Posts Tagged ‘growth’

The lagging small cap category this year has been the small cap growth category. At the Mutual Fund Site, we decided to take a quick peek at a fund that fell into this category and like the top performers we examined last month, the Marshall Small-Cap Growth Fund (MASCX) is an above-average fund. Rated at four stars by Morningstar, it is considered one of the better performers in this category.

Small Cap Growth funds have been lagging behind Small Cap Value and Small Cap Blend funds on a year-to-date basis

In looking at the risk adjusted rating, this fund hold the coveted 5-star rating for its 5 year performance record, which should not go unnoticed. Not surprisingly, the latest management addition happened in 2007, possibly a large contributor to the fund’s 5 year rating.

Another note about management is that the previously high turnover was noticed by Morningstar in 2009 and mention was made. Ironically, the same author noted caution about the fund in 2009 (due to turnover) but less than 1 year later made not of how the “fund is making a name for itself.” More on this later.

One of the things that we feel is most important to a fund’s long-term track record is its underlying portfolio. With the Marshall Small Cap Growth fund, 38% is in small cap securities, another 38% is in Micro Cap securities and the rest is in mid-cap securities. This spread of risk is important because it ensure the right balance, particularly in periods of heightened volatility. We like this kind risk mitigation for a small cap fund; the spread is nice, but there does seem to be enough money invested in mid cap securities that one might question whether the manager is comfortable with the small cap sector in the first place. Why so conservative?

Digging deeper, however, we see that nearly 19% of their assets is invested in Healthcare; followed by 13% in IT Hardware and lastly they have just a little less than 12% in Telecom. The risk in these sectors may be enough to point to that heavy mid-cap presence and get the justification one needs.

With just 82 stocks under management, roughly 28% of their holdings are in the top 10 holdings. Their biggest holding, Energy XXI (Bermuda) Ltd., is an energy play; Ebix Inc. is a software play (number 3 holding) and Heckmann Corp is a financial play (number 6). Let’s look closer at these holdings:

Energy XXI (Bermuda) Ltd (4.52%)
This is the fund’s largest holding. It is also one of the top contributors as far as the fund’s returns go. The interesting thing with Energy XXI is that it reported a loss for 2009 of over 1/2 Billion. Since then, their revenues have been a lot more promising, enough so that the analysts polled by Thompson/First Call have a hold rating on it (recently, analysts have been a little more bullish on the stock).

The biggest problem facing this company is its liquidity. Current assets are insufficient. However, their property holdings conrtibute considerably to their overall positive equity position and the stock price speaks for itself. We would not be surprised if Marshall (which also owns this company in its Mid Cap fund) starts to trim their position, especially after the run up it has experienced on a YTD basis.

Ebix, Inc (3.22%)
This number 3 top holding is a software play. This company focuses on helping insurance companies with their management of independent agencies, policies, administration and claims management processes as well as accounting, reporting and rating tasks.

This stock has skyrocketed in 2010. Currently trading in the $15 range, this stock has been as low as $1. (That is not a typo). Likewise, it has been as high as $51. A recent share buying announcement, increasing revenues on annual and quarterly basis as well as positive analyst opinion will certainly continue to drive this stock price upward.

Heckmann Corp (2.6%)
One of the worst performers in the portfolio with YTD returns of -19%, Heckman is the fund’s 6th largest holding. Although it is officially listed as a “financial” company, this company is actually a holdco for China Water and Drinks and Heckmann Water Resources. Both companies are involved in the delivery and transportation of water (like an oil pipeline, transport company, shipper, etc., except water).

Although this company has been losing a tremendous amount of money over the past 2 years, its concept remains sound and with greater demand for water, it may actually have a viable business model. Of course, the two analysts that cover this stock rate is as a buy and the firm not only has a ton of cash on hand, but virtually no debt whatsoever. In other words, it is a strong, viable company.

Our biggest beef with this holding is that the stock does not move all that much, thereby limiting potential gains. This could also be a selling point in that, as a top holding, its relative stagnant levels can provide stability to an otherwise fairly volatile portfolio (standard deviation is over 25%).

