Markets

Midcap Growth Funds Power Ahead Amid March Malaise

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Best Mutual Funds 2015:First-Quarter Performance Report

M arch left motion-sick investors in mutual funds adrift in a sea of red. U.S. diversified equity funds slipped an average 0.3% last month. They were up 2.5% for the first quarter as a whole.

Stock funds were buffeted by several cross-currents: A slowdown in the U.S. economy, brought on in part by a brutal winter and a labor standoff at West Coast ports. A stronger dollar that's putting the squeeze on exporters and adding to market volatility. And most of all, lying in wait but indistinct, a Federal Reserve rate hike.

"The Fed is data driven and the market seems to be Fed driven," said John Heffern, a senior portfolio manager at Chartwell Investment Partners and a co-adviser forVanguard Mid Cap Growth Fund . Heffern added: "There's consternation about the approaching change in monetary policy and what that means for growth."

Large-cap mutual funds , which tend to have heavy exposure to multinational companies, took the biggest hit as the dollar surged. Large-cap core funds -- which hold both growth and value stocks -- fell 1.5% for the month, but managed to cling to a 0.9% gain for the quarter.

Domestic-focused companies, whose bottom lines are more insulated from currency volatility than firms selling overseas , fared better. Small-cap growth funds topped, rising 1.6% in March and 5.9% in Q1.

Midcap growth funds similarly edged out their core and value peers last month. They grew 0.8%, taking Q1 gains to a hefty 5.8%.

By comparison, S&P 500 index funds fell 1.6% in March and inched up 0.8% in the first quarter.

Midcaps' strong year-to-date performance is not out of character for the segment, Heffern noted.

"Long term, midcaps have tended to outperform large caps in indexes, although with some volatility," he said. Midcaps are an attractive asset class or style, especially in the current climate. They haven't grown to such an extent that growth is slowing. Nor do they involve taking on risk the way small-cap stocks might.

" Investors want growth but are afraid of risk," Heffern said. "Midcaps answer that call in a very nice way."

M&A Angle

They also can play both sides of the uptick in M&A activity -- as acquirers and as acquisition targets. "That's another element undoubtedly attracting investors," Heffern added.

Most of all, he likes the fact that the advance in midcap growth indexes has come from various sectors such as health, technology, consumer services and financials.

"That's a healthy sign," Heffern said. By comparison, small-cap growth stocks are overly reliant on health care, particularly biotech, for their performance, he adds.

An actively managed mutual fund . It's popped 7.4% year to date. The midcap growth category grew 5.8% over this period. VMGRX benefited from several stocks' performance.Biomarin ( BMRN ), a specialty pharmaceutical focused on orphan diseases, is attracting attention as the industry aggressively consolidates.

"It has a strong and interesting pipeline," Heffern said.

On the consumer side,Hanesbrands ( HBI ) is "an exceedingly well managed company," Heffern said. "They did a terrific job themselves as well as making acquisitions."

Hanesbrands acquired DBApparel, a European maker of intimate garments, in September. It took over Knights Apparel, which sells collegiate logo wear, in February.

Cruise linesCarnival ( CCL ),Royal Caribbean ( RCL ) andNorwegian ( NCLH ), also fueled VMGRX'S performance. Consumer demand has improved and "supply in terms of ships in the market has been constrained, so we're seeing yields improve," Heffern said. Cheaper energy has also benefited the lines.

Michael Arone, a chief investment strategist for State Street Global Advisors, points out that stock funds rebounded somewhat after the Fed made clear in mid-March that rates would stay lower for longer. A strong employment report in early March had sparked a sell-off in many risky assets. "That raised concerns the Fed will raise interest rates more quickly than anticipated," he explained.

Gradual rate hikes should especially benefit small caps as the cost of doing business remains lower.

A more domestic focus also makes small caps less exposed to a rising dollar or energy price swings than multinationals, Arone said.

Biotech Stocks Beat

Among sector funds, biotechnology continues to lead. Health and biotech funds scored 2.4% stock market gains in March and are up 11.5% in Q1, making them standouts by a margin.

They have averaged 14.7% annual gains over the past 10 years.

Investors continue to believe in more blockbuster drugs to come as well as better earnings. Plus, biotechs are relatively cheap from a historical price perspective.

"These stocks have earnings, are developing good drugs and are worth paying for," Arone said.

Besides biotech, consumer and real estate funds shone in March. "Wages have bottomed," Arone said, notingWal-Mart (WMT),Target (TGT) andT.J. Maxx (TJX) are among retailers raising minimum wages. Even as incomes are rising, people are spending less on expenses such as gas for their cars. "With time, we will see consumers put this money to work," he added.

In March, consumer services funds rose 0.3%. They're up 4.5% in the first quarter.

Real estate funds rose 1.4% in March and 4.3% in Q1.

With interest rates likely to stay low awhile, these funds are proving popular with income investors.

"Retirees, for example, use REITs (real estate investment trusts) to generate income," Arone said, describing these investments as "bond proxies."

Bond investors shared in the March malaise. Domestic taxable funds slipped an average 0.05% while tax-exempts tacked on 0.3%.

Passive, indexed funds have had a great run for several years. However, Heffern believes active management could outperform as the bull market begins to mature.

"We're in an execution-oriented market now around companies: Which can grow? Which can scale? Which can take market share?" he said. "That's the opening for active managers."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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