Did Your Funds Jump in 1996? Only Question Is How High

The key to success in stock mutual funds in 1996 was . . . not owning Japanese funds.

Period.

For a second year in a row, nearly every major category of stock fund produced tremendous gains as the 1990s bull market rolled on here and abroad.

The average general U.S. stock fund enjoyed a total return (price change plus dividend income) of 19.3% in 1996, according to preliminary data from fund tracker Lipper Analytical in New York.

That was down from a 31.1% gain for the average fund in 1995, but the ’96 return is still roughly four times what you would have earned just letting your cash sit in a money market fund for the year.

Once again, the typical fund manager also lagged the performance of the chief stock market index, the blue-chip Standard & Poor’s 500, which gained about 22.5% for the year, including dividends.

That underperformance just served to increase pressure on many fund managers during the year, even as they (and their shareholders) suffered through the U.S. stock market’s sudden July pullback, only to see stocks surge again in August and rally further in the fourth quarter.

The pressure on managers was exemplified by the turmoil within the largest fund group--Fidelity Investments--where Jeff Vinik, manager of the flagship Magellan Fund, resigned in May after betting heavily on bonds (and thus against stocks) in the first part of the year. Magellan ended the year up 11.7%, still far behind the typical stock fund, even though new manager Robert Stansky has reoriented the giant fund back toward stocks.

The average U.S. growth stock fund gained 19.2% for the year, a respectable showing considering that some of the highest fliers among growth funds were slammed in the summer market decline and never fully recovered.

For the year, the biggest fund-category winners were a motley crew:

* Real estate funds took top honors, gaining 35% for the year, on average, seeing a stunning 17% surge in the fourth quarter alone. The funds, which typically own real estate investment trusts, became a favorite refuge for investors after the summer market plunge.

The appeal: hefty dividend yields and the hedge potential in owning real property--which, in theory at least, could hold value even if the stock market overall were to head south again.

* Natural resources funds rose 32.1% for the year, on average, largely on the strength of gains in energy stocks, as oil and natural gas prices refused to swoon.

* Financial services funds gained an average of 27.9%, as banks and other financial companies racked up another year of strong profits, thanks in part to relatively tame interest rates and to healthy consumer demand for loans.

* Perhaps the biggest story was the spread of U.S.-style stock bullishness worldwide. Latin American markets finally snapped out of their funk, and the average Latin stock fund rocketed 24% for the year.

In Europe, markets also came alive, buoyed by falling interest rates and growing shareholder pressure on companies there to boost earnings. The average European stock fund rose 23.8% for the year.

Only Japan proved to be a significant disappointment among major foreign markets. The average Japanese stock fund lost nearly 11%, hurt not only by Japanese stocks’ continuing weakness in the face of the country’s anemic economy, but also by the dollar’s strength against the yen.

*

What’s the best stock fund strategy for 1997? Not surprisingly, many market pros are advising caution, because it seems like pure gluttony to expect the U.S. stock market to post a third big year in a row.

Michael Lipper, head of Lipper Analytical, advises investors who want to put cash to work to look toward funds that favor “value” stocks--typically, lower-risk issues that pay high dividends or which sell for relatively low prices compared with earnings per share.

Lipper notes that his firm’s index of major value funds just hit a record high last week and that an index of major “growth” funds--which tend to focus on higher-risk, higher-return stocks--peaked out in October.

Kurt Brouwer, principal at financial advisory firm Brouwer & Janachowski in San Francisco, also likes the value stock concept. He favors Skyline Special Equities, a fund that focuses on smaller-capitalization value stocks--perhaps one of the least appreciated market sectors in recent years.

Likewise, many experts say foreign stock funds are a better bet for 1997 than U.S. funds, if only because most foreign markets have lagged far behind the U.S. market in the 1990s.

But some pros warn that if you’re looking for a hedge against a deep U.S. market decline, you may be disappointed no matter which fund sector you choose. If a painful bear market arrives in the American market, chances are it will spread to most other markets worldwide and spare few stock sectors, Lipper advises.

If you want to make an aggressive bet for 1997, some market veterans advise staying with the recent sector leaders.

Steven Check, head of Check Capital Management in Costa Mesa, believes that financial services stocks as a group remain appealing, thanks to low price-to-earnings ratios and strong earnings outlooks. “That’s where we’re still finding values,” he said.

In the energy sector, meanwhile, manager Dan Rice of the State Street Research Global Resources fund in Boston--the best-performing U.S. stock fund overall in 1996, with a gain of 70.3%--insists that there is much more to come from energy-related shares.

He is focused heavily on smaller oil and gas exploration and production companies, which he says are “much more leveraged not only to changes in [oil and gas] prices but to changes in expectations” for the industry.

Rice isn’t a raging bull on the price of oil itself. His argument for higher energy stock prices is that even if oil and gas prices level out, many of the stocks are still historically depressed relative to the cash flow they can generate. All that’s needed, he says, is for more investors to continue changing their mind-set about energy investing--that it’s finally capable of producing healthy returns again, after 15 years of mediocrity.