Overall, we like this fund. It’s low entry level, its low fees and decent Beta (at 1.1) suggest a medium risk investment (Morningstar rates it this way as well, giving it an “average” rating for risk and an above average rating for returns.

Provided that the fund remains closely managed, it could very well fit in a portfolio for someone with an apetite for volatility with the potential payoff of good returns.

The small cap growth category is an interesting one. Since small cap mutual funds are an interesting breed to begin with, investing in small cap growth funds implies less risk in a category that is abundant with risk anyway. The Wells Fargo Advantage Small Cap Growth fund illustrates just how it can be that a small cap fund can be less risky than others in its category.

The Wells Fargo Advantage Small Cap Growth fund illustrates how you can have less risk in a category that has an abundance of risk.

Starting with rates of return, the Wells Fargo Advantage Small Cap Growth fund has outperformed the Index every year since 2003 except in 2008. It has outperformed its category every year since 2003 except in 2008. And up to April 30, 2010, it has also outperformed. Each year’s performance has deviated wildly from the Index, meaning that in all but one year, it provided exceptionally greater returns than the Index and Category.

The reverse is true for that one year, in 2008, when it underperformed.

Yet on a 10-year basis, Morningstar considers the fund’s returns as just “average.” (Overall, and its 3 and 5 year returns are considered Above Average, High, and High, respectively).

Wells Fargo Advantage Small Cap Growth has taken a clear position with its portfolio make up.

When it comes to this small cap fund’s portfolio, it is evident that this Wells Fargo fund has taken a clear position in certain securities. With just 104 stock holdings, the fund can be considered average in its size. With 69% of its total $ under management invested in Small Cap, this fund has remained true to the Small Cap Growth sectory. The fund also invests 21% in Micro Cap and another 10% in Medium cap securities to round out the portfolio.

Most small cap funds that we have seen this month have spread the risk equally among different sectors. Wells, on the other hand, is pretty deep into Business Services with 23.6% of holdings. The second largest sector is Healthcare at 16.8%, and the third largest is Software at 11.3%.

In terms of individual holdings, the Fund’s Top 10 (22.4% of total holdings) consists of just one Business Services firm, one Healthcare firm, two software firms, and three Consumer Services firms. Interesting approach, one that has worked well for the fund.

The three top picks we will examine are GSI Commerce, Gartner Inc., and Live Nation.

GSI Commerce (2.97%).
At nearly 3% of total holdings, GSI represents a fairly significant holding. So what does GSI do, exactly? Well, it creates and operates over 100 e-commerce websites for retailers, manufacturers, entertainment companies, etc. It earns revenues from sales made through these sites, earning a commission for each transaction. This business model has proven profitable. This company has earned 3 years of consecutive year-over-year growth. This company also generates good cash flow that is nearly 3 times greater than it was previously. As a “Software” company, there is little reason to question why GSI makes up such a large percentage of the fund’s total holdings.

Gartner, Inc. (2.62%)
Gartner provides analysis and forecasts for IT planning for companies that would prefer to outsource this task. Overall, they provide a valuable service, mostly to chief technology officers and chief financial officers to help budget for IT programs. However, with the economic slowdown, such services have not been in high demand. With that said, Gartner has been able to maintain a relatively stable revenue level as well as maintain their equity level. For firms in this space, Gartner is definitely the one to own.

Live Nation (2.08%)
Live Nation is the sixth largest security holding in the Wells portfolio. Considered Medium Cap, Live Nation is the world’s largest event host, owning booking rights to over 155 venues. The company generates revenues in excess of $4 Billion. However, the past few years have seen net losses to the tune of $350 million in 2008 and $7 million in 2009. With such a strong equity position, the company is likely to recover nicely once the economy gets back on track.

The top holdings outlined above are pretty strong, although some uncertainty is worth noting on the Live Nation holding. Overall, the Wells Fargo Advantage Small Cap Growth fund has certainly invested a lot of attention in picking its top holdings. This small cap mutual fund, while lower in risk overall than many others surveyed here at the Mutual Fund Site, would be best suited to a growth oriented investor who refused to hold value equities and who needs to fill a somewhat larger gap (say 10% to 15%) in their equity space and needs a small cap fund to achieve that.

