Now what happens?

Kiplinger's Personal Finance Magazine, August, 1998 by Manuel Schiffres

Franklin, 45, takes both a bottom-up and top-down approach to managing the $1.3-billion fund. She looks for either growth or change for the better, but those are criteria that can be applied to a company, an industry or even an entire economy. She figures that two-thirds of her fund's superior performance over the past year was due to stock selection and one-third to timely country bets. Although she's not counting on a repetition of the past year's returns in the next 12 months, Franklin says European stocks still hold promise.

Diversified international funds that favored holdings in Western Europe were this year's clear winners. For instance, Lord Abbett International, the number-one diversified international fund over the past year, recently had 80% of its $114 million in assets in generally small European stocks, 10% in Canadian issues and the rest in cash, with nary a penny in Asia, Latin America or Eastern Europe. London-based manager Christopher Taylor says he arrived at this European tilt not because of any call on the big picture but because his process is designed to identify 40 to 50 companies "that are best at what they do" and that are reasonably valued. Adds Taylor: "We concentrate on companies, not Countries, because no matter what you do you still have to buy shares at the end of the day."

BONDED TO BONDS

BOND INVESTORS, PARTICULARLY THOSE willing to take extra risk by owning long-term or low-quality debt, were rewarded for their loyalty (see "In Defense of Bond Funds," on page 136). The peppy economy was a plus for investors in junk bonds. Yet despite strong economic growth of the sort that often leads to higher interest rates, long-term yields fell more than a full percentage point over the past year, to 5.7% in mid June on the benchmark 30-year Treasury bond. The drop in yields guaranteed that funds with the longest average maturities would head the past year's winners' lists (bond prices move inversely to rates). It also ensured that funds that invest in zero-coupon bonds--IOUs whose prices are most sensitive to changes in interest rates--would shine the brightest. Hence the eye-popping returns of the American Century Benham larger funds.

At least one top-performing bond manager sees yields continuing to fall. Daniel Fuss, whose $1.6billion Loomis Sayles Bond is the five-year leader in the investment-grade corporate category, says he expects to see Treasury bonds yielding 5% within a year. "The world economy is weaker than it was last fall," he observes. "Asia isn't getting any better, and Japan is really in the soup."

Roger King, who runs the $240-million Dreyfus High Yield, the year's top-performing high-yield Corporate bond fund, scored big with a 25% stake in telecommunications-company bonds. Perhaps the most notable aspect of the fund's holdings is its 40% stake in CCC-rated bonds, whose issuers fall below even BB and B bonds in terms of creditworthiness. Many of these bonds, says King, pay 10% to 12% (the fund itself recently had a yield of 11.1%), and such lush payouts are likely to find a lot of demand from yield-hungry investors. "This is a very aggressive fund," warns King. So far, "it has paid to take risks." The same can be said for virtually the entire spectrum of funds over the past five years. The question is when that risk-taking will come home to roost.