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Funds That Have Outperformed In a Rising Rate Environment

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May 18, 2004 — With higher interest rates looming, investors may wonder where to turn. Fund Advisor looked at funds that outperformed in 1994, when interest rates also rose. The following table lists large-cap blend funds that beat their peers in 1994, as well as over the ten-year period through last month. These funds are also headed by managers that have been associated with their portfolios since at least 1994.

Large-cap blend funds were selected because large-cap stocks are likely to outperform going forward, according to Ken Shea, director of global equity research at Standard & Poor’s. Shea expects large-cap stocks to do better than small- and mid-cap stocks for the rest of this year due to their attractive valuations, resulting from underperformance in recent years. Healso notes large-cap stocks tend to do better in the second year of bull markets as investors become more discriminatory, and shift to higher quality stocks.

Despite the challenges of interest rate shifts, Standard & Poor’s investment policy committee forecasts that the S&P 500-stock index will rise to 1215 by yearend. Higher corporate profits will more than offset the effects of higher interest rates on stocks, according to Shea. He notes that Standard & Poor’s equity analysts collectively predict S&P 500 operating earnings are likely to be up 19% this year.

William Frels, co-manager of Mairs & Power Growth Fund (MPGFX) also thinks corporate profits will offset the rise in rates because “the outlook for profits is so strong.” Frels cautions rapid interest-rate gains could undo this forecast, but notes the Federal Reserve is projecting gradual increases.

The projected hikes are “probably the most anticipated rate rises ever,” notes Duncan Richardson, manager of Eaton Vance Tax-Managed Growth 1.0 (CAPEX). Such expectations could lessen market volatility, but Richardson recommends “not trying to make big bets on any one scenario.” As a result, he is focusing on high quality companies that can “deliver earnings in any economic environment.” Richardson says his caution stems from the wide variety of situations currently possible, ranging from hyperinflation to deflation.

Because of potential uncertainties, the team at Brandywine Blue Fund (BLUEX) is focusing on companies that will grow independently of interest rates since they “can’t predict them,” says lead manager Bill D’Alonzo. While the manager says that the strategy is “very earnings sensitive,” which follows the funds long-term focus, he also believes that inflation, which would prompt Fed rate hikes, would also boost earnings. Inflation is likely to aid corporate earnings since it would give companies greater leeway to raise prices for their goods and services, D’Alonzo says.

Despite the likelihood of rate hikes, D’Alonzo doesn’t predict sizable increases, or a long period of high interest rates. “I expect a minor change for about a year from now,” he forecasts. Standard & Poor’s expects interest rates will rise through 2005, and then plateau in 2006 and 2007.

“We are well along in the adjustment of the yield curve,” notes Eaton Vance’s Richardson. The manager adds that it’s rare for periods of rising rates to last for more than a year before they shift direction.

1994 Returns


Ten-YearAnnualized Returns

Through 4/30/04 (%)

One-Year Annualized Returns Through 4/30/04 (%)
Eaton Vance Tax-Managed Growth 1.0 (CAPEX) +6% +12.7% +21.9%
Mairs & Power Growth Fund (MPGFX) +5.6% +17.6% +28.3%
Victory Diversified Stock Fund/A (SRVEX) +4.0% +13.3% +26.8%
Brandywine Blue Fund (BLUEX) +2.3% +10.4% +26.4%
Legg Mason Eq Tr: Value/Prim (LMVTX) +1.4% +17.2% +28.4%
Large-Cap Blend Funds -0.3% +9.8% +22.2%
S&P 500-Stock Index +1.3% +11.4% +22.9%

Source: Standard & Poor’s. Total returns are in U.S. dollars and include reinvested dividends. Data as of 4/30/04.


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