There is a difference between investing in China and investing in China’s growth. This is a careful distinction that a lot of investors fail to make, yet it is a necessary one if one is seeking to profit from the undeniable growth that the Chinese people are expected to enjoy in the years to come.

Investing in China

The act of investing in China is the same as investing in domestic companies. The process involves narrowing down a large field of potential companies and ideas to a handful of prospects and then digging even deeper to determine whether that company meets fundamental basics to earn your investment.

These fundamentals would include such things as an appropriate equity level, satisfactory growth rates, margins and so on. The key difference is that such companies are actually based in China, so our everyday experience with them would be virtually non-existent (compared to investing in, say Wal-Mart or Ford or Apple, etc.).

Another key disadvantage to investing in foreign companies is that most people are unfamiliar with their political alliances, which becomes increasingly important in countries like China. To make an investment in a Chinese company, one should understand their political standing and how that bodes for their future growth and sustenance.

Investing in China’s Growth

In contrast to the above, investing in China’s growth is quite different. This involves taking positions in domestic companies that have the potential to profit from China’s growth. For example, companies that outsource key manufacturing processes would fall into this category. Such companies will be able to reduce their cost of goods sold (manufacturing costs) since labor in China is at a discount to domestic labor.

Another example would involve companies that are positioned to enjoy part of the expected growth in the middle class. This class historically creates a deeper demand for certain products and services, such as discretionary and luxury goods. Companies that have been allowed to establish a presence in China obviously stand to benefit from this and could offer great investment potential as well.

Summary

It is unquestionable that China is set to enjoy an aggressive growth rate in the years to come. Positioning one’s portfolio to take advantage of this growth is a little more complicated — does one invest directly in companies that have little relevance domestically and operate in a foreign political climate, or does one invest domestically in companies that have taken the steps necessary to enjoy part of this aggressive growth?

As often happens, the question becomes one of risk tolerance and investment knowledge. Knowing that there is a difference between the two surely helps.

In an article published at Bloomberg.com on March 18, 2010, it was noted that bonds issued by financial services firms like JP Morgan and Credit Suisse in particular came with rates that were substantially higher than rates in the general market. What this means for mutual funds and growth funds in particular is that there is plenty of opportunity in the financial services sector. Let’s take a closer look.

The Bloomberg article in questions makes it quite clear that the debt sold by banks, brokers and insurers returned 0.81% compared to the broader market’s return of 0.48%. This is a premium of more than 80% over what the broader market dictates. Consider this for a minute as we explore another interesting comment that was made in the article in question.

Brian Machan, a money manager at Aviva was quoted as saying that very few people are “underweight” in financials. This means that mutual funds are heavily buying up this debt. They are doing it because it looks attractive. The reason it might look attractive is that the yield is expected to drop, thereby increasing the value of those bonds on the open market.

The flip-side is that the financial services firms issuing this debt find rates attractive. This means they expect rates to increase in the future, allowing them to finance debt at today’s currently low rates. All indications support a rising interest rate environment; if ever there was a time to issue corporate debt now be that time (to the benefit of the borrower, that is).

Now, getting back to the premium paid by these financial services firms. Consider why they might need to raise this type of capital. It is cheap. Plus it helps finance a whole lot of plans. These banks have something up their sleeve and it is just around the corner by the look of things.

As far as growth funds are concerned, the mutual funds that are bullish on financial services such as the Ivy Small Cap fund we wrote about already or the Dryden fund we bragged about earlier, send a strong message to the investment community: financial services stocks are expected to outperform. This sure seems to be supported by the level of debt they are confidently raising right about now.

Other growth funds that invest heavily in financial services stocks include the FBR Small Cap Financial fund which has a history of LOW risk and above average returns. Morningstar rates it as a 5-star fund! Like the Ivy Small Cap fund that we touted as our Top Small Cap Pick for 2010, the FBR fund has a large interest in Iberiabank and East West Bancorp, regional banks that stand to substantially benefit from a positive shift in the economy.

Regardless of what type of mutual fund you choose, ensure that your growth funds have at least some exposure to the financial services sector. Whether they are smaller, regional financial companies like those held in the IVY or FBR mutual funds or larger banks like JP Morgan and Credit Suisse, the indications are quite clear that these firms expect to reap the profits and rewards of an economic turnaround that is just waiting to happen.

