What goes up must come down. Mutual fund investors were reminded of this Newtonian principle during the three months that ended Sept. 30.
The market's bull run was interrupted in the third quarter, which ended with fund managers nursing an average loss of 5.37 percent, after an 11 percent gain in the spring, according to Lipper Inc.
Although it was the first down quarter of the year, it was the third decline in the last six quarters, Lipper noted--a fact that runs counter to the general perception of a steadily rising stock market.
With the exception of mid-cap and small-cap growth funds, which were up slightly, all the diversified domestic stock funds were down for the quarter.
The best-performing funds in the third quarter were those that invest in Japan or gold. The Warburg Pincus Institutional Japan Growth Fund was the top fund, gaining 40.1 percent, and American Century Global Gold was up 28.85 percent. These two categories are negatively correlated to the U.S. market.
Science and technology funds also were winners, romping home with an average gain of 7.02 percent.
But don't flog your fund manager if he wasn't invested in these sectors. The average managed fund could still boast that its 5.37 percent decline was less than the 5.78 percent drop in the Dow Jones industrial average and the steeper 6.56 percent slide in the Standard & Poor's 500-stock index.
In fact, more than half of the stock funds outperformed the S&P 500 index--and funds that mimic it--for the quarter, and 40 percent were ahead of the index for the year to date.
Gnawing on Wall Street were worries over rising interest rates, a falling dollar and the rising trade deficit. "Fear contributed to the market fall," said Michael Farr, president and chief investment officer of the District-based financial consulting firm Farr, Miller & Washington.
Worst hit were value stocks--relatively low-priced issues with strong fundamentals. Multi-cap value funds took the biggest hit, losing 9.60 percent in the quarter, followed by mid-cap (8.91 percent) and large-cap value funds (8.22 percent).
Funds that invest in relatively high-priced, high-appreciation issues (or growth stocks) did better. Mid-cap growth funds were up 0.61 percent in the quarter, and small-cap growth funds 0.85 percent.
Believers in small-cap funds were rewarded for their faith. In a reversal of the trend of the past five years, small-cap funds outperformed large-caps both in the third quarter and for the year to date.
Among the largest domestic funds, Janus Twenty once again topped the charts, with a 1.18 percent return. The fund has the best one-year showing of the largest 25 funds, returning 54.55 percent. The largest fund, Fidelity Magellan--which manages more than $90 billion--reported a decline of 5.97 percent, although it still is up 6.96 percent for the year to date.
The second quarter's top two performers among the 25 largest--Growth Fund of America (with a 12.29 percent gain) and Fidelity Equity Income Fund (up 10.58 percent)--were down 2.17 percent and 8.78 percent, respectively.
The best-performing fund among the largest 25 was the Europacific Growth fund, which returned 5.74 percent in the quarter and 21.60 percent for the year to date.
By categories, some of the star performers were SSgA (multi-cap growth fund), up 13.35 percent; Vertex (multi-cap value fund), up 7.89 percent; Santa Barbara (mid-cap growth), up 20.13 percent; Monument (mid-cap core), up 18.50 percent; Gintel Fund, (mid-cap value), up 8.95 percent; and Turner Technology (science and technology), up 37 percent.
Sector funds were down on average by 3.51 percent. The worst-performing sector funds were invested in financial services; they were down 12.68 percent for the quarter. The best sector funds were those in science and technology. In fact, seven of the best-performing domestic funds for the year to date are science and technology funds.
Interestingly, while the second quarter's laggards were those focused on Europe, gold and health care, the third quarter's winners came from these categories. So what does that tell an average investor? "Diversify your portfolio and stay invested," said Jan Holman, vice president of investment services at American Express Co.
Diversification, of course, needs to be carefully planned. The average fund manager invested in Asian markets outside Japan sustained losses.
Many fund managers believe the fourth quarter will be more stable than the third, partly because the bad news of the third quarter is priced into the market. As a result, market indexes are expected to move within a narrow band, reducing price volatility, they said.
The silver lining: Domestic diversified stock funds are still up 5.23 percent for the year to date, and sector funds are up 9.42 percent.
Best and Worst
Funds with the highest returns for the third quarter . . .
Warburg Pincus Instit.: Japan Growth 40.1%
Fidelity Japan Small Co. 39.1
Warburg Pincus Japan Small Co. 37.1
Turner Technology Instit. 37.0
Turner Top 20 Instit. 36.6
. . .and those with the worst:
World Funds: Third Millennium Russia -34.9%
Lexington Troika Dialog Russia -33.9
IAI Value -33.0
Fidelity Select Environmental Services -30.6
Pauze Tombstone (Class B) -29.7
SOURCE: Lipper Analytical Services