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Fund Spy

U.S. Equity Funds Press Higher but Fade Late in the Third Quarter

Investors pile into what's working.

U.S. equity markets posted further gains in the third quarter, but it was an uneven journey. Bolstered by loosening lockdown restrictions and continued hopes for accommodative monetary and fiscal policy, the S&P 500 gained 14.1% from July 1 through Sept. 1, when it reached an all-time closing high of 3,580. However, the rally was narrow. Familiar names from the technology and consumer cyclical sectors led the way, with each sector gaining over 20% each.

Apple (AAPL) saw its already massive market capitalization soar 47%, accounting for nearly 20% of the entire index’s gain for the period. Fellow behemoths (AMZN) and Facebook (FB) weren’t far behind, gaining over 25% apiece. Perhaps no stock embodied the market’s frothy sentiment better than electric-auto manufacturer Tesla (TSLA). After nearly tripling during the first half of the year, shares spiked another 131% to their late-August peak, making the company one of the 10 largest in the United States at the time.

Other sectors didn’t see such success during the rally. Financial services gained a comparatively modest 10%, while healthcare returned 7%. The much maligned energy sector suffered losses of 7%. With such polarization, it was no surprise that the Russell 1000 Growth Index gained an astonishing 32%, while the Russell 1000 Value Index fell 9.2%. The growth versus value divide wasn’t the only important factor as small- and mid-cap stocks posted markedly lower results than large-cap stocks. The small-cap Russell 2000 actually declined 4.5%, while the Russell MidCap Index barely made it above water with a 0.5% gain.

The strong rally began to fade in September as high valuations and concerns around Congress’ ability to pass another round of fiscal stimulus weighed on markets. The S&P 500 dropped 3.8% during the month, with the stronger performers from earlier in the quarter taking the brunt of the losses. The tech-heavy Russell 1000 Growth fell 4.7%, worse than the 2.5% drawdown of the Russell 1000 Value.

Still, the September decline didn’t offset prior gains as the S&P 500 closed the third quarter up 8.9%, the Russell MidCap gained 7.5%, and the small-cap Russell 2000 Index finished up 4.9%. Equity markets continued to be buoyed by low bond yields and optimism surrounding an eventual vaccine for the coronavirus, which have been enough to push prices higher despite many companies electing to withdraw earnings guidance because of uncertainty and broader depressed economic activity. 

Category-Leading Funds

Baron Discovery (BDFFX)  
Given the market’s continued favoritism toward growth companies, it’s no surprise funds embracing fast-growers tended to perform the best. Baron Discovery targets innovative companies early in their life cycles and made many good calls during the quarter. Its 18.7% return ranked in the top percentile of small-growth Morningstar Category peers. While most of its assets are concentrated in technology and healthcare stocks like most small-growth managers, stock selection within consumer cyclical and communication services was the most impactful. A well-timed purchase of casino operator Penn National Gaming (PENN) in the first quarter was the fund’s best trade. Shares opened the year at around $25 but plummeted to a low of under $5 in March, only to rebound strongly to over $70 by September. The fund’s top communications stock was S4 Capital PLC (SFOR), a U.K.-based digital advertising and marketing firm that returned over 50% during the quarter.

Fidelity Blue Chip Growth (FBGRX)
Fidelity Blue Chip Growth got a boost from an overweight position in consumer cyclical stocks and strong stock selection across other sectors. The fund’s 17.0% gain placed it in the top decile of large-growth Morningstar Category peers for the quarter. Electric-auto manufacturer Tesla was the largest contributor, as the high-flying company gained 99% during the quarter on increased optimism surrounding the switch to electric vehicles. Other winners in the consumer space included e-commerce behemoth Shares in the online retail leader jumped 14%. Additional top performers were semiconductor firm Nvidia (NVDA), whose shares rose 43%, and online car dealer Carvana (CVNA), which posted an 86% gain as investors grew more optimistic about the firm’s prospects with more people shopping from home.

Funds Lagging Behind

Janus Henderson Small Cap Value (JSCVX)
Small-cap value has been the worst-performing market segment in the U.S. in 2020, and that trend continued through the third quarter. Janus Henderson Small Cap Value had a particularly tough time, as its 5.0% decline ranked in the bottom decile of small-value Morningstar Category peers. Stock selection woes in the consumer cyclical and financial-services sectors were the key detractors. Apparel companies like Steve Madden (SHOO), Columbia Sportswear (COLM), and Carter’s (CRI) failed to keep pace with the consumer discretionary sector’s gains, while the portfolio’s various regional banks experienced sharper loses than many of their counterparts.

American Funds AMCAP (AMCPX)
American Funds AMCAP struggled on a relative basis in the third quarter as its 6.2% return ranked in the bottom decile of large-growth Morningstar Category peers. One reason was the fund’s 8% cash stake entering the quarter. The fund’s managers haven’t been afraid to hold cash when they can’t find enough investment opportunities, which has helped in downturns like the first quarter of 2020 but which tends to hurt in rallies. Additionally, the portfolio is much less concentrated in the mega-cap behemoths that dominate the Russell 1000 Growth and many peers’ portfolios. The fund’s nearly 11-percentage-point underweight in Apple, the index’s largest constituent, cost it dearly as the tech leader’s shares gained 27%. The fund’s more conservative growth tilt also was a headwind as it avoided pricey stocks like Tesla and Nvidia, two fast-growers that rocketed up 99% and 43%, respectively.

Adam Sabban has a position in the following securities mentioned above: BDFFX. Find out about Morningstar’s editorial policies.