In order to achieve long-term growth within your mutual funds portfolio it is believed you will need to incorporate a fairly significant amount of equity or growth funds. While this certainly seems to be a valid argument based on historical rates of return and the difficulty associated with accurate market timing, not all investors need to have a portfolio that consists entirely or primarily of growth mutual funds.

For highly risk averse investors, loading up on growth mutual funds would obviously be imprudent and no financial advisor, tenured or otherwise, would ever recommend doing so. But imprudent would also be ignoring the growth asset class entirely.

Now there is a way for investors to ensure that they eliminate equity risk in their portfolio, even while investing in the wildest, highest of high risk equity funds. They do this by finding a guaranteed investment, whether it is a quality bond, term deposit or other virtually or entirely risk-free investment and working out how much interest they will earn over the time horizon of their investment.

Let’s take a closer look at an investment that pays 5% per year. If you had $10,000 in total to invest and you wanted to make sure that it was guaranteed over ten years, you could actually invest $3,860 in high risk equity mutual funds that could return whatever the market allows. The remaining $6,140 would earn 5%.

But regardless of the performance of those equity funds, the remaining $6,140 invested in that guaranteed or extremely low-risk investment at 5% would be worth $10,000 after ten years. This allows you to invest $10,000 today and enjoy absolutely no risk at all. The catch? That you wait 10 years without touching the $6,140.

The worst-case scenario would see the equity mutual funds worthless after 10 years. The best-case scenario is that the return is greater than 5%, leaving you with more than if you invest $10,000 in its entirety in the guaranteed 5% investment. Realistically, you should expect a higher return. Even a 7.5% return on the equity fund would bump your portfolio’s performance from 5% to a little over 6%.

Might not seem like a lot, but 7.5% over 5 years is really a lower-risk equity fund. And, really, the point is not so much that you are now outperforming your friends, but that you are achieving that performance without any risk at all to your capital.

As one of the BRIC nations (Brazil, Russia, India and China), China represents a huge opportunity for investors with nerves of steel and a risk tolerance that most people would love to have (particularly when it comes to alpha-male poker tourneys). When it comes to mutual funds, legendary manager Anthony Bolton has come out of retirement specifically to head up a brand new, China-based mutual fund for one of the leading fund companies in the world – Fidelity. So what does that tells us regular folks about the merits of China insofar as growth funds are concerned?

For starters, it confirms the global opinion that China certainly presents a huge investment opportunity. This is not simply a North American view (Bolton is, or was, based out of the UK and his track record from 1997 to 2007 with Fidelity’s Special Situations Fund speaks for itself). But investment field aside, all industries are a little nervous about China. Why? Because of what will happen as their economy grows.

See, as China’s economy continues to grow, the financial demographics of their population will shift. There will be a growing middle class, regardless of what naysayers might preach about the socialist possibilities of their government. There is already evidence of this as Chinese workers outsource their skills to the world through the internet and other legitimate venues. In addition, China is one of the world’s largest student’s of the English language. It is estimated by People Stream that as China becomes the world’s largest English-speaking nation, the market will increase by 300 million possible employees. Even at 1/2 of the salary (this is being generous) of North American employees, Chinese candidates present a huge cost savings for companies that need English-speaking individuals. (You can view their 5-minute YouTube presentation here). For the Chinese, this translates into a growing middle class with growing middle class wants and vices. Even if the naysayers are right and a “socialist” government controls Chinese markets when they cannot control the inflow of wealth, they may be able to control where that wealth is spent. Regardless of whether there is much control, a lot of that wealth will be spent in China, allowing Chinese companies to see a long road of prosperity ahead of them. And that is as of today! Not five years from now, but right now.

Some of the risks to investing in China are well-known already. They include poor transparency in terms of environmental controls. Poor transparency in terms of financial reporting. They include a currency that the government will not allow to fluctuate on the free market (it is pegged to another currency, the US dollar). These are all risks; an investor might find a great Chinese company one day only to find that it has not made a dime or was bankrupt or presented inaccurate financial records or was penalized for not having the right government contracts and so on and so forth. In other words, it could be gone within a matter of days… These are real risks with investment in China.

