In 1991, when stocks in general had a very good year -- and some even rose by 300 percent -- it was possible to build a diversified equity portfolio that would beat the 30.5 percent total return of the Standard & Poor's 500 Stock Price Index.
Likely? No. Unless you had the data, analytical skills, willingness to take calculated investment risks, and self-confidence that would have led you to buy the year's winning stocks -- in a gloomy economic environment -- before they took off.
For most people, it would have been easier to buy shares in one xTC of the year's leading capital appreciation funds, whose portfolios are run by professional managers to achieve maximum capital appreciation.
In fact, 85 of 132 capital appreciation funds beat the S&P 500, the widely used measure of the U.S. stock market's performance, according to Lipper Analytical Services.
If you're thinking of investing in one of the 85, remember that a one-year record as a market-beater doesn't tell you enough.
A fund should have exceeded the index over a longer period, especially because capital appreciation funds are typically more volatile -- or risky -- than the market. Thus, they have to rise more than the market in good years to make up for losses in bad years, if they stay fully invested in stocks and if their stocks provide little or no dividend cushion.
When you look at long-run records, you'll see fewer above-average funds. Only one-third of those in business for at least five years (32 of 97) had average annual returns exceeding the S&P 500's 15.3 percent for that period, and only one-third (14 of 43) topped the index's 17.5 percent annual rate for the last 10 years.
Assuming that your investment time horizon is long enough so that you can tolerate the volatility of capital appreciation funds, you may wonder whether this is a good time to get into one. And, if so, which funds' reward-risk profiles might make them suitable for you.
Talk about investment timing to the portfolio managers of top funds, such as the leading five-year performers listed in the table, and you find agreement on at least two points:
1. Stock prices in general may be high, but stocks of a number of companies continue to sell at reasonable levels.
2. Despite the sluggish economy, this should be another good year for the stocks their funds own -- if not as good as 1991. The reason: an expected recovery in corporate profits and the business prospects in certain industries.
No fund family with entries in the capital appreciation category turned in better results than Twentieth Century Investors, whose Ultra, Growth and Vista Investors ranked first, third and 15th, respectively, for the last five years.
Management chooses stocks on the basis of accelerating earnings, and the funds remain fully invested regardless of what the market does. Stocks are assigned to them on the basis of the market capitalization (number of shares times share price) of the companies and the funds' sizes. Growth gets the largest; Vista, the smallest.
Their results attracted hundreds of millions in cash, which had to be invested without hurting performance. Net share sales for Ultra alone approached $1.3 billion during the year that ended October 1991 -- or two-thirds of the increase in its net assets (to $2.1 billion).
"It wasn't much of a problem," Robert C. Puff, Jr., vice president for investments, says. Management added to existing positions in several stocks, such as Amgen (up 267 percent last year) and Microsoft (up 122 percent), which it continued to regard as buys. "The strong have gotten stronger."
Mr. Puff acknowledges that price-earnings ratios for a number of his funds' stocks have gone up significantly despite higher earnings for the latest 12 months. But he adds: "It doesn't disturb us."
Jeffrey Malet, portfolio manager of Pacific Horizon Aggressive Growth Fund since mid-1990, is invested in about 140 stocks but points out that he is "not afraid to take a big position." His No. 1 holding, U.S. Bioscience, accounts for more than 5.5 percent of assets. The average cost of his Bioscience holdings: $14.50 vs. the recent market price of around $85.
Searching for explosive growth in areas from biotechnology to do-it-yourself retailers, he buys "whatever looks good." While two-thirds of his stocks are smaller companies, he doesn't limit himself to them. "The last thing you want to do is sell Amgen when its market cap hits $1 billion," Mr. Malet says. His No. 2 holding, Amgen, now has a capitalization exceeding $8 billion.
Thomas F. Marsico, portfolio manager of Janus Twenty Fund, on the other hand, limits his fund to about 25 stocks. He, too, has been inundated with cash, which helped to raise the fund's net assets from $200 million to $1.3 billion in the last year.
Given the size of the fund and his preference for a short list, Mr. Marsico looks for larger-cap companies that meet his criteria for earnings growth and positive corporate changes. He's finding them in financial services and in a mix of low-cost producers of goods and services. His current top holding: Waste Management.