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By Suzanne McGee 

Some mutual-fund managers will look back on 2020 as the worst of times. Others are having the time of their lives, posting year-to-date returns of 75% or more.

The difference between the winners and the laggards is relatively straightforward: the extent to which portfolios were heavily weighted with stocks of companies that stand to benefit disproportionately from disruptive change. Some of these have become household names, like Zoom Video Communications Inc., whose visibility and share price have soared since the Covid-19 pandemic lockdowns forced billions of people to reimagine their lives. Others are less well-known, like medical genetic testing company Invitae Corp. (up nearly 500% from its lows in March), or Coupa Software Inc. (which delivers a cloud-based spending-management platform to help businesses get a grip on costs), up 155% since March's market meltdown.

"We would never have guessed that a pandemic-related recession would have led companies to reimagine the way they do business so rapidly," says Anthony Zackery, one of the portfolio managers overseeing several top-performing mutual funds at Zevenbergen Capital Management. "They had planned to execute changes slowly, over years, but those adoption windows for new technologies have been compressed to months."

Zevenbergen's growth-stock funds captured three of the 10 top spots in The Wall Street Journal's third-quarter survey of the best-performing actively managed U.S. equity funds, based on their returns over the trailing 12 months. Of these, Zevenbergen Genea Fund (ZVGIX) triumphed in our quarterly Winners' Circle competition by posting a return of 121% for the 12-month period ended Sept. 30, and a year-to-date gain of 92%.

Our quarterly survey limits its scope to the universe of actively managed and diversified U.S. equity funds with more than $50 million in assets and a track record of at least three years, and draws on data provided by Morningstar Inc. Not included: sector funds, funds that employ leverage or derivatives to boost returns or cushion losses, blended funds including fixed income, global funds or quantitative funds that rely on models or algorithms to build their portfolios rather than traditional fundamental research.

The results aren't intended to give readers a "buy" list of mutual funds guaranteed to continue delivering stellar returns. Some of the share classes may be less-accessible to ordinary investors, or carry unacceptably high fees.

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Because the survey emphasizes returns for the trailing 12 months, it can emphasize shorter-term performance, which may be less useful for investors seeking funds able to outperform for the next five to 10 years. Of course, this list may showcase funds that simply aren't suitable for every investor's asset-allocation strategy or risk tolerance. However, examining these top-performing funds and delving into their strategies and holdings can give investors insight into the way top-performing managers approach specific market opportunities and evaluate potential investments.

In 2020, argues Joe Dennison, another member of the Zevenbergen portfolio team, "there is a scarcity of exceptional companies and founders in which to invest," and being able to identify businesses likely to deliver true growth in both revenues and earnings regardless of the economic backdrop is crucial. Genea typically owns positions in only 25 to 35 companies, compared with as many as 45 positions in Zevenbergen Growth Fund (ZVNIX), which ranked fourth in our quarterly contest, with a trailing 12-month return of 114%.

Returns like that certainly grab an investor's attention in the midst of a broad market environment that remains both volatile and uncertain.

Over the 12 months ended Sept. 30, the S&P 500 index has

gained 16%. Year-to-date, while the 10 best actively managed funds that met our criteria provided gains of at least 73%, the S&P 500 advanced 3.25%. Moreover, as of Sept. 30, the entire universe of actively managed, diversified U.S. equity funds with more than $50 million in assets and a three-year track record posted an average loss/gain for the trailing 12-month period of 8.7%, according to data from Morningstar.

True, the index's recovery from its lows in March, when the U.S. economy was largely shut down to fight the pandemic, are significant. But top-performing funds' emphasis on the handful of stocks that actually seem likely to continue to benefit from pandemic-related issues as well as longer-term secular trends has helped them trounce the index.

"A lot of managers are focused on the question of 'how can I beat the index?' which we think is backward-looking," says Catherine Wood, CEO of ARK Investment and manager of American Beacon ARK Transformational Innovation Fund (ADNIX). For Ms. Wood, the index -- any index -- is irrelevant; she says her fund's returns of 116% for the trailing 12 months and 85% for the year to date -- putting her in second place for our contest -- come from trying to imagine what the world will look like in five to 10 years. The fund then looks for companies that will profit most from that transformation, based on a research strategy that favors "innovation platforms" like robotics, DNA sequencing, energy storage, blockchain technology and artificial intelligence.

Tesla's time

This approach led ARK's team to invest in Tesla Inc. about five years ago; for the past three years, Ms. Wood says, it has been the fund's top holding. That means that investors have benefited handsomely from the nearly 10-fold explosion in Tesla's share price over the last 12 months, a surge that occurred even though drivers of Tesla's electric cars might have been expected to stay home during a pandemic lockdown while new buyers might have postponed purchases.

