Which Equity Funds Stood Up to the Bear Market?

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Christine Benz: Hi, I'm Christine Benz from Morningstar. Amid the current pandemic, stocks just wrapped up their worst quarter in 12 years. Joining me to provide a recap of U.S. equity fund performance is Katie Reichart. She is director of U.S. equity Strategies coverage in Morningstar's Manager Research Group in Morningstar Research Services. Katie, thank you so much for being here.

Katie Reichart: Thanks for having me.

Christine Benz: Katie, it obviously was not a great quarter for equity investors, but let's discuss some of the broader trends that prevailed in the fund universe. You noted that we just continue to see this big gulf in performance between growth stocks and growth funds, and value stocks and funds.

Katie Reichart: Absolutely, yeah. It was obviously a very difficult quarter for equities, equity funds across the board, but we are continuing to see growth funds outperform value, a trend that's really persisted for the past several years. And just to put some numbers around it, in the quarter, large-growth active equity funds on average lost 15%, and that compares to large-value, which lost 27%. So, obviously, quite a disparity there, and probably the worst-performing category was small-value and on the active side, it lost 35% year-to-date. One thing I would note there is that small-value is an area where active held up a little better for the quarter. The passive average was 39% loss.

Christine Benz: Let's talk about some of the things that have been holding growth stocks, and in turn, funds aloft or relatively aloft during this really difficult period?

Katie Reichart: Well, for one, most growth funds don't have a lot of exposure to energy. That's obviously one sector that got completely pummeled in the first quarter with oil prices just near historic lows. And obviously, continued questions about the demand for oil with people not traveling as much in the immediate future. And then, of course, financials were another sector that got hammered pretty badly, too, with interest rates near zero. So growth funds typically not owning those sectors as much was a benefit, and then also technology held up pretty well. That sector was down just about 13% for the quarter. Obviously, a lot of firms that enable people to stay connected in this odd time where we're all self-isolated, that's been a benefit to many large-growth funds and growth funds in general.

Christine Benz: How about healthcare? Because some of the companies are thought to maybe have some promising therapies or vaccines even in the face of this virus, any news going on in the healthcare sector?

Katie Reichart: Yeah, and healthcare was another sector that was relatively well-insulated. It was down 13%, and like you said, that's going to clearly be an area of the market that's going to be very important going forward, even though other areas like consumer discretionary might face more questions. Lots of companies working on vaccines, antivirals for COVID-19. General usage of the healthcare system, of course. We're seeing that sector has held up a little bit better.

Christine Benz: And healthcare stocks, I guess, are generally perceived to be somewhat impervious in a recessionary environment. I'd assume that helps as well.

Katie Reichart: True.

Christine Benz: Let's discuss funds that manage to hold up really well, specific funds. You mentioned growth funds as a whole did quite well, but can you highlight some specific names that managed to at least hold up relatively well in a tough market environment?

Katie Reichart: Morgan Stanley Institutional Growth was the best-performing equity fund that Morningstar covers, and it had about just under a 4% loss for the quarter, which is still a loss but way better than the Russell 1000 Growth Index's 13% loss. And Dennis Lynch and his team has run that fund for a long time. It was really in the right place at the right time with a lot of the companies it tends to invest in just on a regular basis. Zoom, Slack, some of those remote-working types of companies had big gains. Moderna is one of the biotechs that's working on a vaccine for COVID-19. And then, it doesn't own any energy or financials, so clearly that was a huge tailwind in this type of environment.

Christine Benz: How about funds in our coverage universe and your team's coverage universe that performed particularly poorly? I know that you and the team have been watching closely, the Primecap group of funds, generally growth-oriented, but they didn't have such a good quarter.

Katie Reichart: Right, and that might seem a little bit surprising, but when you look at the holdings, the Primecap funds are owners of some of the airline stocks. And clearly, airlines have just gotten pummeled right now with travel really screeching to a halt and the picture a little bit murky for the foreseeable future for travel. But very tenured team, great process. They remain Gold-rated and I think good long-term picks.

Christine Benz: How about among large funds? I know that Fidelity Contrafund, for example, is one that you and the team cover. It's one of the largest active funds out there. How have some of the big active funds performed during this period?

Katie Reichart: Contrafund under Will Danoff--typically that's performed a little bit better in market drawdowns. He likes competitively managed businesses that tend to hold up pretty well, and it did outperform its large-growth peers. It was a tad bit behind the benchmark, but I would point out that Contrafund typically has a bit more financials, a bit bigger financial stake than the benchmark and some peers, so that just by nature was a bit of a headwind at this point.

Christine Benz: How about over at Dodge & Cox? Value Shop--I would imagine that wasn't their best campaign in the first quarter.

Katie Reichart: Right, and Dodge & Cox, obviously, struggling with the value angle and being very contrarian, and so some of their picks in energy, financials have just gotten hit really hard. I would point out they obviously had a tough time in the financial crisis as well. But then, they came roaring back, and so I think that's what we would hope to see here, too. Continued strong leadership there, great process, very disciplined, and they really stick to their guns, and investors need to just be patient with it.

Christine Benz: And they might tend to be buyers in environments like this, which can set them up for an eventual recovery potentially.

Katie Reichart: Exactly.

Christine Benz: Another trend that you and the team have been monitoring is funds reopening. And let's talk about first, why this happens sometimes in difficult market environments, and maybe you can highlight some of the funds that you think are perhaps worthwhile that have recently reopened?

Katie Reichart: Sure. Well, I guess one silver lining to a big drawdown is that some funds that are very mindful of capacity and how many assets they've taken in and tend to close--some of those reconsider of whether they should open to new investors again. And typically, that's because they might anticipate outflows with investors maybe not wanting to stay the course in a tough market.

And also, some managers really want the capital coming in because if the market is down, they're seeing a lot of opportunities to buy, and so that can lead to reopening funds. And we have already started to see this trend persist. We've seen Wasatch Small Cap Growth, that's a Gold-rated fund that's reopening, and that's been closed since 2011, which really just goes to show the magnitude of this bull market we've been in, how long some funds have been closed. And Wasatch Core Growth is another Gold-rated fund that's reopening.

We have a couple of Artisan funds. Artisan International Value, Silver-rated. That's also been closed since 2011. Artisan Small Cap Value is Silver-rated as well. And then, Fidelity Small Cap Growth, Bronze-rated, and Fidelity Small Cap Discovery, Silver-rated. So all those are reopening and Medalist funds. We think they're great long-term picks. And frankly, as investors might now be thinking, "Should I rebalance towards equities?" These might be good opportunities for them.

Christine Benz: Katie, always great to get your perspective. Thank you so much for taking the time to be here.

Katie Reichart: Thanks, Christine.

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