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Domestic Equity Funds -- Year-End 2002 Review

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Jan. 7, 2003 — With most U.S. stock funds showing negative returns for the third year in a row — the average domestic equity fund tracked by Standard & Poor’s was down 23.0% in 2002 — many fund industry professionals are wondering whether or not the worst is over.

Eyeing an economic recovery, some fund managers see stocks rising this year. “2003 will be an up market — inflation and bond yields suggest that stock valuations will be up,” says Jonathan Simon, manager of JPMorgan Mid Cap Value Fund/I (FLMVX).

However, some fund managers expect the market will be hurt by long-standing problems: high valuations, poor earnings, and weak capital spending. “2003 will probably be like 2002 — consumer spending will slow down, and business spending won’t pick up,” says Cliff Hoover, Jr., co-manager of PIMCO NFJ Small Cap Value/Instl (PSVIX). The portfolio rose 3.2% last year, making it the third-best performing small-cap value fund in 2002.

In fact, last year’s market offers support for both bulls and bears, since stocks fell for most of the year before rallying in the fourth quarter. Losses were so steep that all domestic equity-fund style categories showed sizable declines for the year. In contrast, gains were widespread in the fourth quarter, with all style categories up during the period.

In 2002, a bearish outlook was apparently the right call, since many of last year’s best-performing funds followed defensive strategies. “We never bought into the assumption that the market would recover in 2002,” said JP Morgan’s Simon. Steve Lehman of Federated Investments, a long-time bear, feels that high corporate and consumer debt will limit corporate profits “for years to come.” Lehman’s portfolio, Federated Market Opportunity Fund/A (FMAAX), was the third best-performing mid-cap value fund last year, gaining 1.5%.

Investors have been generally bearish since the first quarter of 2000, noted Sam Stovall, Standard & Poor’s chief investment strategist. This pessimism continued into last year, as seen in the broad declines of most industry sectors, he said. Stovall points out that none of the ten largest sectors in the S&P 500 posted positive returns in 2002. “There is no place to hide in a bear market,” he observed.

Factors that kept stocks down in 2002 — earnings, investor sentiment, and historical cycles — will buoy them in 2003, Stovall predicts. A recovering economy, rebounding earnings, investor optimism, and favorable historical comparisons will boost stocks overall this year, he says. Standard & Poor’s investment policy committee predicts 15% gains for the S&P 500 and the NASDAQ in 2003.

Bill D’Alonzo, manager of Brandywine Blue Fund (BLUEX), forecasts a modest rise for the market in 2003. This year’s market will show “some growth, but not barn-burning returns,” D’Alonzo predicts, since consumer spending is likely to slow, while corporate spending probably won’t rise substantially. The seventh-best performing mid-cap growth fund, Brandywine Blue fell 13.5% last year.

Federated’s Lehman predicts no real growth for the market over the next several years, only sharp rallies and sharp declines. Lehman is particularly concerned about non-economic factors, such as war and terrorism. “It’s hard to recall a time when the external risks to the market were so high,” Lehman said.

Charlie Dreifus, manager of Royce Special Equity (RYSEX), sees opportunities in uncertain times. Dreifus feels investors have become more rational, focusing on companies with transparent accounting, simple business models, and inexpensive valuations. While Dreifus feels “the jury is out on whether last year was overdone,” he cautions that that low market returns over the next several years are “totally within the realm of possibility.”

Randy Bateman, manager of Huntington Dividend Capture Fund/Trust (HDCTX), is more hopeful, saying “the market is in fairly good shape.” One positive sign, according to Bateman, is that corporations have largely digested excess inventories. As a result, the manager expects earnings to rebound this year. Batemen’s fund was the second-best performing large-cap portfolio in 2003, finishing unchanged for the year.

Also optimistic, Chuck Zender, manager of Leuthold Grizzly Short Fund (GRZZX), predicts an improving environment in 2003, in part because it is the third year of a presidential administration, historically a favorable period for the market and the economy.

