Domestic Equity Funds -- Mid-Year 2003 Review

Optimism Is in Fashion

July 1, 2003 -- The market is finally shifting from a classic bottom, according to several investment professionals. That's been reflected in the broad-based gains of domestic equity funds this year: The average domestic equity fund is up 12.94% in the first half of 2003, and 17.12% in the second quarter alone, according to data from Standard & Poor's.

"Last quarter was a turnover quarter due to better than expected earnings, tax cuts, the weaker U.S. dollar, and the end of the Iraqi conflict," said Sam Stovall, chief investment strategist at Standard & Poor's. Many investors also raised their forecasts for economic growth, adding to higher expectations, Stovall said.

Ron Sachs, manager of Janus Orion Fund (JORNX) says "the overall market's risk tolerance has improved." Sachs believes market gains were fueled by low interest rates, attractive valuations, and improving fundamentals. Broad-based optimism is an important factor, says Sachs, who adds that "to pay for growth, you have to have confidence in the future." Janus Orion, a large-cap blend offering, is up 18.1% so far this year.

Small-cap growth and mid-cap growth are the first- and second-best performing domestic equity categories so far this year. The remaining small- and mid-cap U.S. stock-fund style categories also had strong gains, indicating that smaller-cap issues are also enjoying outsized returns in a recovering market.

Historically, small companies tend to do better in rising markets, said Stovall. Eric Miller, co-manager of Heartland Value Fund (HRTVX) said that following steep declines in the recent bear market, small-cap stocks offered better growth prospects at lower prices than large-cap stocks. A small-cap value offering, Heartland Value is up 24.6% so far this year. Among small-cap stocks, many growth stocks had become value stocks because of the long bear market, noted Suresh Bhirud, manager of Apex Mid Cap Growth Fund (BMCGX). Though Bhirud's fund has almost doubled this year, the high-beta offering has been among the worst performers versus its peers for the five years ended in May.

Higher beta companies in more economically sensitive areas generally outperform in a market recovery, said Stovall, adding that in an upturn, these companies are usually growth investments. "Growth stocks always outperform in a bull market," said Richard Gould, manager of Rockland Small Cap Growth Fund (RKGRX). The fifth best-performing small-cap growth fund so far this year, Rockland Small Cap Growth has risen 33.6%.

"You have to be optimistic," said Peter Bourgeau, assistant manager of Smith Barney Large Cap Growth Fund/A (SBLGX). As the market hit a trough, Bourgeau said his fund become "a little more aggressive," increasing its technology, health-care and consumer discretionary exposure. Smith Barney Large Cap Growth has risen 22.4% so far this year.

Low interest rates have been a boon for growth stocks, said Jim Oelschlager, manager of Pin Oak Aggressive Stock Fund (POGSX). Oelschlager said that with low interest rates, stock multiples tend to expand, and that the greatest multiple expansions will come from growth stocks. A mid-cap growth offering, Pin Oak Aggressive Stock has risen 24.1% so far this year.

Even though growth funds have generally outperformed value funds this year, value funds, too, are enjoying solid returns. Value investing gains stem from low interest rates, which support higher valuations for all domestic equity style categories, says Richard Behler, manager of Van Kampen Value/A (MVUAX). He notes that the market saw broad gains across all categories when the Federal Reserve reaffirmed its low interest-rate policy. A mid-cap value portfolio, Van Kampen Value has risen 15.3% so far this year.

David Katz, manager of Matrix Advisors Value Fund (MAVFX) says he "moved to play offense." Based on bottom-up stock picking, Katz found that the most attractive companies were poised to gain from an improving economy. A large-cap value offering, Matrix Advisors Value has gained 19.9% so far this year.

Technology, financial services, and selected pharmaceutical companies are likely candidates for outperformance, says Katz. Typically, value managers don't like technology or brokerage companies, but Katz says these areas have become appealing as stock prices have declined.

Outlook

A market upturn is likely to continue in the second half of the year, says Standard & Poor's Stovall. He predicts that the S&P 500 will rise to 1030 by year end, a result of "massive" fiscal and monetary stimuli to the economy. While optimistic, Stovall cautions the market may "pull back a bit" this summer. He notes that since 1945, third quarters overall have had an average increase of 0.06%, versus an average 4.1% increase for fourth quarters.

As far as portfolio managers are concerned, Matrix's Katz expects a "meaningful pickup" in the second half of 2003, due to low interest rates, low inflation, and Federal Reserve moves to boost the economy. Looking ahead, Bourgeau of Smith Barney believes forward multiples are trading "at what they should be." Bourgeau also thinks the recent rises in the market will attract retail investors, who have been "late in the game." These added inflows are likely to consolidate market gains, he said.