By holding a growth fund with a China focus, investors would hope that the mutual fund manager has done his or her due diligence. Some funds, however, will not do this properly, they will not visit the company or do more than analyze the figures. There could be more risk with funds with low assets under management than larger funds with enough of a capital base to fund such trips to China. The bottom line is that investors should approach these types of investments with a great deal of caution. They should understand the thinking behind the fund itself and should be comfortable with the management team. With such things out of the way, investors looking to enjoy long-term growth will surely be rewarded.

The idea of using the yield curve to forecast the future of the economy is nothing new, not to mutual fund managers anyway and particularly not for people who are interested in, investing in or working for bond funds. It is an essential ingredient to cooking up the right investment management strategy for the quarter and year to come. But what can the yield curve tell people about other types of mutual funds, like growth funds, dividend funds and, gasp, small cap funds?

The idea that the yield curve is relevant only to bond investors is silly.

In fact, the yield curve can tell investors a lot. At the Mutual Fund Site, we believe that the Yield Curve can help confirm or refute areas of perceived value. And small cap mutual funds are potentially one area of great value. Why? Because even after a strong equity market that showed tremendous leaps of recovery in 2009, small cap shares remain somewhat unattractive. In fact, the average small cap growth fund will have returned -7.29% over a 3-year period as of February 11, 2010, while the average large cap growth fund returned -5.29 over the same period. The same story is told in the small cap blended and large cap blended categories according to Morningstar.com, but when looking at straight value plays, the opposite is true: small cap value funds have performed better than their large cap counterpart.

At any rate, what does the yield curve tell investors?

According to the definitions provided by Smart Money, the normal spread between 3-month Treasury Bills and 30-year Treasury Bonds is 3%. When the spread is greater than that, investors are signaling that they believe that the economy will improve quickly in the future. Long term investors become nervous that they will stay locked in at currently low rates (sounds familiar) and demand higher returns on their capital. According to the traditional definition, the yield curve is currently steep, as demonstrated by data available at Bloomberg.com.

How does a steep yield curve help small cap companies?

Well, small cap funds historically perform very well after a recession. That is because larger companies as well as retail consumers are more willing to try out the small guy. They can “afford” to experiment a bit. This could mean buying a home from a small-cap builder, using technologies developed by a small-cap company and so on, whereas in the past they have kept a close eye on their budgets and stuck to well-known, established providers who might have even undercut their small-cap competitors.

Additionally, as the economy improves, large cap companies that have been able to finance their survival through the recession may find themselves paying more for the money they borrow, particularly if they borrow on floating rates such as LIBOR or some derivative thereof. Small cap companies in comparison have been shut out of the credit system as lenders and capital sources became increasingly nervous about where they lent their money. So while larger companies juggle higher debt payments smaller companies will not have as much debt to worry about, resulting in lower debt/equity ratios which in turn means stronger financial statements.

Lastly, based on the above, small cap companies stand to enjoy grater profit margins. With less overhead, less debt, and more money flowing into their companies, small caps will seem “stronger” financially than their large-cap counterparts. Of course, this depends on the measures being used but with stronger profit margins and a conservative fiscal policy, small caps will be able to retain those earnings and build their equity base quicker (in percentage terms anyway).

The Yield Curve tells us this. It tells us that since December 2008, the outlook on the economy has been steadily improving to the point where it is at today (February 11, 2010) with the spread between 3-months Treasury Bills and 30-year Treasury Bonds greater than 3% (it is at 4.57% in fact). And the trend suggests this spread will only widen, meaning that small cap mutual funds a touch more attractive right now than their growth fund counterparts.

Note: we recommend that you speak with your financial adviser before investing in higher risk mutual funds such as small cap funds.

One of the most e-mailed op-ed columns in the NY Times was published on February 1, 2010… a few days after the Mutual Fund Site released its write-up on the Dryden Financial Services Fund, a mutual fund that has a strong reputation for its investment management prowess and stunned investors with staggering returns in 2009.

Why is this important and why should you care?

