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5 big-cap growth funds for the next Fed turn
One day soon, the Fed will stop raising rates. When that happens, big-cap growth funds will be the winners. Here are five of the biggest and best.
By Timothy Middleton
The Fed's continuing series of interest-rate hikes has been weighing on the stock market for months. Even counting recent gains, the Standard & Poor's 500 Index ($INX) remains about 2% lower than where it began the year.
But this is no time for pessimism. At the first sign the Fed is finished tightening, stock prices are likely to explode upwards -- and big-capitalization growth stocks are likely to benefit more than any others.
The past year's weak market is typical of a rising-rate environment. In 1994, when short-term rates rocketed to 5.5% from 3%, the S&P 500 eked out a total return (including dividends) of only 1.3%.
The following year, however, when tightening ceased, the 500 index had a total return of 37.6%, its biggest gain since 1958.
"1994 was a great time to buy (stocks)," says Jeff Auxier, manager of Auxier Focus Fund (AUXFX), a tiny fund that has been boosting its exposure to big-cap stocks. "These credit tightenings are a tremendous opportunity to buy high-quality assets."
Short-term interest rates have tripled, to 3%, in the last 11 months. As further increases become less likely, the probability of a sharp stock rally increases.
For mutual fund investors, that means the best funds of the last five years, such as small-company and value funds, are likely to surrender leadership to the recent laggard, big-cap growth.
In my own portfolio I have been performing just such a rotation, trimming my biggest five-year winners and boosting my stake in big-cap growth. The fund I'm plowing the most money into is Fidelity Contrafund (FCNTX), but there are at least four other widely held funds I can recommend. One or more of them might even be available in your 401(k) plan.
Growth, without the froth
The case for growth comes down to relative values. Six years ago, Fortune 500 companies were trouncing all rivals, outperforming beaten-down, or value, stocks by 10 percentage points and small stocks by more than 20. Average price/earnings ratios of the stocks in the Russell 1000 Growth Index ($RLG.X) were above 50.
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Today the growth index's PE is around 22. At the same time, the stocks' valuations relative to both value and small-cap stocks have plunged to well below their historical average from much above the average.
"We think large-cap growth stocks offer the best risk-reward comparisons at recent prices, and that growth stocks in general should perform better as economic growth ebbs," Bob Smith, manager of T. Rowe Price Growth Stock Fund (PRGFX), wrote in a recent report to shareholders.
That fund is one of the best among those with substantial assets, meaning they have huge shareholder bases. When I screened the Morningstar database for large growth funds that consistently perform among the top 25% of their peers, it was one of only five to make the final cut.
| Best of the big big-caps | | Fund | 1-year performance | 1-year percentile rank | 3-year percentile rank | 5-year percentile rank | | Fidelity Contrafund (FCNTX) | 15.1% | 3 | 2 | 2 | | Janus Growth & Income (JAGIX) | 13.8% | 6 | 25 | 14 | | Growth Fund of America A (AGTHX) | 10.7% | 18 | 6 | 6 | | Vanguard Morgan Growth (VMRGX) | 10.0 | 23% | 10 | 17 | | T. Rowe Price Growth Stock (PRGFX) | 9.8% | 24 | 15 | 7 |
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Data as of 5/23/2005. Performance percentile ranking within large-cap growth group; 1=best, 100=worst. Top-ranked funds with at least $4 billion of assets.
Source: Morningstar
Fidelity Contrafund: I have written so much about this fund in recent months (read this December column and this one in March) that I sound like a shill for Fidelity. I'm not. I'm just a shareholder who bought the fund for the reasons I have cited.
Among the high-quality, broadly diversified names it owns are 3M (MMM, news, msgs), Samsung Electronics (SSNLF, news, msgs) and Gillette (G, news, msgs).
Janus Growth & Income (JAGIX): This fund's reputation was built by Tom Marsico, who has since gone on to run his own namesake group of funds. When a new manager, Minyoung Sohn, took over at the beginning of 2004, I was concerned he wouldn't be able to maintain the fund's sterling record.
He has. In the most recent 12 months the fund has outperformed 93% of its rivals. Janus, meanwhile, has substantially reorganized after the scandals of late 2003, easing my concerns about its corporate governance. Sohn's top three holdings are Exxon Mobil (XOM, news, msgs), Tyco International (TYC, news, msgs) and Citigroup (C, news, msgs).
Growth Fund of America A (AGTHX): This is part of the American Funds group and the largest of all growth funds, with about $100 billion of assets. The fund employs an unusual management structure: Nine individual managers each invest a portion of the assets however they want, under the watchful eye of Capital Research & Management, arguably the best investment company in the nation.
The fund's top holdings include Time Warner (TWX, news, msgs), Microsoft (MSFT, news, msgs) and Target (TGT, news, msgs). (Microsoft is the publisher of MSN Money.)
Vanguard Morgan Growth (VMRGX): This fund is also team-managed, in this case by three men, two of them quantitative analysts and the third a stock-picker. Only one of the three, Gus Sauter, is a Vanguard employee. The other quant, John Cone, is with Franklin Portfolio Associates, and the fundamental analyst, Robert Rands, is with Wellington Management.
This fund's unusual style has led it to invest much more heavily in mid-cap names than its rivals, which could be a negative in a mega-cap market. But since all three managers are looking for above-average stocks with below-average prices, a revival of big-cap fortunes could put them on those managers' radar screens.
The fund's top stakes are in Yahoo! (YHOO, news, msgs), Microsoft and eBay (EBAY, news, msgs).
T. Rowe Price Growth Stock Manager Bob Smith has already migrated to megacap names, in recent months picking up American International Group (AIG, news, msgs), Wal-Mart Stores (WMT, news, msgs) and Citigroup. Last year, a timely move into Tyco International helped propel the fund to a total return of 10.2%, nearly four percentage points more than the Russell 1000 Growth Index.
The fund's top holdings are Microsoft, Citigroup and General Electric (GE, news, msgs).
Standard & Poors' recent downgrade of General Motors (GM, news, msgs) and Ford Motor Co. (F, news, msgs) bonds to junk status is likely to make the Federal Reserve very cautious about raising interest rates sharply in coming months. The current economic recovery, though robust, is spotty. (Ford is still rated investment grade by both Moody's and Fitch.)
That's good for the market, though exactly when things turn won't be known until after it has happened. Any of these funds will be a good place to be in that environment, and they aren't at all painful to own right now.
At the time of publication, Timothy Middleton owned or controlled the following securities mentioned in this article: Fidelity Contrafund and Microsoft..
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