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The Daily Interview: How the Quarter Stacked Up for Mutual Funds

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Equity mutual fund returns certainly improved in the second quarter, with the average one up 7% in the quarter, according to fund-tracker Lipper. But even that performance wasn't enough to make up for these funds' awful first-quarter performance -- the average equity fund is still down 7.7% for the year, with 32 out of Lipper's 42 equity fund categories in negative territory.

Tom Roseen, a research analyst with Lipper, discusses the few pockets of strength in mutual fund investments this year, as well as the resurgence of growth stocks and sectors such as health and technology in the second quarter.

TSC: The first and third best-performing categories so far this year have been small-cap and mid-cap value funds, up 15.1% and 8.5%, respectively. Why are these sectors doing well, and how much longer do you expect them to continue to outperform?

Tom Roseen
Research Analyst,
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Roseen: As we all know, the large-caps got run up pretty highly in their P/E multiples over the past two years, and small-caps were left alone. People didn't do a lot of investing into that group. So now they have become more attractive because they have reasonable multiples. I think this will continue until some of the larger growth companies out there start coming out with good valuations, good earnings prospects. Then I think you'll start seeing some folks start falling back into the large-cap growth area.

And we have seen bits of that, by the way. If you look at the second-quarter returns, growth beat value for the first time in five quarters in all of our investment objectives, whether it was large-, mid-, multi- or small-[cap]. Small-cap growth was up 17.5% in the second quarter, mid-cap growth was up 13.5% and multi-cap growth was up 9.6%.

TSC: Gold-oriented funds are the second-best performing equity category year to date, up 12.9%, and the best-performing category in the second quarter, up 19.2%. Is it worth it for investors to explore these funds?

Roseen: If you look at the longer end of this, the three- and five- and 10-year performance [-0.8%, -14.4% and -4.7%, respectively] has all been negative. And until we find some good uses for gold, like gold-plating and in electronics, gold may be a cautious investment. Gold has been a real good investment for inflationary fears, historically, and a hedge against wars, when people like to have a tangible asset in their hands. But I don't know that we are at the risk of either one at this time, so I am not sure that this is a great place for investors to be in at this point.

Best-Performing Equity Fund Categories
Year to date through June 29
Small-Cap Value 15.1%
Gold-Oriented 12.9
Mid-Cap Value 8.5
Small-Cap Core 7.7
Real Estate 7.2
Latin American 3.2
Multi-Cap Value 1.4
Income 0.7
Financial Services 0.7
China Region 0.1
Source: Lipper

TSC: One of the most notable surprises of the second quarter was the resurgence of science and technology funds. While these funds are still down 25.8% year to date, they rallied with a refreshing 12.6% return in the second quarter. Telecommunications funds, which are down 24.3% year to date, haven't staged as much of a comeback, but they were up 4.8% in the second quarter. What's helping these categories?

Roseen: I think people saw some interesting buys. I think they saw that the valuations were low, and I think they are cautiously entering back in. The technology side of it was obviously helped considerably by the Microsoft decision, which shot the wind out of the judge's sails. Additionally, the cuts in interest rates are very beneficial for science and technology funds. This will assure them of cheaper financing.

Best-Performing Equity Fund Categories
Second quarter ended June 29
Gold-Oriented 19.2%
Small-Cap Growth 17.5
Small-Cap Core 14.8
Health/Biotechnology 14.7
Small-Cap Value 13.8
Mid-Cap Growth 13.5
Science & Technology 12.6
Mid-Cap Core 11.9
Multi-Cap Growth 9.6
Real Estate 9.3
Source: Lipper

TSC: Almost every category was up in the second quarter after being down considerably in the first. How common is such volatility?

Roseen: I think that the violent downturn that we had [in the first quarter] is unusual. The run-up was a very lofty run-up, so when the market came down, it came down fairly hard. Now, due to the Federal Reserve rate cuts in the absence of inflation, this bounce back up is a normal response that you would expect from that. So, I think there is light at the end of the tunnel and the unusual part about the market's recent actions was the result of the huge run-up in the market.

TSC: In sum, given that the second-quarter figures are so much brighter than the first, do you think that this might be a sign that things are improving and that investors can expect a healthy third quarter?

Roseen: I think that's possible, but I think we have to look at the larger companies out there. I think you really need to look at the growth stocks out there, and whether they come out with good earnings projections and solid P/Es. That will be an indicator of whether this can continue on and whether there is possible light at the end of the tunnel.

Worst-Performing Equity Fund Categories
Year to date through June 29
Science & Technology -25.8%
Telecommunication -24.3
European Region -17.8
Multi-Cap Growth -16.4
Large-Cap Growth -15.8
International -14.0
International Small-Cap -13.7
Mid-Cap Growth -13.2
Global -11.8
Health/Biotechnology -11.4
Source: Lipper

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