By Suzanne McGee
What a difference three months can make in the world of top-performing mutual-fund managers.
At the end of 2018, "the entire portfolio felt like a bunch of losers," says Dennis Lynch, head of the Counterpoint Global team at Morgan Stanley.
Mr. Lynch's assessment was overly bleak. Despite the market collapse in the waning months of 2018, two of the funds of which Mr. Lynch is lead portfolio manager still were among the six best actively managed U.S.-stock funds at the end of the fourth quarter, according to our continuing survey.
Now, thanks in part to the dramatic market recovery so far this year, Morgan Stanley's funds and other growth-oriented mutual funds are faring even better.
"We were taking advantage of the selloff to add to some of our favorite ideas," he says of the weakness in stocks at the end of last year, "but we were surprised when they rebounded so rapidly."
The magnitude and speed of the market's recovery helped three Morgan Stanley mutual funds land in the top six in The Wall Street Journal's first quarterly Winners' Circle contest of 2019.
Top laurels, meanwhile, were again won by two Fidelity Investments funds that focus on growth companies. Fidelity Advisor Series Growth Opportunities Fund (FAOFX) repeated as the best-performing stock fund over the previous 12 months. (Under our contest rules, funds must be diversified U.S.-stock funds, actively managed, with at least $50 million in assets and a record of no less than three years.) The fund posted a 12-month return of 38% as of March 31. Fidelity Advisor Growth Opportunities (FAGOX), was again No. 2 with 33.5%.
The three standout Morgan Stanley funds in the contest, all overseen by Mr. Lynch and his team, were Morgan Stanley Institutional Fund Trust Discovery Portfolio (MPEGX) with a return of 30.87%, Morgan Stanley Insight Fund (CPOBX) with 28.98%, and Morgan Stanley Institutional Fund Inception Portfolio (MSSGX) with 27.32%, which put it in sixth place, a bare 0.10 percentage point behind fifth-place winner Virtus Zevenbergen Innovative Growth Stock Fund (SAGAX). The $180 million Virtus fund is led by subadvisers Joe Dennison and Anthony Zackery of Seattle-based Zevenbergen Capital. (The three Morgan Stanley funds changed their names in February; they used to have midcap, multicap and small-cap, respectively, in their names. The Virtus fund formerly was labeled RidgeWorth.)
Readers shouldn't treat this as a list of recommended funds. Often, the managers recognized in our contest are reaping the fruits of investments made several years ago and have endured periods of underperformance en route to their moment in the spotlight. It is also worth noting, this month, that our top-performing fund can't be accessed directly by investors; instead, it is an underlying investment in Fidelity Freedom Funds and certain asset-management programs. Our rankings exclude passive investment vehicles, sector funds, funds that use leverage to amplify returns or manage risk, and quantitative funds that employ screens to select their holdings.
The key to outperforming their peers in the first quarter was the ability to demonstrate old-fashioned investor discipline. Several of this quarter's top-ranked managers, for example, took some of their profits off the table during the bull market's gains in the first nine months of 2018. When prices began to plummet in the final months of the year, they saw it as buying opportunity, focusing on a stock's fair value or its growth potential, rather than the market volatility.
Fidelity's Kyle Weaver, manager of the first- and second-place funds now in two consecutive quarters, says he used the year-end downturn to add to positions in companies with the best and fastest-growing business models. He notes that the fourth-quarter selloff was particularly painful for Carvana, the Tempe, Ariz.-based online car retailer that went public in the spring of 2017; while the Fidelity funds at one point had a sixfold return on their original investment, at the end of 2018 the return was only threefold, Mr. Weaver says. "You could argue that it got ahead of itself," he says. He sold some of the shares, and redeployed the gains in other areas, he says, but when the price fell still lower, he boosted his holdings.
"My thesis remained intact," Mr. Weaver says, "and the gap between its price and its intrinsic value had widened out significantly." Carvana's share price nearly doubled between the end of the fourth quarter and March 31, soaring to $58.06 from $32.71.
Big turnarounds like that helped propel this quarter's top-performing fund managers into the Winners' Circle, as core growth-stock holdings resumed their roles as market darlings. These types of companies, some of the winning managers say, offer products or services that are new to the market or enable other businesses to operate more efficiently or effectively.
A case in point is Twilio, a major contributor to at least the two best performing Morgan Stanley funds in the contest. This cloud-based communication-services company provides the platforms that allow app users to transmit or receive phone calls, texts or other messages. Twilio "powers a lot of the messaging that occurs in everyday applications," Mr. Lynch says. "For example, when you use a ride-sharing company and get a notification telling you when the car will arrive, Twilio is providing that communications function."
Zevenbergen's Mr. Dennison offers an example of a health-care company that he sees as providing an innovative service with huge potential. Some of the biggest gains over the past 12 months to the Virtus Zevenbergen portfolio, he says, have come from Exact Sciences, the molecular diagnostics company whose stool-testing product enables doctors and patients to test for colon cancer without the need for invasive colonoscopies.
Morgan Stanley's Mr. Lynch and investors in some of his growth funds also have benefited from biotech and health-care stocks, such as Inspire Medical Systems, developer of what remains the only FDA-approved implantable device designed to address sleep apnea.
"There's a large market for this," Mr. Lynch says, arguing that demand will grow as patients and doctors become more aware of the device and as more insurance companies cover it. Another medical investment by the Morgan Stanley team that has done well is Intuitive Surgical, a leading robotic-surgery platform. "As a percentage of total surgeries, their penetration is still very low," Mr. Lynch says.
Mr. Dennison and Mr. Zackery, meanwhile, are moving further into what they believe will be part of the next generation of medical treatments. They have invested in one of the early cannabis companies to go public, Tilray, a Seattle-based firm that is a major player in the Canadian medical-marijuana market.
"As growth managers, it is impossible to ignore an industry that is moving from prohibition to serving a market that may be worth $500 billion," Mr. Dennison says. His team likes to back early-stage companies, like Tilray, that are fresh to the public markets. Tilray, he says, "has done well at building strong relationships with both customers and regulators, and brands that can build that trust will be the biggest winners."
As the past six months have demonstrated so vividly, there can be no certainty about what lies ahead either for these managers or their portfolio holdings. "The upside is not what it was" at the beginning of the year," says Mr. Lynch. "We don't have the same optimism about prospective returns."
That is secondary, however, to his confidence In his core process: identifying companies that will benefit disproportionately from disruptive change.
"We don't try to manage what's going to happen in the next three to six months," Mr. Lynch says, "but instead try to make long-term decisions, to find unique and underappreciated companies that are capable of generating longer-term value. That's easy to talk about, but harder to do."
Ms. McGee is a writer in New England. She can be reached at firstname.lastname@example.org.
Corrections & Amplifications
This article was corrected April 8, 2019 because RidgeWorth, the former brand name for Virtus Zevenbergen Innovative Growth Stock Fund, was misspelled as RidgeWay in the original version.