Mutual funds that focused on the biggest stocks, US investments led the way this year

Markets Associated Press

Go big and stay home. Anyone who followed that strategy with their mutual funds in 2014 is likely sitting on another year of healthy returns.

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Funds that focus on stocks of the biggest companies were some of the year's strongest performers, while U.S. stock and bond funds generally did much better than their foreign counterparts. The line between winning and losing mutual funds was also more pronounced than in 2013, which means investors had to be choosier to make gains.

A winning strategy last year was simply to buy a stock fund -- pick one, virtually any one, as 92 percent of them rose -- and avoid most bond funds and then do nothing. This year 72 percent of stock funds avoided losses through Tuesday, according to Morningstar.

It may be a downer to see many stock funds drop when the main barometer of the U.S. stock market, the Standard & Poor's 500 index, is setting multiple record highs. But it can actually be an encouraging thing. It shows the value of having a diversified portfolio, where portions move in different directions. If everything always moved the same way, it's painful when the direction is down.

BIGGEST WAS BEST

Large-cap stock funds jumped as a growing economy helped drive earnings to record highs. The job market appears to have finally caught momentum, and the economy roared ahead last quarter at its fastest pace since 2003.

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The average fund invested in large-cap growth and value stocks returned 12 percent, tracing the ascent of the large-cap S&P 500 index. It's the fifth year in the last six that such funds have delivered an annual return of better than 10 percent. They turned in the 10th best performance of the year among the 102 mutual-fund categories tracked by Morningstar, and most of those ahead of them in the rankings are smaller, more niche categories.

Funds that focus on smaller U.S. companies also logged gains, but more modest ones than in recent years. The average small-cap growth stock fund returned 2.3 percent, for example. That's far short of its 2013 return of 40.9 percent.

Small-cap stock funds were likely victims of their prior success. The price of small company stocks rose so quickly last year - and so much faster than their earnings -- that they looked too expensive to many fund managers.

U.S. WAS STRONGEST

Whether large- or small-cap, most foreign-stock mutual funds fell last year. Economies around the world, from developed markets in Japan and Europe to emerging markets in China, are struggling with either slower growth or outright recession.

Not only that, many currencies are also at their weakest in years against the dollar. That undercuts the return of foreign stocks when measured in dollars. The MSCI index of French stocks, for example, is up 1.3 percent this year in euros. But a euro is worth 11 percent less against the dollar than at the start of the year, so the French index is down 10.5 percent in dollar terms.

A big outlier among foreign markets this year has been Indian stock funds. They were among the world's best, riding excitement that the country's new prime minister, Narendra Modi, can push through economic reforms. Matthews India returned 60.9 percent, for example, more than any other mutual fund.

BONDS BOUNCED BACK

One of the most widely held beliefs at the start of the year was that bonds were going to struggle again. Investment-grade bonds had just turned in their worst year in almost two decades, the result of rising interest rates.

When rates rise, it knocks down the value of existing bonds by making their yields suddenly look less attractive. Expectations generally called for the U.S. economy to continue to grow, and most fund managers thought interest rates would keep climbing.

They were wrong. The economy did grow, but rates dropped, and the yield on the 10-year Treasury even dipped below 2 percent at one point in October, down from 3 percent in early January.

The most popular bond fund category, intermediate-term bond funds, has returned an average of 4.8 percent. It's a sharp turnaround from a loss of 1.4 percent a year earlier.

Long-term bond funds generally are the riskiest when it comes to interest rate increases. But modest inflation has helped to keep long-term interest rates low, and long-term bond funds have had particularly strong returns. Many have performed even better than U.S. stock funds this year.

INDEX FUNDS GAINED

It was another tough year for stock pickers. Through early December, 85 percent of mutual funds that invest in a mix of large-cap growth and value stocks were trailing the S&P 500. That's their worst performance since 1997, according to Goldman Sachs.

Many investors have also grown tired of the higher expenses charged by actively managed funds, and they've opted instead for index funds.

Funds that track the S&P 500 and other U.S. stock indexes have attracted $156 billion in new investment over the year through November. Actively managed funds have had net withdrawals of $92 billion over the same time, according to Morningstar.