Over-Teched? Big-Cap Growth Funds Got a Lesson in Diversification in 2000

Just as a tornado gives you the chance to see your neighbors' interior design, a big selloff tells you what was in your fund's portfolio.

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In 1999 and 2000, we talked about investors' rising dependence on the technology sector as record inflows gushed into then-sizzling tech funds and the average diversified growth fund put more than 40% of its money into tech stocks. The problem, of course, was that when tech was caught in the rain, investors' portfolios caught pneumonia. That's exactly what happened last year.

Last week we looked at the tech funds that best weathered the tech tempest and those that re-enacted our favorite scene from The Perfect Storm. Today, let's do the same with big-cap growth funds, also looking at what stocks separated the winners from the vanquished; some of the category's biggest and most popular funds are among the leaders and laggards. This is a lesson in the value of diversification and risk control.

It also highlights the current opportunity to use last year's tumble to your advantage. OK, tough markets are awful, but they do help you measure your risk tolerance and your fund managers' acumen.

Likening last year's tech tumble to a tornado isn't really that overblown. After all, between the Nasdaq Composite's March 10 peak and the end of the year, the tech-heavy index lost more than half its value, as did the average tech fund. The less tech-heavy S&P 500 lost only around 5%, but the average big-cap tech fund lost almost 20%.

2000's Tech Meltdown Between the Nasdaq Composite's March 10 peak and the end of the year, things got ugly for tech stocks and tech-heavy funds

Source: Morningstar and Baseline/Thomson Financial.

But not all big-cap growth funds drank Wall Street's Kool-Aid, and decided to ignore tech stocks' thin-air valuations. On average, the 20 funds in this pack that weathered the storm best spread their money more broadly around the market, with about 30% of their assets in tech stocks. That's a significant weighting, but more than 10 percentage points lower than their average peer's.

Here's a look at the 20 large-cap growth funds that best survived last year's tech bloodbath -- screening out smaller funds with less than $250 million in assets.

Big-Cap Survivors These 20 large-cap growth funds weathered last year's tech meltdown
Fund	Return 3/10-12/31	3-Year Annualized Return
(HGWTX)Huntington Growth Tr	13.4%	10.5%
(CHTIX)Alleghany/Chicago Trust Growth & Income N	8.9	18.6
(NRGAX)Nuveen Rittenhouse Growth A	6.8	10.8
(AMCPX)Amcap	4.7	19.5
(MCGFX)Alleghany/Montag & Caldwell Growth N	3.6	13.2
(ILCAX)AmSouth Large Cap A	2.9	15.9
(ENGRX)Enterprise Growth A	2.9	12.6
(ICGAX)AmSouth Capital Growth A	2.9	15.5
(AETIX)Armada Tax Managed Equity I	2.7	N/A
(SRLAX)State Street Research Legacy A	-0.3	14.8
(MOMGX)Pioneer Growth A	-2.1	8.3
(LCPAX)AIM Large Cap Opportunities A	-4.1	N/A
(SHRAX)Smith Barney Aggressive Growth A	-5.6	35.7
(BSPAX)Bear Stearns S&P Stars A	-6.9	24.6
(NVLCX)Wells Fargo Large Co Growth I	-7.3	23.4
(TWCIX)American Century Select Inv	-7.6	13.8
(PRGWX)Principal Growth A	-8.2	6.4
(AGTHX)Growth Fund of America	-8.4	26.9
(SBLGX)Smith Barney Large Cap Growth A	-9.4	23.2
(NOGEX)Northern Growth Equity	-9.6	15.0
Avg. Large-Cap Growth Fund	-19.5	15.4
Source: Morningstar. Data through Jan. 8.

It's a fairly eclectic list, but one theme running through many of these funds is a consistent price-consciousness. Translation: Many of these funds' managers did focus on fast-growing companies, but didn't forget that a stock's valuation matters.

Maybe the best examples of this approach are the $7.3 billion (AMCPX)Amcap and the $36.1 billion (AGTHX)Growth Fund of America funds -- both adviser-sold funds run by quiet giant American Funds. I highlighted this firm yesterday and, more specifically, these two funds precisely because their management teams have consistently beaten their peers without paying untenable prices for stocks that are more story than substance.

It's probably no mistake that these two funds beat the S&P 500 and their average peer over the past one-, three-, five- and 10-year time periods, as Morningstar numbers show.

Another marquee fund that proved its mettle and made our list is the $4.1 billion, broker-sold (SHRAX)Smith Barney Aggressive Growth fund. Richard Freeman has run this fund since its 1983 inception and his record is distinguished. He scours the market for small- or mid-cap stocks that boast at least 20% earnings growth and typically holds on for the long term.

He's managed to beat the S&P 500 and at least 95% of his peers over the past one-, three, five- and 10-year time periods. And over the past three years, his fund has weathered down months better than its peers, too, according to Morningstar.