Let’s take a look at the column in question. In it, Nobe Prize winner, Paul Krugman describes how the Canadian banking system, which was coincidentally modeled after the first American secretary of Treasury, Alexander Hamilton, is remarkably the soundest system in the world (versus the US system at 40th). More specifically, Krugman points out that the banking reform currently pushing its way through the system will substantially Canadian-ize the domestic banking system.

In addition to the obvious statements by Paul Volcker (who advocated in early 2009 that his vision for the banking system “looks more like the Canadian system…”) and those by President Obama (let’s not get started), it seems that the US banking system may some day soon resemble Canadian system.

This is key, and also brings us to the importance of the publication dates for these two pieces. Less than a week prior to Krugman’s op-ed column, the Mutual Fund Site gave “top marks” to the Dryden Financial Services fund. And guess what makes up their core holdings. That’s right, Canadian banking stocks.

More than 11% of their meager $162 million under management is invested in Canadian banks. In fact, three of their top 25 holdings are Canadian banks, all of which have among the lowest P/E ratios in the fund’s top 25. What makes this interesting is that the Dryden Financial Services mutual fund has outperformed, by a long-shot, the S&P 500 as well as its peers in the last year, proving that their investment management strategy and, most importantly, their attention to detail has really paid off. Some of this might have to do with the Canadian banks’ ability to maintain dividends and, in many cases, increase those dividends. If bought at the right time, some of those yields would have exceeded 8%. Still, even with an 8% dividend yield, another 60% in return had to come from somewhere…

Does Krugman’s popular piece provide support for investing in a mutual fund like Dryden’s? Not necessarily, although it certainly provides some credibility to why we, at the Mutual Fund Site, gave Top Marks to the Dryden mutual fund. More importantly, given the amount of attention the New York Times piece has attracted, it seems that, if governments start modeling their financial services firms after the Canadian system, and it seems they will, Dryden could see some good, long-term growth provided their investment management team and strategy remains intact.

It seems that any time positive news comes out about the state of the economy, growth funds and small-cap funds in particular get a nifty little boost in value. It stands to reason, of course, that as the markets react to such positive news, so too should mutual funds. But what mutual funds stand to benefit most? This is a question that a lot of investors, like those who want to know where to invest $20,000 or so, have.

Homebuilders
One area that gets a nice boost (or gets tanked) every month relates to the housing market. Since this sector was blamed for many of the problems relating to the latest recession (if it was not the bank’s imprudent lending practices, then it was housing for its hyper-inflated values and the subsequent flooding of inventory), it makes sense that housing stocks will be particularly, positively influenced by positive news for the sector.

For example, on February 2nd, positive news about housing  had the impact of bumping one particular housing company’s stock price by as much as 10% in the session. Other related shares got a nice boost of no less than 5%. A nice little return, wouldn’t you agree?

Risks
The risks with such big moves is twofold. First, this has the effect of increasing volatility for these types of shares, making them more difficult to trade individually. An investor needs to exercise displine to realize the gains he or she wants and not stay in too long; otherwise, they will record an immediate loss.

What Mutual Funds Own Such Stocks?
The best way to find the funds that invest in these types of sensitive shares is to visit Yahoo! Finance and search under the security’s Major Holder’s section. This gives a fairly accurate snapshot of what companies are owned by what mutual funds.

In the case of housing stocks, Vanguard has taken a fairly large interest in several of the housing stocks in its Small-Cap and Mid-Cap funds. It makes sense. Housing continues to be out of favor and these types of out-of-favor stocks are often what turn regular investors into astute investors.

As well, housing is one of those areas that will need to improve before the rest of the economy improves. That means that it is quite likely that the sector could receive a boost through some type of government incentive that sees people buying more and more houses and in the interest of keeping people employed (or hiring more people back), some of these incentives are likely to incent or at least benefit the homebuilders. Vanguard has taken an interesting approach (among others).

Does this suggest that mid- and small-cap mutual funds is where to invest $20,000 (getting back to that question)? Probably not for the whole $20,000. But 20-25% of an aggressive portfolio that can benefit from a mid- to long-term investment period, sure… no, absolutely. In fact, they can be expected to easily outperform growth funds held for that same period.

