Minnesota funds ride volatility to profits

You can't blame investors for still feeling bruised. They carried the Dow Jones industrial average to a record high in mid-July, only to lose confidence by month's end amid news of more subprime mortgages going bad and a credit crunch that made for more expensive borrowing.

Add in talk of recession, pricey oil, interest rate uncertainty and a weak U.S. dollar, and investors had plenty to lie awake thinking about during much of August and September.

It wasn't until the Federal Reserve swooped in with a rate cut for banks and a larger-than-expected cut for the federal funds rate -- from 5.25 percent to 4.75 percent -- that the market reversed course.

Last week, the Dow once again closed above 14,000, reaching a new record and managing to eke out a 4.2 percent return for the quarter. The Standard & Poor's 500 index mustered a 2 percent return.

Neither uncertainty nor volatility could wipe away positive returns for the majority of Minnesota's stock mutual funds in the third quarter, the Star Tribune's Quarterly Money Managers Report shows.

Jeffrey Mellas, who co-manages Wells Fargo's Advantage and WealthBuilder funds, calls the market recovery warranted. Aside from housing, he said that "95 percent of the [gross domestic product] is humming along pretty well," citing a bright jobs picture, rising export markets on the back of the falling dollar and historically low inflation rates.

Coming in on top among Minnesota-managed or Minnesota-affiliated funds were those in the high-flying emerging-markets sector. The quarter's best performer was the RiverSource Emerging Markets fund (IDEAX), returning 14.19 percent for the period and 30.68 percent year-to-date. The Sit Developing Markets Growth Fund (SDMGX) wasn't far behind, finishing the three months that ended Sept. 30 with a 13.95 percent return and an admirable 35.2 percent rate so far this year.

Sit's recipe for success? Terrific stock selection in the energy and consumer staple sectors and a portfolio heavy on Chinese stocks, which have risen more than 100 percent this year alone. "That shouldn't be surprising, given who we are," said Eugene Sit, who was born in China and now serves as global chief investment officer and CEO of Sit Mutual Funds in Minneapolis.

In third place: the Sit Science & Technology Growth Fund (SISTX). The fund rose 10.29 percent this quarter, thanks to "capital spending and a lower dollar," Sit said. That fund had brought up the rear of the Minnesota funds in the first quarter.

The great run overseas, particularly in the emerging markets, worries those who think that a bubble could be developing.

"A lot of dollars are chasing emerging markets," said Patrick Egan, director of asset management marketing for Thrivent Financial for Lutherans. Despite being bullish in the international arena, the company is cutting some of its positions overseas in preparation for what could be a 10 to 15 percent dip in the next six to 12 months. Sit is closely watching stock valuations and inflation in China.

Others, including domestic fund managers, can't keep their hands off of emerging stocks from places such as Asia and Latin America. Bob Markman, who runs the Edina-based Markman Core Growth Fund (MTRPX), is assigning just shy of 10 percent of his fund's assets to overseas markets.

"This is the greatest global boom of anybody's lifetime," he said. Many of his large-cap growth picks -- Apple, Goldman Sachs, Google and McDonald's -- do big business overseas. His fund returned 3.07 percent for the quarter compared with the 6.2 percent average return for funds in the large-cap growth category, according to Lipper. (Large-cap growth means investing in large, fast-growing companies relative to the rest of the market.)

On the bond front, global came out ahead as well. Nic Pifer, portfolio manager for RiverSource Global Bond Fund, ended the third quarter with a 4.86 percent return to top the list of Minnesota's fixed-income funds. He thanks the declining value of the dollar. For a sense of how far it's fallen, values of the Canadian loonie and the U.S. dollar are about equal for the first time since 1976.

The dollar helped his fund because when its value dips, the fund benefits from its exposure to currencies from all around the world that are now much richer in dollar terms. The concentration of housing market issues in the United States has also been helpful to foreign investments.

Overall, Wan-Chong Kung, a senior bond portfolio manager for First American Funds, describes bond valuations as being "pretty challenged." For instance, the spread earned for taking on the risk of a high-yield bond over a Treasury is below the 15-year average, she said. That means that investors are not being rewarded for their risks.

More records ahead?

Going into the historically strong fourth quarter, Markman is optimistic. He figures that, because the business media's been thoroughly covering economic issues from the housing slowdown to inflation concerns, that any effects these factors would have on the stock market are "already baked in the cake, or priced into the market," Markman said.

But not everyone is certain that the mortgage mess is contained.

"The $64,000 question is, how much further fallout effects will we have from mortgage financing?" Sit said.

All eyes will also be focused on corporate earnings season. Analysts have been expecting earnings to drop from double-digit levels to the low single digits. But so far, companies have continued to outperform.

And then, of course, there's inflation. First American Funds' Kung sees inflation as a risk, because of elevated prices in the energy and commodities markets as well as a "fairly tight" labor market. Sit agrees.

Thrivent's Egan figures everyone with money in any market is watching the Federal Reserve and wondering: "Is [Chairman Ben] Bernanke one and done?"

Kara McGuire • 612-673-7293

Kara McGuire • kara@startribune.com