That conventional analysis of Tesla as no more than an automotive company misses the point, Ms. Wood says. "That's the most narrow way of looking at it," she says."It's actually a robotics company, it's an energy storage company because of its emphasis on battery technology, and it's an artificial intelligence company because of the evolution of autonomous vehicles." The icing on the cake? Tesla is expanding its global footprint, she says, while also taking steps toward making its vehicles more affordable for the mass market.

Tesla also is a top holding in the three Zevenbergen funds in our survey, and was the single-largest holding for the Genea Fund. "No, it's not a company that benefits from pandemic-related trends," Mr. Dennison acknowledges. Rather, he believes that it will emerge as a long-term beneficiary of the transformation that Covid-19 is causing.

"Once the virus hit, more investors started recognizing that the world had just changed," says Ms. Wood, who agrees with the Zevenbergen analysis. "Now, the question is how we capitalize on that change."

Many of this quarter's top-performing funds in our survey are benefiting from companies that they and others believe will dominate the post-pandemic business and market landscape. The Zevenbergen and ARK funds all include Square Inc. in their top holdings, as do several funds overseen by Dennis Lynch, head of the Counterpoint Global team at Morgan Stanley Investment Management, including our third-place finisher, Morgan Stanley Institutional Discovery Portfolio (MPEGX). The latter recorded a gain of 115% for the 12 months ended Sept. 30, while two other Morgan Stanley growth funds -- Morgan Stanley Insight (CPODX) and Morgan Stanley Institutional Growth (MSEQX) also showed up in the list of the 10 best-performing funds for the period yet again, with returns of 105% and 99%, respectively.

Square, whose share price has nearly tripled in the past 12 months, is a provider of a contactless payment system used by retailers. Its allure for Ms. Wood and other investors goes beyond its ability to offer contactless transactions. The company is morphing into a new breed of financial services company that Ms. Wood believes will be a long-term threat to commercial banks, with their high fixed costs and a relative lack of innovation. "Square helped deliver PPP [Paycheck Protection Program] funds to small businesses, and it has calculated that 60% of the small businesses who used it to get those funds were new to Square and have now adopted its platform" for other uses, she says.

Three-part market

Mr. Lynch, for his part, says he believes that the stock market this year has split into three parts. The smallest of the three consists of stocks like Square, Tesla, Zoom, Spotify Technology SA and Twilio Inc., companies at the leading edge of innovation and post-pandemic transformation. By far the largest group, he argues, is made up of businesses that Covid-19 has affected in unpredictable ways and that have little visibility in terms of earnings or revenue growth as they try to navigate the recession. Then there's the third group: companies whose revenues and profits rely on people getting together in person, like travel businesses, some commercial real estate and restaurants. "Many of these have suffered significant [stock-]price shrinkage," says Mr. Lynch. "That seems logical to me."

This "trifurcation" of U.S. equities, Mr. Lynch says, means that more investors likely will seek out just the kind of stocks in which our top-performing mutual-fund managers have been investing for years. Already, valuations for many are soaring, prompting Mr. Lynch and others to wonder "whether some of the beneficiaries have come too far, too fast" and whether at least some of the businesses in the largest group have seen share prices tumble enough to make them interesting value investments.

For now, at least, Mr. Lynch says that he doesn't see many compelling alternatives to his current portfolio holdings, and that he's happy with what he owns. "Many of them are still early in their life cycle; many have founders or management teams with a lot of skin in the game." If he is tempted to take some of his profits off the table, he has to consider where else to put that money -- and those options are relatively few.

Other top-performing managers don't worry much about climbing price-to-earnings ratios and other metrics, especially in light of the astonishing low interest rates and forecasts of lower GDP growth. Ms. Wood suggests that "with a new normalized growth rate [including inflation] of 2% to 3%, the new normal for earnings multiples for true growth companies could be 33 to 50 times," instead of 25 times earnings, as it was in the pre-pandemic market.

In Ms. Wood's view, the soaring values of stocks in companies that benefit from pandemic-accelerated transformation simply means that innovation is being valued more appropriately by the market. She thinks these businesses are capable of delivering sustained growth of 25% a year, even if the overall economy and market are stuck in the doldrums.

If these top-performing fund managers are correct in their assessment of what lies ahead, the real longer-term winners will be those investors able to accurately winnow out those resilient companies capable of thriving in tough times by solving problems for both consumers and businesses. Index investing may be less costly, but this kind of active stock-picking is the strategy most likely to deliver above-average returns consistently, they contend. Especially if pandemic-related economic struggles re-emerge and continue.

"There's a tendency to think that we're at the end point of the crisis," says Mr. Lynch. "But I think we're still in the middle of it."

Ms. McGee is a writer in New England. She can be reached at reports@wsj.com.

(END) Dow Jones Newswires

October 04, 2020 20:52 ET (00:52 GMT)

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