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April 3, 2007 > Mutual funds manage gains in 1Q

Mutual funds manage gains in 1Q

By Tim Paradis

NEW YORK (AP), Mar 30 _ Mutual fund investors who avoided panic when volatility strode back onto Wall Street in recent months managed decent if decidedly smaller returns for the first quarter.

Returns from mutual funds concentrated in natural resources stocks and utilities far outpaced those in other areas, but most mutual fund classes showed gains for the quarter. Financial services funds and funds that bet stocks would fall, known as short-bias funds, were laggards.

The 7,977 U.S. diversified stock funds tracked by Lipper Inc. showed an average preliminary return of 2.1 percent for the three months ended Thursday. The final trading session of the quarter was Friday, when major stock indexes were little changed. Collectively, the funds' assets rose to $3.82 trillion from $3.74 trillion at the end of 2006.

By comparison, the Standard & Poor's 500 index rose 0.18 percent during the first quarter. The S&P 500 total return index, a preferred measure by the industry because it includes dividend appreciation, was 0.64 percent. The Dow Jones industrial average, made up of 30 blue chip stocks, fell 0.87 percent for the quarter.

In any case, the pace of Wall Street's advance slowed markedly from the fourth quarter, when diversified equity funds produced an average return of 12.9 percent.

``Over all, it was a decent quarter,'' said Lipper analyst Jeff Tjornehoj. ``We certainly had a lot of momentum at the beginning of the year and that dropped precipitously at the end of February with problems in China. Since then it's been rather sideways,'' he said.

Investors who didn't rush to perceived safety in large capitalization funds did better in midcap and smallcap funds.

Multicap funds showed returns of about 4.3 percent to 4.4 percent, depending on whether they targeted faster-growing companies or those more established companies that might pay dividends. Smallcap funds saw gains of about 2.5 percent to 3 percent. But large cap growth funds showed 1.02 percent return and largecap value funds turned in 1.01 percent.

In years past, smallcap funds had often showed stronger returns than largecap and midcap funds.

``Investors are coming to the conclusion that smallcaps are probably at their at their zenith right now,'' Tjornehoj said.

``Certainly if the U.S. economy were to suddenly shift into a lower gear then we would see a sharp turn into large caps. That doesn't seem to be on the horizon. Instead we're looking at a mildly slowing economy.''

Largecap stocks and the funds that invest in them are often regarded as defensive because such companies tend to have international operations that can perhaps better withstand economic changes and can get by on thinner profit margins.

Investors did seek some defensive positions during the period. The quarter saw a broad selloff on Feb. 27 that began with a drop of nearly 9 percent in the often-volatile Shanghai Composite Index. The global rush of sell orders that day shaved more than 3 percent off the major U.S. stock indexes. Though stocks eventually made up much of the lost ground, volatility returned after keeping a low profile for much of the second half of 2006 and into the first part of 2007.

``Volatility reared its ugly head,'' said Brett Hammond, managing director and chief investment strategist at TIAA-CREF, a financial services organization that managed more than $406 billion at the end of 2006. ``We had quite a long period of relative calm. Some bumps and grinds around the world began to make people feel they needed to do some repricing of risk.''

``I don't think it was a change in fundamentals. I think perceptions changed.''

Funds that invest in utilities, whose business models often bring steady cash flow and dividend payments, as well as natural resources stocks showed strong gains. First-quarter returns for utility funds totaled 8.15 percent and came in at 6.86 percent for natural resources funds.

``There is a reason to think investors were shifting into utility funds because they thought those fantastic number on real estate funds were starting to peter out,'' Tjornehoj said. He noted, however, that investors weren't dumping real estate funds; utility funds remain about one-fourth the size of real estate funds.

Real estate funds showed a 2.26 percent return in the first quarter.

Financial services funds showed a negative return of 1.76 percent on average, perhaps reflecting jitters over a possible downturn in the economy and on Wall Street. Financial services companies make money from hefty trading volumes and draw fees from advising on mergers and acquisitions.

In addition, some of the funds could have met with the ire of investors upset about a possible implosion of some subprime mortgage lenders, which make loans to people with poor credit.

High-profile troubles for subprime lenders such as New Century Financial Corp. and Fremont General Corp. could have weakened financial services funds, observers say.

``The subprime market has been getting a lot of attention recently and the area that seems to be getting hit by that is financial services,'' Tjornehoj said. ``Certainly not every financial services fund is going to have exposure to subprime lenders but they all seem to be getting hit at the same time by investors.''

He said the average decline among financial services funds for the quarter seemed like a ``slap on the wrists'' given the possible scope of the problems among subprime lenders.

And funds that employ short selling, or betting stocks will fall, posted a negative return of 0.42 percent.

Hammond contends the end of a quarter that reintroduced more normal levels of volatility brings opportunity for investors.

``Long term investors want to make sure they're not panicking,'' he said.

``If you haven't looked at your portfolio for a while you may want to reassess it.''

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