Beaten-Down Growth Funds Beckon to the Brave of Heart

If you think it’s finally time to start loading up on what’s beaten down in the market, you’re probably looking at growth stocks or growth-stock mutual funds.

No question, the damage has been dramatic over the last two quarters. And picking the ultimate bottom is nearly impossible. So, you may figure, why not start at least nibbling now?

If you’re brave enough to jump in, there are two ways to go: Buy severely depressed funds that have solid longer-term reputations, or stick with funds that have held up better than the average growth fund so far in the bear market.

If you’re considering bargain-hunting among funds that have been rocked hard by the last year’s market, financial advisors say it pays to make sure that everyone else isn’t leaving just as you’re getting in: A fund that is experiencing heavy redemptions can be a nightmare for the fund manager--and for investors who stay put.

Battered domestic growth funds that still get high marks from analysts at fund tracker Morningstar Inc. include two large-cap offerings--White Oak Growth Stock, managed by James Oelschlager, and Strong Growth, run by Ron Ognar--and a mid-cap fund, Turner Midcap Growth, managed by Christopher McHugh and Robert Turner.

All three sank in the neighborhood of 30% in the first quarter alone.

Of course, many fund losers got that way because of collapsed tech stocks. That also means the funds might have large accumulated losses on holdings they’ve sold. And those losses can be a bonus for investors lucky or smart enough to get in at the bottom.

How so? Fund managers are allowed to carry realized losses forward almost indefinitely to offset future gains. That means those losses can be used to minimize future capital gains distributions by the funds.

The upshot: A depressed fund might be able to rise in value if the market recovers, without having to pay out large--and taxable--annual capital gains.

There now are many “attractive funds with a clean slate on taxes” as measured by potential capital gains exposure, Russ Kinnel, Morningstar’s head of fund research, noted in a recent column.

One of the better funds with little or no capital gains exposure is Dresdner RCM Global Technology, according to Kinnel. The $278-million fund has fallen more than 50% in the last 12 months.

But as bad as that sounds, three-quarters of its tech-sector peers have fared worse. And managers Huachen Chen and Walter Price Jr. have racked up annualized gains of about 30% over the last five years.

If deeply depressed growth funds scare you, the other way to play an eventual growth-stock recovery is to look for relatively strong performers amid the plunge of the last year. The idea: If a fund manager was savvy enough to avoid the market collapse, he or she also may be savvy enough to play the eventual recovery well.

Here are some funds that managed to keep losses minimized:

* Manager John Bogle Jr. relies on corporate number-crunching in running Bogle Small Cap Growth, and so far, the young fund’s own numbers have been adding up. In 2000, its first full year, the fund gained 27%, beating 95% of its peers. In the first quarter of this year it was down 8.7%, holding up better than 80% of the competition.

Bogle, son of Vanguard Group founder Jack Bogle, “realized that the ‘momentum’ world has extracted all it can from things like beating [corporate] earnings estimates,” Kinnel said. “Instead, he looks for signs from the balance sheet and income statement that a company’s business is poised to improve.”

Though his fund is new, Bogle built a strong record at N/I Numeric Investors Micro Cap in the late 1990s before launching his own shop.

* Aided by a relatively light technology stake of about 20%, Brazos Micro Cap fell a relatively modest 8.5% in the first quarter. The team-managed $182-million fund has kept volatility surprisingly reasonable for a fund of its type. Its three-year returns beat 99% of its small-cap peers.

* Among mid-cap growth funds, Kinnel called T. Rowe Price Mid-Cap Growth a good choice for investors who “want to bet on growth but don’t want to get crushed if they’re wrong.” The $6.6-billion fund, run by Brian Berghuis, lost 13.2% in the first quarter, a smaller loss than 84% of its peers. Its five-year return beats two-thirds of its peers.

Berghuis keeps the portfolio more diversified than most of his competitors and keeps valuations reasonable, providing a cushion. Just don’t expect to get the full ride if Nasdaq blasts off again.

* Morningstar analysts also give high marks to several other mid-cap growth funds with smaller-than-average losses this year, including Artisan Mid Cap, managed by Andrew Stephens; Fidelity Mid-Cap Stock, managed by David Felman; and Hartford Capital Appreciation, run by Saul Pannell.

* Among large-cap growth funds, two choices from the Janus family--Janus Growth & Income and Janus Equity-Income--have been steadier performers that haven’t suffered the heavy losses of other Janus funds.

The $7.8-billion Janus Growth & Income, managed by David Corkins, fell 11.2% in the first quarter, while the $884-million Equity-Income, managed by Karen Reidy, lost 10.4%. Both beat at least 90% of their peers in the quarter.

Corkins’ fund has been in the top half of its peer group every year since he took over in mid-1997.

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Growth vs. Value Since 1990

Growth stock funds over the last year have racked up their biggest losses since 1987. But as the last 10 years show, the funds can come roaring back after declines. Here are average total returns of growth funds and value funds since 1990, subdivided by small-cap, mid-cap and large-cap sectors.

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Small-cap Mid-cap Large-cap Year Growth Value Growth Value Growth Value 1990 -5.6% -14.1% -7.2% -8.0% -2.5% -6.4% 1991 +54.5 +37.3 +52.9 +30.8 +42.9 +28.7 1992 +11.6 +20.6 +9.0 +14.9 +6.1 +9.8 1993 +16.4 +16.7 +15.7 +18.1 +10.7 +13.2 1994 -0.3 -0.8 -0.9 -2.0 -2.5 -0.3 1995 +35.4 +25.1 +34.9 +29.6 +32.5 +31.6 1996 +20.2 +25.6 +17.1 +20.3 +18.9 +20.8 1997 +18.2 +30.0 +17.2 +26.4 +25.0 +27.0 1998 +4.5 -6.9 +17.4 +4.2 +33.4 +13.0 1999 +61.3 +4.8 +65.9 +8.8 +40.5 +6.8 2000 -5.8 +17.0 -6.7 +17.0 -13.8 +5.6 2001 Q1 -17.9 +0.7 -22.5 -2.9 -19.7 -5.8

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Source: Morningstar Inc.