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Fund Spy

The First Quarter in U.S. Equity Funds

Aggressive strategies strike back.

The U.S. stock market snapped back from 2018's loss to post a strong gain in the first quarter of 2019. After falling more than 14% in the fourth quarter of last year and more than 5% for all of 2018, the Morningstar U.S. Market Index climbed 12.5% for the year to date through March 27, 2019. All areas of the Morningstar Style Box rose, but, in general, growth beat value, smaller-cap stocks led larger equities, and the technology, energy, and communication-services sectors made the largest advances.

Morningstar Category returns reflected the trends. The small- and mid-cap growth categories led all diversified stock categories and were among the best-performing peer groups overall with gains of 15% and 16%, respectively. So were the technology, energy, and real estate categories, with returns ranging from 15% to 18%. Even lagging U.S. equity peer groups put up decent numbers. The typical financials fund gained about 9%, while the average large- and small-cap value funds rose around 10% and 11% each, respectively.

This Aggression Stood
Those were impressive gains, but not as impressive as the results of aggressive growth funds in the first quarter. Few are more assertive than  Eventide Healthcare & Life Sciences (ETIHX) and  Eventide Gilead (ETGLX), which both have Morningstar Analyst Ratings of Neutral. Manager Finny Kuruvilla, a doctor and venture capitalist, has a large appetite for mid- and small- cap biotechnology stocks, including many micro-caps, in the Healthcare & Life Sciences fund and mixes in speculative tech and alternative energy stocks, such as  Splunk (SPLK) and NextEra Energy Partners (NEP), in the Gilead portfolio. Eventide Healthcare & Life Sciences gained nearly 31% in the year to date through March 27, beating all other healthcare funds and all rated domestic-equity funds; Eventide Gilead, which Kuruvilla runs as an environmental, social, and governance offering, was not far behind with a nearly 26% gain. The strategies are capable of explosive returns--in either direction. They have lost more than 16% in a single quarter before, including the final frame of 2018.

Though manager Dennis Lynch and his team have toned their style down a little in recent years,  Morgan Stanley Institutional Inception (MSSGX) and  Morgan Stanley Institutional Discovery (MPEGX) remain among the more aggressive funds that Morningstar analysts cover. The strategies--rated Neutral and Bronze, respectively--jumped 29% and 24% for the quarter through March 27, 2019, on the strength of stocks less than a year distant from their initial public offerings, including cancer-testing firm Guardant Health (GH) and online database company MongoDB (MDB). Feast can turn to famine quickly at these high-conviction, thematically driven growth strategies. They have a strong taste for tech startups that are plowing all their cash into their nascent businesses. Some will succeed, a few might go bust, but all of them will be volatile. Both these funds lost about 20% in 2018's turbulent fourth quarter.  

Neutral-rated  Lord Abbett Developing Growth (LADYX) is also a bit of a wild child and was one of the top-ranked among rated U.S. equity strategies in the first three months of 2019. Manager Tom O'Halloran and his team usually lean heavily on technology and healthcare stocks but aren't afraid to change their tack in pursuit of growth. This fund also owned oncology testing firm Guardant, as well as television-streaming device maker Roku (ROKU) and high-end cooler and travel-mug seller Yeti (YETI). This also is a volatile fund whose moves, such as a 2016 foray into basic-materials stocks, have not always worked out. The strategy's management team also has seen some changes since 2014.

Left Behind, For Now
Financial-sector strategies clustered at the bottom of the ranking tables. Neutral-rated  Emerald Banking and Finance  (HSSAX), Bronze-rated  Franklin Mutual Financial Services (TEFAX), and Silver-rated  Davis Financial (RPFGX) all posted mid-single-digit gains and lagged most of their peer group averages, as well as most other rated domestic-equity funds. Bank stocks, hurt by the Federal Reserve's decision to pause interest-rate increases, weighed on returns, as did insurance-related companies such as Alleghany (Y), Everest Re (RE), and  Berkshire Hathaway (BRK.B).

A large financials stake, nearly a fourth of overall assets as of the start of the year, restrained Gold-rated  Dodge & Cox Stock's (DODGX) results. So did health insurers  Cigna (CI) and  UnitedHealth Group (UNH), as well as pharmacy  CVS Health (CVS) and large-cap drugmaker  Bristol-Myers Squibb (BMY), reflecting that outside of the biotech subsector, healthcare was in the doldrums. Dodge & Cox's team-oriented, patient, contrary value style can look out of step with the market from time to time, but it usually pays off in the long run. Indeed, the managers maintain that the healthcare stocks they own are more-defensive options than consumer staples stocks, and that the market has not yet fully recognized the improved fundamentals of their financial holdings.

 Royce Special Equity (RYSEX) can't blame financials for its lagging performance in the first quarter. It doesn't own any because of their opaque balance sheets. Veteran manager Charlie Dreifus and comanager Steven McBoyle demand pristine accounting statements, in addition to solid, well-managed businesses and low valuations. Being picky has advantages and disadvantages. The managers' high standards and tendency to let cash build rather than buy anything to stay invested buoy the portfolio in corrections and bear markets; it shed far less than its average category peer and benchmark did in 2018's fourth quarter. This strategy's predilections, however, also can prevent it from fully participating in rallies (cash was at nearly 18% as of the end of February). A variety of industrial and consumer discretionary stocks, such as metal fabricator Insteel Industries (IIIN) and Cooper Tire & Rubber (CTB), detracted from returns in the first quarter. The short-term performance is not out of character for the Silver-rated fund, though.

Dan Culloton has a position in the following securities mentioned above: RYSEX. Find out about Morningstar’s editorial policies.