Fund Investment StyleAverage Returns 2002 (%)

Large-Cap Growth-27.87%

Large-Cap Value-20.09%

Large-Cap Blend-22.88%

Mid-Cap Growth-26.23%

Mid-Cap Value-14.02%

Mid-Cap Blend-19.79%

Small-Cap Growth-28.63%

Small-Cap Value-12.45%

Small-Cap Blend-19.61%

Domestic Equity Funds*-22.97%

S&P 500-22.09%

Domestic Equity Funds* Best Performers2002 Returns (%)Worst Performers2002 Returns (%)

Large-Cap GrowthMillennium Growth Fund (MGFQX) -1.1%Pin Oak Aggressive Stock Fund (POGSX) -50.2%

Large-Cap ValueVontobel US Value Fund (VUSVX) -2.1%Citizens Value Fund/Retail (MYPVX) -40.5%

Large-Cap BlendFidelity Fifty (FFTYX) +0.3%ProFunds: UltraBull ProFund/Serv (ULPSX) -46.7%

Mid-Cap GrowthLiberty Acorn Twenty Fund/Z (ACTWX) -8.2%Van Wagoner Mid-Cap Growth Fund (VWMDX) -49.9%

Mid-Cap ValueJPMorgan Mid Cap Value Fund/I (FLMVX) +3.2%Dreyfus Growth & Value Fds: Midcap Value Fd (DMCVX) -33.3%

Mid-Cap BlendYacktman Focused Fund (YAFFX) +15.0%MFS Institutional Mid-Cap Growth Fund (MCGEX) -46.8%

Small-Cap GrowthHennessy Cornerstone Growth Fund (HFCGX) -4.7%Van Wagoner Post-Venture Fund (VWPVX) -67.3%

Small-Cap ValueRoyce Special Equity (RYSEX) +15.3%J Hancock Small Cap Equity Fund/A (SPVAX) -44.3%

Small-Cap BlendLeuthold Grizzly Short Fund (GRZZX) +15.5%Shaker Fund/A (SHKAX) -48.5%

Fund Investment StyleAverage Returns Fourth Quarter 2002 (%)

Large-Cap Growth+5.30%

Large-Cap Value+7.86%

Large-Cap Blend+6.68%

Mid-Cap Growth+3.81%

Mid-Cap Value+6.25%

Mid-Cap Blend+5.87%

Small-Cap Growth+4.78%

Small-Cap Value+4.84%

Small-Cap Blend+5.48%

Domestic Equity Funds*+5.92%

S&P 500+8.43%

Domes Equity Fnds* Best Performers4th Qrt 2002 Ret (%)Worst Performers4th Qrt 2002 Returns (%)

Large-Cap GrowthChoice Focus Fund (CHFCX) +24.8%Reserve Private Eqty Srs Informed Inv Grth/R (RIGAX) -9.7%

Large-Cap ValueGabelli Blue Chip Value/AAA (GABBX) +19.6%Navellier Performance Large Cap Value (NPLVX) -4.2%

Large-Cap BlendLegg Mason Focus Trust (FOCTX) +21.4%CDC Nvest Targeted Equity Fund/A (NEFGX) -11.2%

Mid-Cap GrowthLegg Mason Inv Tr:Opportunity Tr/Prim (LMOPX) +19.0%Navellier Millennium Top 20/A (NTGRX) -12.1%

Mid-Cap ValuePIMCO PEA Renaissance Fund/A (PQNAX) +16.7%CGM Capital Development Fund (LOMCX) -9.5%

Mid-Cap BlendFidelity Advisor Leveraged Company Stock/A (FLSAX) +27.9%MainStay Funds Mid Cap Growth/A (MMCPX) -6.7%

Small-Cap GrowthNevis Fund (NEVIX) +36.8%Frontier Equity Fund Portfolio (FEFPX) -20.0%

Small-Cap ValuePolynous Growth Fund/A (PAGFX) +27.3%CGM Focus Fund (CGMFX) -4.4%

Small-Cap BlendKelmoore Strategy Eagle Fund/A (KSEAX) +18.4%Leuthold Grizzly Short Fund (GRZZX) -11.3%

*Excluding sector and balanced funds.

Source: Standard & Poor’s. Total returns are in U.S. dollars and include reinvested dividends. Data as of 12/31/02.