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Kinnel: What Rattled Funds in the 1st Quarter

Russel Kinnel
Christine Benz

Christine Benz: Hi, I'm Christine Benz for The first quarter of 2018 marked a return of volatility to the equity market, and bonds didn't perform especially well, either. Joining me to provide a recap of mutual fund performance in the first quarter is Russ Kinnel. He is director of manger research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: We waited until the very last minute to shoot this because the market has just been so volatile, especially here in March. We weren't sure where we would shake out. Where we sit today, which is on the last trading day of the quarter, it looks like most equity categories, most U.S. equity categories, are poised to end up the quarter in the red. Let's talk about the things that were weighing on stocks during this period.

Kinnel: I think it starts with getting a whiff of inflation, which also means rising interest rates from the Fed, and of course, the markets don't like either of those. That's a little unsettling. We've had a very long run of low inflation and low interest rates, and of course, that's great for stocks.

Benz: When we look at the categories that performed relatively well, it's mainly the growth categories, which have been outperforming for a while now, technology stocks in particular. We saw them give up a lot of ground recently here in March. Let's talk about the news that was weighing on some of the growth-oriented categories in tech stocks.

Kinnel: If you had asked me a couple of weeks ago, at that point, large growth was up maybe 7% or 8%, and now, it's about flat. What's happened is the FANG stocks that have been so good for the last few years really …

Benz: Let's just tell people what the FANGs are.

Kinnel: Facebook, Amazon, Netflix and Google or Alphabet as it's also known. These have been dominant stocks. Of course, there are some other go-go large growth names that have done well, too--Apple another one. It's really been a story of stocks that have really had a great run but now have really sold off, Facebook being the biggest sell-off because it came out that, one, Facebook sold user data in a way no one expected, but also it came out that Facebook was maintaining data records on people far greater than people thought. Those are big negatives for Facebook. And then some other issues, too, and so really all of those names have sold off, but Facebook the most.

Benz: Yeah, spooked the whole sector. Let's talk about overseas. If investors have foreign stock funds in their portfolio, they've probably seen a little bit of red ink there as well for the quarter. It seems like the more aggressive you were in terms of your foreign stock fund holdings, the better you fared. What's been going on there?

Kinnel: In both foreign and domestic, you had growth doing better than value and small growth doing about the best. But as you say, emerging markets were among the best places to be in foreign equities. They more or less had modest gains of about 0% to 1% was typical for diversified emerging markets. Latin America did even better than that.

I'm not sure exactly why they did better. One possible reason is their valuations were fairly cheap. They had less to go off. Of course, the U.S. is maybe the highest valuation, so hat could be one thing working in their favor. It's an interesting illustration that emerging markets don't have to be the area that gets burned when there is a sell-off. Sometimes, they do just in sympathy. The U.S. sells off 10% and emerging markets will go down 20%, because of course, a lot of that money in emerging markets is from U.S. and other developed market investors. It doesn't always work that way and it didn't work this time.

Benz: Another big topic I want to cover with you, you touched on rising interest rates and the implications for equity fund performance. Bonds have also had a rough go of it here in the first quarter. Let's talk about some of the better and worst performing fixed-income categories.

Kinnel: The long end of the yield curve really got smacked, so therefore long-term corporate or government bond funds bore the brunt. Naturally, the short and ultrashort held up the best. We also saw some currency plays, for instance, because the dollar sold off. The funds that were diversified out of the dollar, tended to hold up a little better.

Benz: Those emerging markets local currency-denominated bond funds, which, I guess, we should point out, that's not a core fixed-income category. You'd want to hold it around the margins of your bond portfolio.

Kinnel: Very much a niche category, but a nice diversifier if you use it correctly.

Benz: This return to volatility really has spooked some investors. We have not seen this certainly for a while. Maybe some of us had gotten a little bit complacent just about how strong returns were for so long. What's your best guidance to investors, and does it depend on their time horizon and their proximity to needing their money?

Kinnel: It really does. I think, for one, we are returning to more normal levels of volatility. We talked at the beginning about low interest rates and low inflation. That's kind of given us an unusually less volatile time period and a time where markets have gone up really steadily. You might have a bad six months or a year, but then you make it back with a nice 20% or 30% gain the next year, which is awesome but not typical. I would say, both, get ready for more volatility as well as the chance that a three or four-year investment, you might still be in the red or just have really modest gains, because that's more common in the markets and certainly the longer run you have, the tougher that can get.

And as you say, your time horizon really matters, and it's good to focus in on what are your investments for, what are your goals, and have those aligned properly so that if there's some money you want to spend in the next few years, that's in really short-term, stable investments, than the things like retirement goals or rather really long-term. You should be able to tolerate volatility. Remember when there is a sell-off or a spike in volatility, this is a really long-term investment and so it shouldn't matter. I think, that approach should help you to weather these sell-offs and really just aligning your investments with your goals is always a good idea.

Benz: Russ, great advice as always. Thank you so much for being here.

Kinnel: You're welcome.

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