Though small companies historically have done better in rising markets, Stovall sees certain trends limiting their gains. Small cap performance may be moderated due to higher demand for dividend paying stocks, he says, noting that 71% of the companies in the S&P 500 pay a dividend, versus about 40% in the S&P SmallCap 600 index. Stovall also expects a weaker U.S. dollar will disproportionately benefit larger companies since they are more likely to be exporters.

-- Bill Gerdes

Fund Investment StyleMid-Year 2003

Average Returns (%)

Large-Cap Growth+12.67%

Large-Cap Value+11.80%

Large-Cap Blend+12.07%

Mid-Cap Growth+14.14%

Mid-Cap Value+12.46%

Mid-Cap Blend+13.85%

Small-Cap Growth+14.89%

Small-Cap Value+13.36%

Small-Cap Blend+14.12%

Domestic Equity+12.94%

S&P 500+11.76%

Fund Investment StyleSecond Quarter 2003

Average Returns (%)

Large-Cap Growth+14.07%

Large-Cap Value+16.81%

Large-Cap Blend+15.14%

Mid-Cap Growth+17.17%

Mid-Cap Value+17.91%

Mid-Cap Blend+18.46%

Small-Cap Growth+21.67%

Small-Cap Value+21.07%

Small-Cap Blend+21.61%

Domestic Equity+17.12%

S&P 500+15.39%

Domestic Equity Funds*

Best PerformersMid-Year 2003

Returns (%)Worst PerformersMid-Year 2003

Returns (%)

Large-Cap GrowthReynolds Fund (REYFX) +49.2%Midas Special Equities Fund (MISEX) -4.1%

Large-Cap ValueYorktown Classic Value Trust (YCVTX) +24.7%Hilliard-Lyons Growth Fund/A (HLGRX) +3.2%

Large-Cap BlendThornburg Core Growth/A (THCGX) +33.1%MainStay Funds Select 20 Equity/B (MSBTX) +5.4%

Mid-Cap GrowthLegg Mason Inv Tr:Opportunity Tr/Prim (LMOPX) +42.7%T O Richardson Sector Rotation Fund (TRSRX) -5.5%

Mid-Cap ValueNeuberger Berman Focus/Investor (NBSSX) +28.6%Gintel Fund (GINLX) +4.4%

Mid-Cap BlendFidelity Leveraged Company Stock (FLVCX) +46.6%Old Westbury Capital Opportunity Fund (OWCOX) +3.0%

Small-Cap GrowthApex Mid Cap Growth Fund (BMCGX) +98.6%Frontier Equity Fund Portfolio (FEFPX) -40.4%

Small-Cap ValueDreyfus Growth & Value Fds:Small Co Value Fd (DSCVX) +28.0%Rainbow Fund (RBOWX) -3.2%

Small-Cap BlendBridgeway Ultra Sm Company Port (BRUSX) +37.9%Pioneer Small Company Fund/C (PCSCX) +5.7%

Domestic Equity Funds*

Best PerformersSecond Quarter 2003

Returns (%)Worst PerformersSecond Quarter 2003

Returns (%)

Large-Cap GrowthReynolds Fund (REYFX) +55.6%Bramwell Focus Fund (BRFOX) +4.7%

Large-Cap ValueYorktown Classic Value Trust (YCVTX) +29.0%Wade Fund+7.7%

Large-Cap BlendThornburg Core Growth/A (THCGX) +31.3%Howard Capital Appreciation Fund (HEFGX) +6.6%

Mid-Cap GrowthLegg Mason Inv Tr:Opportunity Tr/Prim (LMOPX) +38.7% Millennium Growth & Income Fund (MGIQX) -0.4%

Mid-Cap ValueNeuberger Berman Focus/Investor (NBSSX) +34.1%Gintel Fund (GINLX) +1.6%

Mid-Cap BlendFidelity Advisor Leveraged Company Stock/Inst (FLVIX) +44.2North Track Funds Managed Growth Port/C (MGPCX) +8.5%

Small-Cap GrowthApex Mid Cap Growth Fund (BMCGX) +81.7%Frontier Equity Fund Portfolio (FEFPX) -26.2%

Small-Cap ValueCorbin Small Cap Value Fund (CORBX) +40.2%Rainbow Fund (RBOWX) -4.4%

Small-Cap BlendRydex Srs Tr:Mekros/H (RYMKX) +36.2%Hussman Strategic Growth Fund (HSGFX) +11.2%

*Excluding sector and balanced funds.

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 6/30/03.

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