Tech's old guard paid off for investors this year

NEW YORK – The big money doubted Apple this year. Oops.

"It's been a really confusing year," said Kim Forrest, an analyst at Fort Pitt Capital Group Inc., which oversees about $1.7 billion in assets under management. "There have just been a handful of stocks that drove the market, and Apple was obviously one of them. It's been tough."

Aversion to the iPhone maker is turning out to be one of the worst blunders in 2014 for money managers, who are trailing benchmark indexes by the most in nearly a decade. Shares of the world's largest company rose four times more than the Standard & Poor's 500 index as Chief Executive Tim Cook's product plans eased concern over the company's future growth.

Investors who clung to winners from the first five years of the bull market, from Internet companies to small caps, got burned in the sixth as chipmakers, utilities and dividend shares rallied. In many ways, 2014 was the year of the hated stock. One of the best things you could've done was own companies with the highest short ­interest and the lowest analyst rankings, according to data compiled by Bloomberg. Such a strategy would have steered you to Exelon and Micron Technology, with average gains of 26 percent since January.

Going against the grain now would lead you to buy energy shares, the industry whose 2014 loss is triple the next worst-performing group in the S&P 500. That's what Bill Nygren is doing after his $6.7 billion Oakmark Select Fund beat 97 percent of its peers this year. Nygren bought Apache Corp., a Houston-based oil producer, during the energy sell-off as crude went from $107 a barrel to $58 in the past six months.

"Unloved companies tend to be the most interesting hunting ground for future outperformance," said Nygren, who is based in Chicago. "The reason that Intel and Microsoft were able to do so well is that they were so unpopular."

Like their colleagues in the bond market, many equity managers entered the year believing economic growth would pick up and interest rates rise. They avoided defensive stocks such as power generators and loaded up on retailers and other industries that benefit when Americans spend money on nonessential goods.

Instead of rising, yields on 10-year Treasury notes fell to 2.08 percent from 2.88 percent a year earlier, as central banks from Europe and Japan boosted monetary stimulus in a bid to spur growth. That fueled a surge of at least 20 percent in utilities and REITs, two groups whose dividends are among the highest. Consumer discretionary shares rose half as fast as the rest of the market.

Apple, Intel and Microsoft account for 22 percent of the S&P 500's advance so far this year after rallying an average of 34 percent. None was a consensus pick of money mangers, according to data compiled by Goldman Sachs.

As a consequence, eight of 10 funds focusing on large growth stocks are trailing their benchmark, the second-highest proportion since 2004, data compiled by Chicago-based Morningstar Inc. show. About 87 percent of funds that purchase the biggest value shares gained less than their benchmark measure, as did nearly 90 percent of the mid-cap funds.

"I never thought I'd get that many basis points out of Apple and Microsoft," said Bob Doll, manager of the Nuveen Large Cap Growth Fund that counts the two stocks as the top holdings and is up 12 percent this year. "What a shame for someone who said they really like it but then underweight it."

At various points in 2014, the year was shaping up as the hardest in a decade to find stocks that generated alpha, the fund-industry term for gains above the market's return. During the 12 months through September, only 30 percent of companies in the S&P 1500 posted gains that exceeded the large-cap gauge, the fewest since 1999, according to data compiled by Leuthold Group.

Compounding the challenge, 2013 proved a poor blueprint for 2014. Apple rose 5.4 percent last year, its second-worst return in a decade, while Amazon.com Inc. rose 59 percent and Twitter Inc. more than doubled after going public. Those two are down 23 percent and 42 percent in 2014.

The Dow Jones Internet composite index, which soared 54 percent in 2013 and 417 percent in the first five years of the bull market, is little changed this year. The Russell 2000 index of smaller companies, up 37 percent last year and 236 percent since March 2009, has fallen in 2014.

Chipmakers are up 31 percent, the most among the 24 industries in the S&P 500, as investors anticipate a pickup in technology spending.

"Everything needs semiconductors to run on and you need high-tech nuts and bolts," said Michelle Clayman, chief investment officer at New Amsterdam Partners, which manages $1.6 billion. "A lot of the new techs have been based on dazzling concepts and promises. It's really hard to figure out who are going to be winners."

Most professional investors decided Apple euphoria was wearing thin after the shares trailed the market in 2013 by the most in 13 years. As Cook unveiled plans to update core products and introduce a mobile payment system and smartwatch, Apple shares surged, beating the S&P 500 by the most for any largest U.S. company since Microsoft's 49 percent outperformance during the Internet boom a decade ago.

"An active manager has to be able to justify the fee beyond the fee an index fund provides," said Marshall Front, chief investment officer and chairman of Chicago-based Front Barnett Associates. "If they're underweight Apple, it may indicate they're fearful there will be a hiccup in the stock and it'll have a disproportionate impact on the fund's performance. So they keep the weights to the market or below to keep diversification."

Among some 278 funds that are benchmarked to the S&P 500 and have at least $500 million in assets, only a fifth hold Apple shares more than their representation in the index, according to latest regulatory filings compiled by Bloomberg.