Small-caps, industrials shine

More aggressive sectors of market turned in best performance

1st-quarter mutual fund scorecard

April 09, 2006|By LAURA SMITHERMAN | LAURA SMITHERMAN,SUN REPORTER

After looking over the names that money manager James Thorne holds in his mutual-fund portfolio, including the industrial firm Walter Industries Inc. and engineering concern Foster Wheeler Ltd., one might think he's missed all that news about the decline of manufacturing and globalization and jobs being shipped overseas.

But Thorne, who works for MTB Investment Advisors in Baltimore, says he has read the headlines and knows that the manufacturing heyday is over. Instead, he says, the "new industrial revolution" is upon us. "We think there is a huge investment opportunity in the old-line companies like construction, manufacturing and commodities," he said.

His theory led his Small Cap Growth portfolio to post one of the best performances among Maryland mutual funds in the first quarter, with a sizzling 18.3 percent return.

Mutual funds with a similar bent, meaning they invest in small companies that are expected to grow rapidly, were among the standouts in the first quarter with an average return of 13 percent. Others with big returns were gold funds that soared 21 percent, real estate funds that were up 14 percent, and China and Latin America funds, which returned 20 and 16 percent, respectively, according to fund-tracking firm Lipper Inc.

While those funds had market momentum behind them - the Standard & Poor's 500 stock index posted its best quarterly return since late 2004 - they also benefited from factors that boosted certain industries, such as oil profits trickling down from energy producers to manufacturers, and from investors willing to pay a premium for companies outside the blue-chip mainstream.

"In general, what really made people money in the first quarter was the more aggressive sectors of the market," said Rick Bernstein, a partner and fund manager at Brown Advisory in Baltimore. "People in today's world are willing to take a lot of risk, and they are willing to pay up."

Of nearly 200 Maryland mutual funds investing in stocks, three lost money in the first quarter, according to a survey by Bloomberg Funds. By contrast, 23 of about 60 bond funds made money. All eyes in the stock and bond markets were on the Federal Reserve in recent months, as Ben S. Bernanke chaired his first meeting since taking over from longtime chief Alan Greenspan.

At first, some investors had hoped the Fed would pause or even end a two-year campaign to raise interest rates. With smaller-than-expected job gains and other signs of a softening economy in January, it seemed the Fed might lay off the rate increases that cool the economy by making it more expensive to borrow money.

But February jobs data rebounded, and by March Bernanke was signaling another boost is in the cards at the May meeting. Disappointment translated into dampened prices in the bond market, where the average fixed-income mutual fund returned 0.4 percent in the quarter.

An exception was high-yield funds. Those often invest in junk bonds, which offer higher interest rates than Treasuries but far more risk of default. Legg Mason's High Yield Portfolio, which invests in lower-quality company bonds, posted a 3.4 percent return. T Rowe Price's High Yield fund had a 2.4 percent return.

John Coumarianos, an analyst with Morningstar Inc., said investors have been crowding into that sector of the bond market. "It doesn't seem like you're being paid more to hold a riskier bond," he said, "yet people are still going for it because they want that yield."

In the stock market, the best-performing sector in the S&P 500 was steel, an industry in decline for several years. Companies such as Nucor Corp. surged more than 50 percent, driven in part by higher steel prices spurred by increased demand after a slowdown in production.

Other industrials are profiting from the scramble to meet energy needs, especially after Hurricane Katrina wiped out oil rigs in the Gulf Coast. Companies such as Halliburton Co. that supply equipment and services to oil and gas companies have risen, and railroads including Norfolk Southern rallied as coal shipments have increased.

"It's all these industrial companies that were left for dead," Thorne said.

A debate is raging among analysts about whether those upswings can be sustained, and Thorne counts himself among the bulls. He said it will take an "extended time" to meet the excess demand for energy, and increasing production capacity will require even more capital investment that benefits industrials.

T. Rowe Price's Small Cap Value fund, which returned 14.8 percent in the first quarter, has nearly a quarter of its portfolio in industrial and business service companies. As with Thorne's fund, one of its biggest investments is in JLG Industries Inc., which makes heavy equipment such as lifts, trailers and aerial platforms.

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