The Year in U.S. Equity Funds: Growth Was King in 2017
Tech-heavy large-growth funds fared best while small-value funds posted smaller gains.
U.S. stocks continued their relentless march upward in 2017, extending one of the longest bull markets in history. (Only the 1990s bull market lasted longer.) The year began with a lot of market optimism due to the business-friendly agenda of the incoming Donald Trump administration, and even though dysfunction in Washington ended up tempering many of those expectations, the economy continued to hum along and corporate earnings were generally solid. The S&P 500 gained 22% for the year to date through December 23, and the tech-heavy NASDAQ Composite Index returned 31%.
In general, growth funds performed better than value funds in 2017, and large-caps outpaced small-caps. Among the nine Morningstar Style Box categories, large-growth funds posted the highest average gains (28%), and small-value funds had the lowest (9%). This pattern was driven by the strong stock performance of big tech names such as Apple (AAPL), Amazon.com (AMZN), and Facebook (FB), each of which gained more than 50% for the year. The same trend drove the impressive gains of technology sector funds, which were up almost 40% on average.
To investors with a long memory, all this may sound uncomfortably similar to the peak of the late-1990s bull market, when big tech stocks were red-hot and anything value-oriented was shunned. More than one person has compared the recent speculative frenzy in bitcoin to the dot-com bubble of the late 1990s, when Internet stocks with shaky to nonexistent business models were bid up to stratospheric valuations before crashing hard. On the other hand, some commentators have argued that this bull market is more substantial than the 1999 one, and that stocks aren't nearly as expensive. (For example, see here and here.)
Although just about everybody made money in 2017, some domestic stock funds performed much better than others. Here are some of the most prominent individual winners and losers of the past year, illustrating key trends.
Morgan Stanley Institutional Growth (MSEQX) and its mid-cap counterpart Morgan Stanley Institutional Mid Cap Growth (MPEGX) are both managed by former Morningstar Domestic Equity Fund Manager of the Year Dennis Lynch and his team, and both have Morningstar Analyst Ratings of Bronze. They were among the best performers in their Morningstar Categories (large-growth and mid-cap growth, respectively) in 2017. That’s not too surprising to anyone familiar with the team’s strategy, which results in concentrated portfolios filled with the type of emerging-growth names that gained big this year. As of Sept. 30, almost 20% of the Institutional Growth portfolio was in Amazon, Alphabet (GOOG), and Facebook, and it also got a boost from such holdings as Illumina (ILMN) and Intuitive Surgical (ISRG). Institutional Mid Cap Growth didn’t hold Amazon, Alphabet, or Facebook, but otherwise benefited from many of the same holdings.
Two other funds that benefited from 2017 market trends were Harbor Capital Appreciation (HACAX) and its clone Prudential Jennison Growth (PJFAX), which are managed by Sig Segalas and his growth team at Jennison. Like the Morgan Stanley funds, these offerings follow a fairly aggressive large-growth strategy, and they benefited from big positions in Apple, Facebook, and Amazon, which together made up 15% of their portfolios as of Sept. 30. But these funds also got a big boost from top-10 positions in Chinese Internet giants Alibaba Group (BABA) and Tencent Holdings (TCEHY), which roughly doubled in price this year.
While the above funds took full advantage of a market favorable to their investing styles in 2017, other funds excelled despite facing major headwinds. Two good examples are the mid-cap value AllianzGI NFJ Mid-Cap Value (PQNAX) and the small-value Royce Opportunity (RYPNX). These two Bronze-rated funds each gained more than 20% and ranked in the top 1% of their respective categories for 2017, despite not owning the big tech names that were the year’s star performers. The Allianz fund achieved this through a combination of strong stock-picking (half of its top 10 holdings gained more than 50% for the year) and an avoidance of energy, real estate, and utilities stocks, which the managers consider too expensive. The Royce fund also had a lot of very successful stock picks, such as top holdings Dana (DAN), Meritor (MTOR), and Comtech Telecommunications (CMTL), and it helped that the fund was particularly heavy in technology, which made up 27% of the portfolio as of Sept. 30.
The worst 2017 return of any U.S. stock fund covered by Morningstar Analysts belongs to Fairholme (FAIRX), a once-hot large-value fund that has struggled mightily in recent years. As of August 31, manager Bruce Berkowitz had about one third of the portfolio in preferred shares of mortgage lenders Fannie Mae and Freddie Mac, which suffered steep losses in the first half of 2017 and dragged down the fund’s returns, even after a third-quarter rebound. It also didn’t help that top holding The St. Joe Co (JOE), which takes up 20% of the portfolio, suffered a modest loss for the year. Berkowitz’s all-in bets on sometimes illiquid securities worked very well from 2000 through 2009, but when things go bad here, they can get ugly, as this year has shown.
FPA Capital (FPPTX) is another one-time high-flier that has gone through a rough time lately, and which ranked at the bottom of its mid-cap value category in 2017. The fund has struggled since the retirement of longtime manager Bob Rodriguez in 2009, largely because its deep-value approach has been very much out of step with the long and often heady bull market. That was especially true in 2017, when 12 of its 19 stock holdings lost money, including top holding ARRIS International (ARRS) and all five of its energy holdings, led by Cimarex Energy (XEC) and Noble Energy (NBL).
Fairholme and FPA Capital both have Neutral ratings due to the protracted nature of their recent struggles, but other funds performed poorly in 2017 for reasons that are more specific to this year. Silver-rated Invesco Diversified Dividend (LCEAX) has been a respectable performer over the past decade, but in 2017 it ranked near the bottom of the large-value category. That was due mainly to the fund’s big stakes in utility and consumer defensive stocks such as PPL (PPL) and General Mills (GIS), which put up generally lackluster returns in a year when dividend payers were not in favor. Another Silver-rated fund, the mid-cap blend Longleaf Partners Small-Cap (LLSCX), has ranked in its category’s top decile in three of the past six years, but this year it landed in the bottom decile when several holdings in its highly concentrated portfolio suffered losses, including top holding Level 3 Communications.
David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.