By Suzanne McGee
In late March of last year, as the world started to deal with
the pandemic lockdowns, the U.S. stock market had already hit
"reset."
A year later, as investors closed the books for the first
quarter of 2021, they are looking back on a market rebound that
outdid even the post-financial-crisis recovery for both speed and
magnitude.
How did the professional stock pickers at mutual funds do?
Overall, no better than an index fund. But the best of them blew
away the field -- including a spectacular 273% gain for the No. 1
fund, the small-stock-focused Morgan Stanley Inception Portfolio
(MSSGX).
The group of actively managed U.S. stock funds that The Wall
Street Journal tracks (based on Morningstar data) for its quarterly
Winners' Circle survey posted an average gain of 47% for the 12
months ended March 31. While that trailed the S&P 500's 56%
total return for the same period -- and fell short of recovering
all the losses investors incurred during the selloff early in 2020
-- the best-performing funds did far, far better.
That's a testimonial either to the pros' ability to anticipate
the kinds of disruptive change that would benefit the companies
they chose to add to their portfolios, or to their ability to tweak
their holdings in response to the rapidly changing market
environment.
A case in point: Dennis Lynch, head of the Counterpoint Global
team at Morgan Stanley Investment Management. Funds managed by Mr.
Lynch and his team have routinely earned top honors in the Winners'
Circle. This time, it was their small-cap growth offering, Morgan
Stanley Inception.
Mr. Lynch doesn't credit his fund's outperformance to any
attempt to pick the bull market's new crop of winners. Rather, his
team has long emphasized identifying opportunities in the kinds of
disruptive business models that emerged as the winners of the
"pandemic market."
Among them: Fastly Inc., whose edge-computing technologies helps
improve the performance of cloud-based apps, including the kind of
online gaming that many Americans flocked to during lockdowns.
Fastly's stock price has soared in the bull market, from lows of
$14 a share in mid-March 2020 to $70.31 currently. While that's
well below its high of $126 a share last October, the gain was
enough -- in combination with big moves by other Inception holdings
-- to boost the fund to the top of the heap.
"We prioritize long-term thinking over knee-jerk reactions,
especially during a period of turmoil and crisis like last year,"
Mr. Lynch says.
As always, the Journal isn't recommending that investors view
the quarterly ranking as a shopping list. Many of the funds may
have high fees, or be closed to new investors or otherwise
inaccessible. But their managers may still offer our readers
insight into what's happening in the market. The survey also
includes only actively managed mutual-fund portfolios with a
three-year record and more than $50 million in assets; it excludes
sector funds, quantitative funds and funds that employ
leverage.
Small stocks strutted
Funds concentrating on small-cap or microcap stocks dominated
the list of winners. That doesn't surprise Scott Opsal, director of
research for Leuthold Group of Minneapolis. "Huge returns coming
off a bear market's bottom are pretty typical," he says. "In a bear
market, investors turn conservative; in the first leg of a bull
market recovery, they're willing to invest in less-stable
businesses, to take a flier on less-established businesses and look
to the future for their rewards."
What is unusual about the past 12 months, Mr. Opsal notes, is
the speed and magnitude of the recovery. "We got so much stimulus
right away, so the bottom was sharp and quick," he says.
"I would never in a million years have envisioned this kind of
market recovery," says Darren Chervitz, portfolio manager of Jacob
Discovery Fund (JMIGX), the No. 2 Winners' Circle finisher. "We've
had more than 26 portfolio names post gains of more than 100% in
the last 12 months." That propelled Mr. Chervitz's fund 220% higher
for the 12-month period.
Mr. Chervitz's willingness to adjust holdings as the bull market
has evolved helped ensure he handily beat top-ranked Morgan Stanley
Inception in a more-volatile first quarter. Mr. Chervitz's fund has
delivered a year-to-date gain of 37%, compared with 23% for Morgan
Stanley Inception.
Jacob Discovery Fund's assets under management ballooned in
response to these returns, thanks both to capital gains and to an
inflow of new cash, from only $10 million at the market's nadir in
March 2020 to about $100 million a year later. Partly as a response
to this and in part due to changing nature of the market, Mr.
Chervitz oversaw a gradual expansion in the number of holdings from
40 to 60 companies.
"When the pandemic first hit, I sought out companies that I
thought would benefit from medical innovations as well as from
people staying home: that was the first wave for me," says Mr.
Chervitz.
He also added to positions in companies like Arcturus
Therapeutics Holdings Inc., which is developing mRNA-based vaccines
(including another Covid-19 vaccine candidate) but also using the
same genetic research to devise therapies able to treat diseases
like cystic fibrosis. The stock's price has tripled over the past
12 months, but it's the longer-term outlook that Mr. Chervitz finds
intriguing.
"I see the potential for this kind of new medical technology to
significantly expand lifespan over the coming decades," he
argues.