A few notable funds and managers that also fared better than their peers last year, but just missed our list: (FCNTX)Fidelity Contrafund (William Danoff), (WOGSX)White Oak Growth Stock (Jim Oelschlager/Donna Barton) and (JAEIX)Janus Equity-Income (Karen Reidy).

If you lump these 20 funds together and check out their cumulative top-10 holdings, you're looking at a fairly tame list of blue-chips. Yes, there are four tech stocks here, but the "New Tech" shops like networkers JDS Uniphase (JDSU) and Juniper Networks(JNPR) aren't among the top 10. Instead, all of these funds owned the more staid pharmaceutical titan Pfizer(PFE) as of their most recent portfolio; even old friend Coca-Cola(KO) cracked the top 10.

Under the Hood The big-cap growth funds that fared best after the Nasdaq's peak had a lighter tech weighting than their peers and it shows in their cumulative top-10 holdings
Stock	Weighting in Top-20 Funds	Number of Top-20 Funds Owning the Stock
Pfizer(PFE)	3.0%	20
Cisco Systems(CSCO)	2.6	15
General Electric(GE)	2.4	13
Intel(INTC)	2.4	18
American International Group(AIG)	2.3	15
Home Depot(HD)	2.0	14
Microsoft(MSFT)	1.7	15
EMC(EMC)	1.5	11
Medtronic(MDT)	1.4	14
Coca-Cola(KO)	1.4	10
Source: Morningstar. Holdings as of funds' most recent portfolio reports

That's a far cry from the cumulative top-10 holdings among the laggards -- yes, they're all tech stocks. That makes sense when you consider that on average these 10 funds had 70% of their money in the sagging tech sector. Here they are, ranked by the pain they felt last year after the Nasdaq peak -- once again, we've screened out funds with less than $250 million in assets.

Hit Hard These 10 funds' big tech stakes put them in the cellar last year, though all of them beat their average peer over the last three years
Fund Name	Return 3/10-12/31	3-Year Annualized Return
(UOPIX)ProFunds UltraOTC Inv	-81.8%	31.5%
(GPFFX)Grand Prix A	-59.4	46.1
(RYOCX)Rydex OTC Inv	-49.6	31.0
(BFOCX)Berkshire Focus	-46.5	54.9
(IAGAX)Idex Alger Aggressive Growth A	-46.3	17.8
(IPSMX)IPS Millennium	-43.5	28.3
(FDEGX)Fidelity Aggressive Growth	-42.7	24.8
(IVENX)Invesco Endeavor Inv	-42.0	N/A
(ACAPX)Alger Capital Appreciation B	-41.8	17.9
(FOCPX)Fidelity OTC	-41.6	18.7
Avg. Large-Cap Growth Fund	-19.5	15.4
Source: Morningstar

Some of these funds might be mislabeled as big-cap growth funds, because they have the vast majority of their money in tech stocks. The (BFOCX)Berkshire Focus fund and the (FOCPX)Fidelity OTC funds, for instance, both had more than 80% of their money in the tech sector, according to their most recent portfolio reports.

And Robert Loest's (IPSMX)IPS Millennium fund might elude accurate classification with its fairly unusual two-pronged focus on the tech and utilities sectors.

A fund's appearance on this list isn't reason in and of itself to dump it. After all, tech stocks killed these funds last year, but they also helped most of these bottom-10 funds to solid returns over the last three years.

David Alger, the high-profile growth specialist, co-manages two funds on this list ((IAGAX)Alger Aggressive Growth and (ACAPX)Alger Capital Appreciation), but he's famous for volatility as well as heady gains.

Still, making this list should clearly raise a flag for current or prospective shareholders. Since losing burgeoning star manager Erin Sullivan on Valentine's Day last year, the (FDEGX)Fidelity Aggressive Growth fund has clearly suffered.

While these funds might interest the most rabid tech bulls, they're probably a must-miss for most investors, unless you view them as tech funds and give them a modest (5% to 10%) weighting in your portfolio.

The Junk Pile

What's a market-like tech-weighting these days, anyway? At the end of last year, tech stocks comprised 22.7% of the Wilshire 5000 Total Market Index, according to the firm's Web site.

Will battered high-yield bond funds -- in the red over the past one- and three-year periods -- be this year's star? In a year-end press conference, Bill Miller, the value guru whose (LMVTX)Legg Mason Value Trust is the only fund to beat the S&P 500 in each of the last 10 years, suggested that the only easy money to be made this year might be in high-yield bond funds. Yesterday Ken Gregory, chief investment officer of the fund-tracker and money manager Litman/Gregory, made the same point as we taped next week's 10 Questions interview. Check out our basics section for details on bonds, high-yield or junk bonds and bond funds.

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