Choosing the right growth funds for 2010 is not an easy task. Normally, this might not pose such a problem because growth funds tend to perform over the long-term, unlike some other mutual funds which perform better at certain times in the year or economic cycle. But after a fairly remarkable 2009 to follow up the turbulent credit-crisis-inspired 2008 and 2007 years, 2010 has provided something of a wake-up call to most investors.

2010 has provided something of a wake-up call.

In fact, most growth funds opened the year with an average return of -2.55% (that’s right, a negative!). And most of the best-ranked funds have returned even less.

What this tells a lot of investors is that growth funds not only have to be held for roughly 5 years in order to realize the type of returns one has come to expect of such funds. But that’s not all. In fact, the stuttering start to the year has led even the highest paid and most respected portfolio managers to wonder whether there is more bad news to come. In an interview with Morningstar, Rudoph-Riad Younes of Artio International Equity claims that by bailing out the banks and not letting them fail, government have simply delayed the inevitable. In that same piece, Oliver Kratz of DWS Global Thematic commented that his fund has taken a less aggressive position globally, investing as little as 10% in one of the hottest economies of the world, China.

One of the only growth funds we could find that outperformed the average, the Monetta Young Investors Fund (MYIFX) which has been managed by Robert S Bacarella since the fund’s inception in 2006, holds a five-star rating from Morningstar. In digging deeper into its portfolio, it seems that Mr. Bacarella has taken to domestic securities as well. Where has he invested? Consumer Goods and Consumer Services with Apple Inc. Wal-Mart, Proctor & Gamble and McDonald’s ranking among their Top 25 holdings (they actually only hold 25 securities). Many of these are the same securities that Younes and Kratz cite in the Morningstar article, hold in their respective funds or they belong to sectors where these two managers invest heavily.

What does this tell investors looking at growth funds this year?

It could be that funds investing in domestic, large-cap securities are part of a growing crowd of institutional investors who believe that there are plenty of risks that are expected to materialize outside of the domestic, North American markets. Does that put global growth funds in the penalty box? It certainly seems that is the message for 2010.

So where should investors put their money? What growth funds are expected to perform in 2010?

Unfortunately, that will be a topic for another day, but the underlying message here is this: even growth funds have a tough time deciding where to invest. So if you have the courage to pull the trigger on investing, remember a couple of things:

• Invest regularly if you can — ten monthly contributions of $1,000 each will average out your $10,000 investment.
• Stay the course — stay invested for a period of 3-5 years (preferably 5 years as the performance on nearly all of these growth funds really starts to shine after 5 years).
• Choose funds that you believe in. Right now, you might believe in a high concentration of domestic securities (the big mutual fund managers seem to as well) but don’t pick a fund that must, by virtue of its Investment Objective/Statement stay invested this way.

This is certainly one area that needs further exploration and we will get into what we believe will be characteristics of the top growth funds in 2010 within the next 30 days.

If one were to look at high return investments, there could be a couple of places one might look. Growth funds might be an obvious starting point, but is quite likely too generic a field to find something with true, high returns. In most cases, one will have to resort to specialized fields. Over the past three years, such a specialized field might have been gold and other resources. Just prior to the recession – agriculture. And prior to that – real estate. But Fidelity’s Select Medical Equipment and Systems has not only been one of the most steady mutual funds over the past 10 years but also one of the best high return investments.

As the name suggests, the Fidelity Select Medical Equipment and System mutual fund is a mutual fund focused on the medical equipment and systems arena. As far as growth funds go, however, this niche mutual fund has been a top performer among other growth funds, having tripled investors’ investments over the past 10 years. Compare this to the S&P 500 which has yet to return your original investment (as of January 28, 2010).

So that begs the question: what makes high this particular mutual fund so special

Well, with $1.3 Billion under management, the fund is quite large. However, it has not allowed its size to get to its head and holds a fairly tight portfolio of just under 60 securities, all of which are somehow related to the healthcare industry. In terms of investment style, the fund does not follow the others with just one or two choice deviations. In other words, it does not list list GE shares as a top holding. In fact, this top performing mutual fund is considered a mid-growth fund according to its investment style; its holdings are mid-cap and are considered growth investments (versus value investments). From a percentage-of-holdings viewpoint, though, the largest exposure is to large-cap securities; with a fairly substantial exposure to small-cap securities (roughly 10% of its total holdings) the overall investment style gets bumped downward into the mid-cap range.

