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MUTUAL FUND QUARTERLY REPORT

A hot quarter for stocks

Investors expecting economic growth push equity funds into positive territory for the year, though a time-tested hedge against bad times — gold — benefits the most.

October 10, 2010|By Tom Petruno, Los Angeles Times

Most stock mutual fund categories scored double-digit gains in the third quarter, lifting 2010 returns back into the black.

Equity markets worldwide surged in September as investors regained confidence in the global economy, or at least stopped expecting an imminent cataclysm.

The average domestic stock fund, which had been down 4.7% year-to-date at the end of June, was up 5.3% as of Sept. 30 after rallying 10.5% in the quarter, according to Morningstar Inc.

In a survey of 170 professional investors nationwide in late August, financial advisory firm Russell Investments found that 57% believed that stocks were undervalued. That set the scene for the September rebound.

Despite the understandably dour public mood about the economy, "Managers are positioning themselves for economic growth," said Mark Eibel, head of client investment strategies at Russell in Tacoma, Wash.

Share prices overall have continued to advance in October. The Dow Jones industrial average closed above 11,000 on Friday for the first time since early May.

Yet the best-performing stock fund sector in the first nine months of the year — precious metals — showed that some investors were hedging against what might yet go wrong.

Precious metals funds, which invest mostly in shares of gold and silver mining companies, were up 15% in the third quarter and 26.2% for the nine months, on average. The price of gold bullion soared 19% in the first three quarters and has hit a series of record highs, ending last week at $1,344.20 an ounce.

In part, gold is playing its traditional role as the hard-currency alternative to paper currencies, particularly the depreciating dollar.

Amid massive deficit spending by the federal government, and with the Federal Reserve seemingly poised to funnel huge amounts of cash into the financial system in the hope of driving interest rates even lower, the dollar fell sharply against other currencies in the third quarter.

But a weaker buck also has some positive implications for financial markets, and that hasn't been lost on investors.

Shares of many U.S. multinational companies have benefited from expectations that the dollar's slide will make American exports less expensive abroad.

Funds that own large-capitalization growth companies, big-name firms whose earnings are expected to grow faster than the market average, rebounded 12.6% in the third quarter after diving 12.1% in the second quarter.

Fund managers who own blue-chip stocks have struggled over the last decade as many of those issues have languished after rocketing in the 1980s and '90s.

Christopher Davis, manager of the $32-billion Davis New York Venture fund, told an audience of Morgan Stanley Smith Barney investors last month that blue-chip issues were "the big idea hiding in plain sight" as the companies' earnings rebound.

The Venture fund, which owns shares in companies such as Wells Fargo & Co., Coca-Cola Co. and Johnson & Johnson, was up just 1.4% in the first nine months.

Big-name stocks have failed to match the performance of smaller stocks this year, repeating the pattern of much of the last decade. The average small-cap growth fund was up 9% in the first nine months, compared with the 3.4% gain for the average large-cap growth fund.

But in the growth sector, a third broad category has beaten both small-cap and large-cap this year, on average: mid-cap funds.

Mid-cap companies, as the name suggests, are those that have graduated from the small-company world but haven't reached big-cap status.

Todger Anderson, who co-manages the $224-million Westcore Select fund in Denver, steered the portfolio to a 15.5% gain in the first nine months by focusing on mid-cap shares such as software firm Intuit, nutritional-supplement company Herbalife and banking firm Comerica.

The appeal of mid-caps, Anderson said, is that they often have better growth prospects than bigger firms and stronger finances than smaller companies.

"To some extent it has always been the sweet spot" for stock-picking, he said.

Overall, though, the third quarter's richest returns were found overseas.

Nine of the 10 best-performing equity fund categories in the period were foreign. Among the largest exchange-traded funds, seven of the 10 biggest gainers were foreign portfolios.

The newly weakened greenback padded returns for U.S. investors who owned foreign funds in the third quarter. When the dollar falls, securities denominated in stronger currencies translate into more dollars.

Case in point: Last quarter the French stock market rallied 7.9% in euro terms but soared nearly 20% in dollars as the U.S. currency slumped.

But that also is a reminder that foreign stocks could get hammered if the dollar suddenly were to reverse course.

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