracking the utilities, industrials, and materials sectors are all in positive territory, none of those ETFs--each of which runs with a large-value portfolio--has cracked 5% for the year to date.
Elsewhere, Energy Select Sector SPDR XLE, another ETF with a large-value lineup, has shed nearly 5% in 2012, amid energy prices that have steadily declined since hitting a peak last March.
Against that backdrop, the year-to-date success of the value-leaning financials sector is somewhat surprising, at least at a glance. Indeed, Financial Select Sector SPDR XLF has climbed by double digits.
Among Morningstar's diversified domestic-equity peer groups, Bruce Berkowitz's financials-besotted Fairholme FAIRX is the year's top-performing fund, although with nearly 30% of its $7.4 billion asset base invested in AIG AIG as of February--and with roughly 75% of assets plunked down on the financials sector overall--Fairholme and its portfolio of just 19 holdings isn't especially diversified relative to category rivals.
Berkowitz is a terrific investor, of course, and the Morningstar Analyst Rating of Silver that Fairholme has earned underscores our conviction that the fund is likely to outperform over the course of a full market cycle. Still, with a portfolio whose debt/capital ratio hovers near 45% and a relatively moat-free collection of holdings, the fund would almost certainly stumble if capital markets were to freeze up or if persistent worries about the economy caused investors to stampede into higher-quality stocks.
With shareholders continuing to yank money out of Fairholme, moreover, Berkowitz could be at least temporarily hamstrung if such calamity strikes, although the fund’s recently increased cash stake would help cushion the blow. Still, to succeed with Fairholme, and in the relatively unhealthy financials sector at large, investors should have heavy exposure to patience.
Not all markets are style-driven, of course, and no sector is a monolith. Still, it's for good reason that health care enjoys a reputation as a defensive safe haven. The actively managed Vanguard Health Care VGHCX, the largest mutual fund to target the sector, features a financially healthy, moat-heavy portfolio whose free cash flow yield sails past the broader stock market's. The fund's Morningstar Risk, a volatility gauge that penalizes poor performance during downturns, is low across all trailing time periods, and as gauged by standard deviation, the fund has been dramatically less volatile than the S&P 500 Index over time, too.
A down-market stalwart, Vanguard Health Care suffered just roughly half of the S&P's losses in hard-hit 2008. Though it's not having a great year in relative terms thus far in 2012--a gain of nearly 10% is merely good enough for the health-care category's bottom quintile--the fund's defensive cast has served investors well over time. In the trailing 15 years through June, an annualized gain of over 11% lands the fund in the peer group's fifth percentile.
Among passive vehicles, Sector Select Healthcare SPDR XLV is also a picture of financial health. Its lineup is even moatier than the Vanguard fund's, and its debt/capital ratio clocks in at under 30%. Both vehicles' portfolios land in the large-blend square of the Morningstar Style Box, but their average valuation measures clock in below those of the broad stock market. The health-care sector has been an overachiever this year anyway, with funds that target the area well-represented among the ranks of 2012's top performers so far. (You can check the complete list of year-to-date winners here.)
In most cases, the health-care funds that have fared best this year don't target the sector broadly, training their sights instead on racier biotech companies. That focus helps to account for their success and the relative outperformance of health-care during a year in which other defensive sectors have lagged the stock market at large. While the health-care sector as a whole has tacked on roughly 10% in the year to date, the S&P Biotech Index has climbed more than 30% so far in 2012.
That dynamic also helps to account for the more-cautious Vanguard fund's poor relative showing this year as well as the success of T. Rowe Price Health Sciences PRHSX. Led by an M.D., Kris Jenner, that fund had more than a third of assets allocated to biotech at the end of May. For the year to date, its gain of more than 25% ranks in the health category's top quintile.
Although it's interesting, and sometimes revealing, to take the market's temperature throughout the year, it's important not to read too much into short, arbitrary timeframes simply because they align with the calendar. As the success of the value-oriented financials sector shows, dominant trends (growth trumps value, for instance) can conceal as much as they reveal and not all markets are style-driven. Moreover, as the relative outperformance of health care thus far in 2012 suggests, performance patterns that seem anomalous at a glance can appear less so once they're given closer scrutiny. In the case of health care, the least defensive companies have fared the best.
Similarly, with persistent volatility continuing to roil equity markets, trends that look linear at a distance are often much messier up close. While growth has indeed trumped value in the aggregate during the year to date period, for example, value has held sway in the past three months. Looking into whether that trend persisted will probably may make for an interesting year-end review, so stay tuned for that. Staying focused on the long haul, however, will make for better investment results.