The fact that mutual funds investing in small companies have been lagging the rest of the stock market for the past year prompted me to recall the situation back in 1999. That year marked the swan song of the dot-com boom. Small cap value funds earned zero for the year while Large Cap Growth funds averaged a 60 percent return. The Janus mutual fund company, which offered a number of successful growth-oriented funds, was capturing over one-third of all the new money invested in the entire mutual fund industry. Investors lived by the axiom, "If it’s worth doing at all, it’s worth doing to excess."
The following year, 2000, Large Cap Growth funds lost 30 percent and Small Cap Value funds gained 30 percent. It marked a 60 percent flip flop between the two diametrically opposed corners of what is known as the "style box." The latter term refers to the nine-box grid that describes the basic investment styles as "Value, Blend and Growth." Value companies are those that borrow less money and pay dividends while growth companies reinvest what otherwise would have been profit and borrow as much as they can get their hands on. Blend is obvious. These three disciplines are then applied to Large, Medium and Small companies resulting in a square with nine boxes or "styles" of investment.
The small cap value sector continued to earn total returns of 20 percent per year for the next three years while large growth companies experienced further losses until starting a gradual recovery. Other investment types, considered to be "out of the box" included funds investing in Real Estate Investment Trusts. This group also earned zero in 1999 but then began a run of 20 percent annual returns for the next several years.
Since history repeats itself, I thought about how annoyed I was back in the early 2000’s when I had failed to capture some of the gains that had come so easily in the second half of the 1990’s. Over one year-and-a-half period, the market had risen almost 40 percent. In those days, most investors thought they had become geniuses. We confused brains with a bull market.
Rebalancing and allocating money into the small cap "loser" as the broader market climbed during the nineties would have offered some smug satisfaction when the implosion took place. Rebalancing does not mean timing the market. It’s just an exercise of taking some of the chips off the table from winners and adding them to fund types that are lagging from year to year.
Considering the sustained rise in market values since 2009, enhanced by the lack of even a minor (10 percent or more) correction since 2012, it feels like now might be time to do something constructive. As an example, one place to start would be to trim whatever we might have had invested in one of the stars of the past five years --- Health Sciences mutual funds. As a group, funds in this category have eclipsed the rest of the market with returns of approximately 30 percent per year for the past three and five-year periods. They are the current boom’s equivalent of the growth funds of the 90’s. Even if we don’t own a health fund specifically, we have benefited elsewhere in our portfolios from the rise in value of drug companies in general. And drug companies represent about 90 percent of the largest holdings in health funds.
We hate to sell our winners --- even small amounts of them. It’s especially annoying when winners defy gravity and continue to rise --- like healthcare funds have done. But seasoned investors have the discipline to bite the bullet and rebalance assets periodically so that the decision-making becomes mechanical rather than a misguided attempt to second-guess future events. Instead, let second grade arithmetic do the heavy lifting. Review what’s in a mix of investments and compare with an old statement from a year or so ago to rebalance back to the original proportionate percentages of the investment types in the portfolio. The net effect will be to have accomplished something constructive without having to be an investment expert.