The impact of this mutual fund’s investment style is that risk is marginally above average (yet is not considered high risk). This has no double allowed it to achieve above average returns over the past 3, 5, and 10 years. With the protection offered by large-cap holdings combined with the growth potential of small- and mid-cap securities, this fund has steadily outperformed the Index with the exception of one year… 2006.

The fund’s largest holding (at 14% of the portfolio, this is a big gamble) is Covidien PLC, a company that touches commercial, institutional and retail markets. Over the past year, it has added 33% to its stock price, itself a nice a return. Less than a week ago, Piper Jaffray upgraded its view on this stock to Outperform; the mean rating is a mildly strong buy… and that can explain why Fidelity has gotten in deep with this security.

Do these stats really qualify the Fidelity Medical Equipment and Systems fund as a one of the best high return investments on the market?

Well, that really depends. For investors looking to get an edge without having to take a scary amount of risk, then of course it does. With a fairly low Beta (0.76) and returns that outpace the market’s, this is one of those growth funds that makes achieving great investment returns look easy and stress-free.

But for investors who want continual mid- to high-double digit returns regardless of risk, then maybe this is not one of those high return investments. Can we suggest real estate funds? Commodity pools? A Gold bear-ETF? Even then, what are the risks and are they worth the potential returns?

See you can say just about anything that gives a 50% return is a great investment, but when you factor in risk and consistency, is it really?

That is where this fund differs and why we think it is one of the best high return investments for those with courage. High returns, marginally above average risk and a history that speaks for itself. If you’ve got $2,500 available to add diversification and a bit of specialization to your growth funds portfolio, consider the Fidelity Select Medical Equipment and Systems fund.

Growth funds are something of a sub-asset class when it comes to your overall asset allocation model. In most cases, growth funds are part of the equity holdings, but depending on your income class profile there could be a growth component to the income class as well. In the case of the income glass, growth will normally come from investing in higher-risk bonds or discounted bonds. These bonds will experience growth in periods of declining interest rates or at maturity when the bonds mature at face value.

In most instances, growth will come from capital appreciation in the value of an equity security, most often a stock. And this is typically how equity class growth funds operate – they will hunt for equities that have demonstrated long-term growth trends or potential. In many cases, growth funds will target stocks in high growth fields such as technology, bio-technology and developing technologies. However, since such industries are often speculative, so too can the investments be speculative.

As such, growth funds can be further categorized into sub-categories such as Large Cap Growth Funds which will invest primarily in securities that have a large market capitalization. These types of growth funds will have a slightly different approach and often a less aggressive investment objective. In most cases, the securities owned by the fund will be larger companies (such as Apple in the case of technology or General Electric in the case of emerging technologies) with strong balance sheets and heavy investments into longer-term, emerging technologies.

In some cases, growth funds will be “laser-focused” on an industry or sector. In the example above, this could mean the technology industry or, in less generalized terms, say the water-purification technology industry. This means that the fund might invest in a blend of large or small cap equities.

And in some cases still, some fund managers will target growth regions of the world. In the latest market bubble, many funds jumped on the “BRIC” nations which showed tremendous growth potential. These nations were Brazil, Russia, India and China. Even after the economic slowdown, many funds remain invested in these regions because of their perceived growth potential.

In other cases, growth funds will take a more general approach and simply invest in equities that show growth potential. In such cases, the fund can diversify across all market capitalization areas as well as across the different industries and sectors and geography. Normally, such broadly focused growth funds are larger mutual funds that merely aim to exceed the index performance.

Generally, growth funds make up a special area of the equity class of investments. Their primary focus is capital appreciation through growth rates that are expected to be greater than growth in other industries/sectors, similarly sized market-capitalized equities, or different geographical areas. Determining what makes a smart growth investment is often a subjective task that relies rather heavily on the skill and astute observations of a keen portfolio manager or analyst.