Rosanne Rosanna-Dana of "Saturday Night Live" used to whine: "If it's not this it's that, if it's not that it's this. It's always something." That's how mutual fund investors must feel after a frustrating first half in which most equity and fixed-income funds turned tail. If it wasn't the sagging dollar, it was dread of derivatives. If it wasn't climbing commodities prices, it was sputtering Japanese trade talks.
The ultimate "something," however, was the Federal Reserve Board. With a series of boosts beginning last February, the central bank took the fun right out of funds. Four increases in four months put intense downward pressure on bond funds, whose share prices drop when rates rise. U.S. equity funds -- having feasted on five years of falling interest rates that pushed individuals seeking higher returns into the stock market -- also slumped. Aggressive growth funds, which had been rising the fastest, were among the hardest hit, along with the interest- sensitive utility funds. Further rate rises may be in the cards, but the markets may be surprised if they're not as bad as presently feared, leading to an improved investment climate overall.
Energy spurt. There were, to be sure, a few equity winners rising from the general slide. The spring turnaround in oil prices helped energy funds stand out, with Fidelity Select Energy Services Fund surging 13.1 percent in the second quarter. But if there was easy money to be made in the first six months of 1994, it was in the handful of funds that specialize in Japanese equities. A sharp rebound in Tokyo share prices, combined with a surge in the yen against the dollar, further enhancing gains, produced returns of 20 percent or more for those funds. The No. 1 performer was Dimensional Fund Advisers' index fund for Japanese small companies, which rose by 46.3 percent in the first half. But the fund accepts money only from investment advisers, so most individuals can't get in.
Investing abroad didn't help much, either. The rise in U.S. interest rates spilled over to foreign markets with a vengeance. Hardest hit were last year's sizzlers -- funds that invest in the emerging stock and bond markets of Asia, Latin America and Africa. And that setback, while subsiding, may not be over yet, according to Mark Mobius, portfolio manager of the Templeton Developing Markets Trust. "A few places do look attractive at this stage of the game," he says, citing Hong Kong, Portugal, Greece, Turkey and Brazil. Nonetheless, he's keeping nearly a third of the fund's assets in cash.
But some savvy advisers are picking through the rubble for bargains. The eponymous head of Thomas J. Herzfeld, a Miami-based firm specializing in closed-end mutual funds, told clients to bail out of pricey emerging-market investments earlier this year. But now the pendulum has swung the other way, with some closed- end funds selling at discounts to net asset value of 10 to 15 percent, and Herzfeld is back in the fray. (Unlike open-end funds, closed-end funds trade like stocks and are listed on the New York Stock Exchange.) His current picks include Emerging Tigers (recent price, $12.75), which focuses on South Asia's fast-growing economies; the Morgan Stanley Africa Fund ($10.50); the Pakistan Investment Fund ($11), and the Global Privatization Fund ($11.50).
Rates, schmates. While the Fed's stance on interest rates will continue to shadow mutual funds, further rate hikes may be less fearsome than the markets currently believe. That's the view of some analysts who see the economy on the cusp of a significant slowdown. Robert Giordano, chief economist for Goldman Sachs, predicts real growth will subside to around 2.5 percent in the second half of 1994 -- against 3.5 percent in the first half -- while he sees inflation humming along at a nonworrisome 3 percent annual rate. As a result, he expects the yield on the 30-year government bond, currently around 7.7 percent, to fall toward 6.5 percent over the next six to nine months.
Glimmers of a slowdown can be gleaned from recent declines in auto and retail sales. But the first good indicator of the economy's speed limit in the second half won't be available until early next month when July's employment numbers are released. A repeat of June's stunning surge, which added 379,000 jobs to the work force, would almost certainly lead to a further hike in rates, perhaps by half a percentage point. If the increase is small, rates could top out, even decline.
That view argues powerfully that investors who have already endured the vicious bear market in bonds should bite their lips and refrain from bailing out now. "The barn door has been open too long for investors to start selling," warns Pacific Investment Management's William Gross, portfolio manager for the $5.5 billion PIMCO Total Return Fund.
Gross believes income-oriented individuals should consider locking up some of the yields currently obtainable. Most attractive in his view are intermediate-maturity government IOUs, ranging from Treasuries coming due in just two years and currently yielding around 6.25 percent to five-year notes returning just over 7 percent. "By the end of the year, fixed- income investors in this area will not only earn their yields but also get a bit of appreciation, adding up to a total return of around 8 percent annualized," Gross observes.
Not since 1984 have both stock and bond mutual funds registered back-to-back down quarters as they have done this year. The last time fixed-income and equity funds dropped for three straight quarters was in the dark days of 1973 and 1974. Then the "somethings" troubling financial markets included a quadrupling of world oil prices and Richard Nixon's resignation. The woes besetting today's markets aren't in that league. Odds are the second half of 1994 will look better -- maybe a lot better -- than the first. THE BEST PERFORMERS IN A DISMAL FIRST HALF
