Growth Funds Flourish in the First Quarter

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. If you're a mutual fund investor, it's a good bet that your funds ended the quarter in the black. Joining me to provide a recap of the first quarter in mutual funds is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, we are not quite done with the first quarter, but it has shaped up to be a tremendously good quarter for investors. Let's talk about why we saw this reversal of some of the problems that investors were having in the fourth quarter of 2018. What drove investors to be more sanguine?

Kinnel: We had all that angst in the fourth quarter. S&P lost about 13%. Now, first quarter, S&P is up about 13%, meaning we haven't caught up all of our gains, but we are close. But it seems like all of those worries have really diminished a bit. We were talking about trade wars and Brexit and things like that, and of course, the trade wars have softened a little, but Brexit is still out there.

Benz: Front and center.

Kinnel: But it seems like common reversal. We see this all the time, where you kind of overdo it in one direction, and you come back and correct for that, and you are at the same place you were to start.

Benz: So, let's talk about some of the mutual fund categories that performed particularly well during the quarter. It was a strong quarter almost across the board, but there were some standout categories. Growth-oriented funds generally continued to beat value. Let's talk about that.

Kinnel: Small growth and mid-growth were the best places to be, some really strong gains there. Funds like Artisan Small Cap and Baron Small Cap had particularly strong returns. But really great double-digit returns across the board on the growth side.

Benz: And that carried over to international equities as well. Performance wasn't quite as strong as U.S. equities, but nonetheless, a stellar quarter for foreign-stock investors.

Kinnel: That's right. It was more like 6% to 10% for foreign, but that's a really good quarter, too.

Benz: Absolutely.

Kinnel: So, a really strong quarter across the board.

Benz: In terms of the worst-performing categories, I'm guessing the conservative stuff didn't do as well as the more aggressively positioned equity funds. Let's talk about that, the categories that disappointed a little bit or maybe just didn't earn stellar gains.

Kinnel: There are categories that, as you say, always have modest returns: the short-term taxable-bond category, short-term muni, market neutral--they had somewhere around 50 basis points of returns, which is not bad for them.

Benz: It's what you expect them to do, right?

Kinnel: But everything else did so well, they looked bad in this quarter anyway.

Benz: I think investors are maybe taking stock. It has been such a great quarter. What counsel would you offer them knowing that all investors are different? But we have been through a very long-running equity market rally. Can you share any guidance about how investors should approach their portfolios?

Kinnel: We have another lesson in how hard it is to time markets. I mean, who could have imagined you should sell before the fourth quarter started and then buy when the first quarter started. No one was predicting that. So, I think that's a constant lesson we're always learning. It's always humbling when you try and predict markets. I think that's one thing. But I do think even as we have another rally, there are warning signs again. A lot of talk right now about how the yield curve has inverted. That means you are getting paid more yield on the shorter end than the longer end, which is weird--it doesn't make sense if you are committing to more time. But what it means often is that if you expect a recession, of course you think all the yields are going to come down and therefore, you'd rather lock in that long-term yield …

Benz: Go long.

Kinnel: … if it's not particularly attractive. So, if that is really what it's saying, and the yield-curve inversion is a pretty good predictor of recessions and bear markets, then there's a whole lot of reason to worry. Of course, now, as people are talking about it, some say, well, it has to stay inverted for a full quarter to matter. Others are saying, often you see a blowout rally and then a sell-off. So, I think there are mitigating circumstances, and I don't think anything is a sure thing to predict the markets. But certainly it ought to sober you up a little, even after we've had this nice rally.

Benz: If you are looking at your asset allocation and you are 10 years older than you were when this started, and we all are, maybe consider derisking your portfolio a little bit rather than putting more chips on the stuff that has performed really, really well.

Kinnel: That's right. The fear of missing out and envy are among the worst reasons to invest. I think even simple rebalancing would imply you are selling some equities and moving into bonds. There's certainly some warning signs out there. Brexit is still looking like a train wreck.

Benz Yes.

Kinnel: And so there are a lot of reasons to worry still. So, I don't think it's a time to take more risk on. It was a great quarter for risky assets, but those things don't necessarily continue.

Benz: OK, Russ. Thank you so much for being here to provide a recap.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.