Scientific change
Looking past the immediate beneficiaries of the stay-at-home
phenomenon, Mr. Chervitz sought out other business models that
could benefit from a willingness to embrace scientific and business
change. Alphatec Holdings Inc., under the leadership of a new chief
executive, Patrick Miles, fell into that camp, he says, as it has
rolled out a series of innovations targeting spinal surgery, such
as software that tells surgeons about the health of nerves during
operations.
More recently, he has invested in a cryptocurrency broker,
Voyager Digital Ltd. (listed on Canada's over-the-counter market),
whose biggest problems may lie in managing runaway revenue growth,
he argues. "Although it has gone from being a penny stock to
trading at more than $30 Canadian dollars a share, its valuation is
still lower than the one being discussed for Coinbase's likely
initial offering," he adds.
Jeff James, the lead portfolio manager of Driehaus Micro Cap
Growth(DMCRX), which ended our competition in fifth place with a
12-month return of 175% and advanced nearly 13% in the first
quarter, also has been actively readjusting his portfolio in
response to the shifts in the economy and the market, adding that
active stock-picking has helped his performance. (The fund is
closed to new investors, though the Driehaus small-cap fund, which
Mr. James says has about a 50% overlap in holdings with the
microcap fund, remains open.)
"For the first half of the last 12 months, the market has really
been about pandemic beneficiaries," Mr. James says, including some
of the fund's existing holdings. These included Freshpet Inc.,
which provides pandemic puppies and kittens (as well as other
animal companions) with refrigerated fresh foods, and Fulgent
Genetics, which developed some of the widely used Covid-19 tests
and which now is pushing forward with research and development of
many kinds of genetic tests.
"As it became clear we'd have effective vaccines emerge, I've
started shifting my emphasis and looking for companies that will
benefit most from a reopening," Mr. James says. For instance, he
took a stake in Bally's Corp., which owns casinos in a number of
regional markets (including Colorado and Rhode Island), as well as
racetracks and an array of online gaming products. "We bought this
in the second half of last year, expecting that while online gaming
would continue in the reopening, Bally's would benefit from a surge
in activity at its casinos, " adds Mr. James.
The Driehaus fund has benefited from this decision to try to
track the evolution of the pandemic and its impact on an array of
businesses. Early on, Mr. James says, the consumer discretionary
sector was the worst performer for his fund, but a growing interest
in home furnishings and outdoor-related activities had transformed
it into the single largest contributor to returns by the first
quarter of 2021. Holdings in stocks like Nautilus Inc. (a maker of
fitness equipment, whose shares have exploded in value from about
$2.50 a year ago to more than $16 by March 31) and Lovesac (a
specialist modular furniture maker, whose stock has soared from
less than $5 to nearly $60 over the past 12 months) were among the
leaders.
Baron's test of time
Not all top-performing fund managers relied on the ability to
identify the biggest beneficiaries of the new bull market as it
unfolded to generate gains. Baron Partners Fund (BPTRX) earned
third place in this quarter's rankings with a 12-month return of
212%, thanks to its managers' early decision to invest in stable
but high-growth businesses.
"All of our core holdings had been in the fund prior to February
2020," says Michael Baron, who manages the fund alongside his
father, veteran investor Ron Baron. "We don't try to outsmart the
market, but we look for high-quality businesses able to weather the
storms and continue to grow, in businesses that we feel will be
much larger in five years' time."
Mr. Baron attributes the outsize gains in many growth companies,
and especially among the ranks of smaller stocks, to the fact that
the pandemic seems to have accelerated the pace of economic change.
"A lot of growth projections we had established for our holdings
for the next several years were pulled forward, and realized in a
much shorter timespan," he says.
The pandemic-related trends contributed to this new focus and
sense of momentum, Mr. Baron argues. Legacy businesses weren't able
modify their business plans rapidly, so disruptive companies
offering new models were able to capitalize on that.
For instance, Zillow Group Inc. already has captured more
attention from eager home buyers (encouraged by ultralow interest
rates) reluctant to tour homes in person in the company of a
real-estate agent. Tesla Inc., the fund's largest holding, came to
be seen not only as the maker of more environmentally friendly
cars, but as a consumer-friendly business in a pandemic.
"Fewer people touch the vehicles when they're made, and there's
no need to go to a dealership and interact with other people to
make the purchase or get the vehicle serviced," says Mr. Baron.
The No. 4 finisher was Hodges Fund (HDPMX), with a 182% gain
under Craig Hodges. It employs a "go anywhere" approach that
enabled Mr. Hodges to add (and later subtract) pandemic-economy
winners like Zoom Video Communications Inc. More recently, the fund
has diversified, adding small positions in sports betting firms (
DraftKings Inc.) and food-delivery companies ( Waitr Holdings Inc.)
Like Mr. James at Driehaus, Mr. Hodges benefited from a stake in
Nautilus and ventured further into the outdoor-sports arena with a
stake in Callaway Golf Co.
Ms. McGee is a writer in New England. She can be reached at
reports@wsj.com.
(END) Dow Jones Newswires
April 04, 2021 13:14 ET (17:14 GMT)
Copyright (c) 2021 Dow Jones & Company, Inc.
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