The mutual funds that get talked about at cocktail parties are usually the small, singular sensations that deliver the sexiest returns. But the bulk of the money still resides in the big-stock funds that have been lagging behind small-company offerings for the past six years.
Finally, though, the millions of investors with billions of dollars in large funds had something to crow about at their holiday get-togethers. Large-cap value funds have gained ground since late spring and are now only one percentage point behind small-cap value funds for the year: 17%, vs. 16% total return (through Dec. 8). Other large-company funds are also catching up with their small-cap counterparts. “This is not a head fake,” says Mark Keller, chief investment officer for Gallatin Asset Management, the fund management arm of A.G. Edwards Inc (AGE).
We’ve heard about large-cap comebacks before. In fact, this time last year, Keller’s line was a common refrain. But now that the economy has slowed markedly, there’s a better chance that larger companies might finally maintain their edge. “Higher-quality, higher-capitalization companies are the safest place to be if the U.S. economy is heading for a soft landing,” says Bob Doll, vice-chairman and chief investment officer for equities at money manager BlackRock Inc. Doll, who is in the soft-landing camp, is further tilting his portfolio to large-cap growth stocks.
With the Dow Jones industrial average and the Standard&Poor’s 500-stock index on high ground, you may not think big stocks are cheap, but they are. That’s because this is the first bull market in 45 years where the price-earnings ratio of the S&P 500 has contracted, says John Carey, portfolio manager at the $7.7 billion Pioneer Fund as well as the $1.1 Pioneer Equity Income Fund. In 2002, the typical S&P 500 stock traded at 17 times the next year’s earnings. Today the forward p-e is 15. That means blue-chip stocks are moderately priced and have room to run.
You can tell large-company stocks have some momentum by looking at the folks who are lining up to buy them. Just peek under the hood of “all-cap” mutual funds, the kind that are free to buy any size stock the manager desires, and you’ll find that the focus is on bigger companies. At Hodges Fund (HDPMX), 66% of the $570 million portfolio is invested in large-cap stocks such as Apple Computer (AAPL), ConocoPhillips (COP), Cisco (CSCO), Wal-Mart (WMT), and Caterpillar (CAT). That’s up from about 45% a year ago.
Co-manager Don Hodges buys a company when it sports a strong balance sheet, good revenue growth, and a stable stock price. In the past nine months some of the blue chips that passed this hurdle are General Electric (GE) and Coca-Cola (KO). “These are stocks I’ve never owned before,” Hodges says. “They haven’t done much for six years, but they quit going down.” He’s also added Halliburton Co. (HAL) to the fund because “as long as oil stays above $40 per barrel, you are going to have a lot of drilling activity.”
Mark Coffelt, manager of the $77 million Texas Capital Value&Growth Fund (TCVGX), also thinks big is better. In the past five months he has shifted half of his go-anywhere fund from small-cap and mid-cap names into big global equities, including the ADRs of Sanofi-Aventis (SNY), Diageo (DEO), and ABN-AMRO (ABN). “These companies have a big global footprint,” Coffelt says.
ABN-AMRO, for example, is gaining market share in India and China, two of the hottest emerging markets. Yet the company’s stock is trading at a mere 12 times 2007 earnings. “That’s cheap for a bank,” Coffelt says. The Manning&Napier Equity fund (EXEYX ), which also has an all-cap mandate, is finding the best opportunities in bigger stocks, too. The fund’s managers aren’t concerned about where a company is domiciled. They point to the fact that 26% of the companies in the S&P 500 derive most of their revenues from outside the U.S. Take Coke: It gets 71% of net operating revenue outside North America, says George H. Stamey, a Manning&Napier managing director. “The distinction between U.S. and non-U.S. is not meaningful,” Stamey says.
Even the big-cap funds are getting more mega in scope. The Chase Growth Fund always focused on larger companies, but the market cap of stocks in its portfolio jumped from $20 billion to $95 billion in the past six months. Lead manager David Scott, who uses quantitative screens to initially identify good prospects, recently upped the fund’s exposure to large pharmaceutical companies such as Johnson&Johnson (JNJ ) because of better earnings prospects.