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By Christine Benz and Russel Kinnel | 10-01-2014 03:00 PM

Quarter Ends With a Whimper for Stock Funds

Large-cap funds fared far better than small-cap in the U.S., while emerging markets held up better among overseas offerings, says Morningstar's Russ Kinnel.

Christine Benz: Hi, I'm Christine Benz for Stock funds ended the quarter with a whimper, but many are still in positive territory for the year. Joining me to recap the quarter-to-date and year-to-date fund performance action is Russ Kinnel, he's director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, I want to talk about equity-fund performance during the third quarter. What are the key trends that you see when you look across our various equity-fund categories?

Kinnel: This was one of those quarters where [the Morningstar Style Box] really explained a lot. Small cap versus large: Large was much better than small. Small value was the worst. It really got hammered. Large growth actually had a slightly positive return. So, a really dramatic story around the style box this quarter.

Benz: Let's talk about why that was. Why have small-cap stocks been getting hit so hard? Not just during the quarter but really all year. It's not been a great year for small caps.

Kinnel: I think a big part of it is simply reversion to the mean and valuation--that small caps had gotten quite pricey, historically. Large caps, not so much. If you remember at our conference in June, Ben Inker of GMO actually said he wouldn't touch small caps with a 10-foot pole. So, there were clearly a lot of people who have been saying small caps are pricey and that seemed to have an effect on the market. Now, obviously, there are always a lot of other things going on; but I think some of that was just valuation and reversion to the mean.

Benz: And large caps were arguably more attractive coming into this year?

Kinnel: A little more attractively priced. They've lagged small caps for a number of years. So, I think they had a little room to catch up, and I think that's being reflected. I think you're seeing a little more growth there. Growth is still somewhat hard to come by in this sort of sluggish recovery, and a large growth with some of the big tech names and some of the health-care names is still delivering that.

Benz: That's what I wanted to ask about--the growth/value spectrum. When you look at that, do you see any pronounced trends?

Kinnel: For the year, it's not that dramatic; but for the quarter, we saw large growth beating large value and small value lagging small growth. So, definitely growth is doing better for a change.

Benz: Most equity funds, certainly large-cap funds, are in the black, year to date. Small-cap equity, not so much. This is domestic equity. Turning over to international equity, what sorts of trends do you see there? Do you see the small caps underperforming there and large caps doing relatively better?

Kinnel: Yes, but it's much more muted. So, everyone had a bad quarter in foreign funds last quarter, but not nearly as dramatically so. Maybe a 5% loss for a foreign small-cap fund versus a 3% or 4% loss for a foreign large cap. So, much more nuanced and, really, everyone had a bad quarter.

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