Most mutual fund investors made a bit of a profit in the first quarter, and that was no small feat considering a deadly terrorist bombing in Madrid, sky-high gasoline prices and a report that Medicare is going broke.
The average U.S. diversified stock fund climbed 2.9 percent, marking the fourth consecutive quarter of gains, according to preliminary data from Lipper Inc., which tracks mutual fund performance.
But that was a dramatically lower return than the previous quarter’s 10 percent romp, and only a rally in the waning days of the quarter saved the average from turning negative.
Money flows into domestic stock funds were a robust $31.5 billion in January and $18.1 billion in February. But the latest estimates show the pace slowed to a trickle in March, $400 million, when the major stock indexes dipped.
Investors apparently have grown skittish of the U.S. stock market after last year’s big gains, said Pat Dorsey, director of stock analysis at Morningstar, the mutual fund rating service.
“The economy and corporate earnings have been improving, but the market improved too much,” he said. “It got overexcited and projected last year’s earnings growth out to this year.”
Although the average U.S. stock fund was up almost 3 percent in the quarter, the largest and most popular mutual fund categories–large-capitalization growth and value funds–fell below the average returns, with gains of 1.2 percent and 2.2 percent, respectively.
Rob Sharps, portfolio manager of the T. Rowe Price Institutional Large Cap Growth fund, pointed out that both of those categories scored hefty 25 percent-plus gains over the last year.
“It was natural to have a correction in the market,” Sharps said. “We had gone from the second quarter of 2003 through January without even a 5 percent pullback. It was time.”
Small-cap stocks have held up much better. The average small-cap value fund increased 5.8 percent in the quarter, making it the best-performing category of all U.S. diversified funds.
Earnings of small companies have gotten a boost from the historically low interest rates, which reduce borrowing costs, said Christine Benz, associate director of fund analysis at Morningstar.
Low interest rates help big companies, too, but the effects of lower expenses and the expanding economy have a larger and more immediate impact on smaller companies.
Benz also believes that small-caps are attracting money because of last year’s average return of more than 50 percent. In other words, investors are “chasing returns.”
“Investors are looking in the rear-view mirror and saying that these things did well last year, so they must have the magic touch,” she said. “And that’s a dangerous way to invest.”
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Although the average U.S. stock fund struggled to stay positive, some of the so-called sector funds posted impressive results.
The average sector fund gained about 3 percent in the quarter, according to Lipper, but some sector funds did even better. Real estate funds were the best-performing sector, with an 11.1 percent gain.
Real estate has been on a rampage for the better part of a year, said John Brynjolfsson, portfolio manager of the Pimco Real Estate Real Return fund. The sector has been supercharged by the low interest rates, which give the owners of hotels, office buildings, shopping malls and apartment complexes better returns.
“We are hitting on all cylinders,” Brynjolfsson said. “There are large inflows into this asset class by both large institutional investors and smaller retail investors looking to get exposure to real estate.”
Tom Roseen, senior research analyst at Lipper, said he believes the pullback in the stock market has actually helped the real estate sector. Investors are seeking safety, and they believe they have found it in a “hard asset” class like real estate, he said.
“People are using real estate like our parents used utilities,” Roseen said. “This category has had four straight years of positive returns.”
As good as real estate was, investors who turned outside the U.S. did even better. Mutual funds with a focus on Japanese firms surpassed all other categories, with a 12.3 percent gain.
This continues a trend that began more than a year ago with the re-emergence of the Japanese economy, said Campbell Gunn, manager of the T. Rowe Price Japan fund. The average Japanese fund is up 64 percent over the last year.
“Japan’s economy has regained momentum because of a revival in exports,” Gunn said. “Trade with Asia is the driving force.”
Roseen said the normally tight-fisted Japanese consumer is starting to spend more, and businesses are starting to buy more equipment.