3Q Fund Review: A welcome return to strong, steady returns
It was a good summer for fund investors, as calm and strong markets around the world lifted most categories to gains from July into September.
The third quarter's smooth ascent was a turnaround from the topsy-turvy returns of the spring, when worries about the British vote to leave the European Union had global markets convulsing. It also keeps most funds on track for an up year. Through Wednesday, 94 percent of the 7,510 funds tracked by Morningstar have made money in 2016. That's a much higher rate of success than 2015, when only 37 percent of funds gained.
Last quarter's returns came despite a long list of worries that could have spooked investors. Economic growth around the world is still only modest, and U.S. corporate earnings are in the midst of their longest string of declines since the Great Recession. Even still, the largest mutual fund by assets, Vanguard's Total Stock Market Index fund, managed to return 4.5 percent in the quarter through Wednesday.
Interest rates remain low, which is pushing investors to pay higher prices for stocks even though earnings are falling. Bond funds, meanwhile, eked out modest gains. Here's a look at some of the trends that shaped the quarter for fund investors:
— The Apple effect
A big factor for many funds' good quarter was the resurgence of Apple's stock. The technology company is the largest by market value, and its immense size means its movements have a bigger effect on how indexes — and the funds that track them — perform than any other stock.
Apple returned 19.8 percent in the quarter through Wednesday, including dividends. It soared on excitement about orders for its new iPhone model.
Funds heavily invested in Apple benefited. The Fidelity Select Computers fund, for example, has roughly a fifth of its portfolio in Apple, and its 16.9 percent third-quarter return through Wednesday was more than quadruple an S&P 500 index fund's return.
Many funds run by stock pickers, though, didn't get as big a lift from Apple's rise. That's because many keep a smaller percentage of their portfolios in Apple than index funds do. In fund jargon, managers say they are "underweight" Apple, whose stock had been mostly falling since peaking in early 2015.
After looking at the holdings of 435 mutual funds with $1.5 trillion in assets, strategists at Goldman Sachs found that the average fund had 2 percent of its assets invested in Apple stock, lower than their benchmark indexes' 2.7 percent. That makes Apple one of the most "underweighted" stocks for mutual fund managers, along with Exxon Mobil and AT&T.
— A quiet quarter for bond funds
Bond funds rose last quarter, but not by much. It's a result of the low yields found across the bond market.
The yield on the 10-year Treasury note dropped to a record low during the summer, and that means bonds are producing less interest income than before. It also means interest rates have less room to fall, and falling rates are what mean price increases for bonds.
A sizable group of investors has been saying bonds have become too expensive and are due for a pullback.
Despite those predictions, demand for bonds has remained strong, keeping rates low and steady through the third quarter. The largest bond mutual fund, Vanguard's Total Bond Market Index fund, returned 0.4 percent through Wednesday. The fund tracks an index of investment-grade bonds, including Treasurys and high-quality corporate bonds.
Actively managed funds have more freedom to focus on areas of the bond market that have higher yields, along with higher risks. The largest actively managed bond funds, the PIMCO Total Return fund and the Metropolitan West Total Return Bond fund, returned between 0.8 percent and 1 percent through Wednesday, depending on which share class you owned.
— Emerging strength
Some of the best returns this past quarter came from a group of funds that only a year ago were among the world's worst.
Emerging-market stock funds have roared higher as investors scour the world for companies able to deliver strong earnings growth in a slow global economy. Bond funds that specialize in developing economies were also strong because they offer higher yields than bonds from the U.S., Europe or Japan.
The Oppenheimer Developing Markets fund is the largest actively managed emerging-market stock fund, and it returned 10.1 percent for the quarter through Wednesday, more than double an S&P 500 index fund. That big jump, though, only means that it recovered some of its losses from earlier, when worries about slowing economic growth in emerging markets weighed down returns. The Oppenheimer fund is still down from two years ago.