Jeremy Grantham, Bill Miller and Donald Yacktman, having told mutual fund investors that 2010 was a year to buy the biggest stocks, and getting drubbed by most of their peers, are sticking with that prediction.
The Yacktman Focused Fund trailed about three-quarters of its rivals last year, according to data compiled by Bloomberg. Grantham's $14.9 billion GMO Quality Fund grew 4.7%, though its top holding, the software firm Oracle Corp. in Redwood City, Calif., rose 28%.
Shares of small and midsize companies roughly doubled the 2010 return of the Standard & Poor's 500 index, the benchmark for large-capitalization equities in the U.S. Still, Yacktman and the others are making the same case for the new year as they did for the last: Big companies are undervalued compared with smaller stocks, and their earnings will benefit more from faster economic growth outside the U.S.
"In 40 years I have rarely seen a situation where so many big, profitable international companies are selling at such relatively cheap prices," Yacktman, who manages his $1.9 billion fund from Austin, Texas, said in an interview.
Two of the top five holdings in the Yacktman Focused Fund — Microsoft Corp., the Redmond, Wash., software maker, and the Pfizer Inc. pharmaceutical company in New York — were among its worst performers.
Miller's flagship large-cap fund, the $4 billion Legg Mason Capital Management Value Trust, gained 5.5% last year, according to Bloomberg data.
Miller's mid-cap fund, the $2 billion Legg Mason Capital Management Opportunity Trust, rose 16%.
In November, Grantham's firm, Mayo Van Otterloo Co. in Boston, predicted that the highest-quality stocks, known as blue chips, would return 5.1% a year above inflation during the next seven years, compared with an average annual loss of 0.8% for small stocks.
"I believe (once again speaking for myself) that high-quality stocks should have an even bigger win over low quality than our GMO numbers suggest," Grantham, the company's chief investment strategist, wrote in a newsletter.
Grantham declined to comment for this story, according to an e-mail from Tyler Bradford, a spokesman for the company.
Grantham, 72, is best known for his gloomy and often accurate long-term forecasts.
In 2000 he predicted that U.S. stocks would lose money in the coming decade.
The S&P 500 averaged gains of 0.8% annually in the decade through Nov. 30, according to data compiled by Bloomberg.
The S&P Midcap 400 Index, a proxy for midsize stocks, climbed 7.3% annually.
The Russell 2000 Index, a benchmark for small companies, increased 6.4% a year.
U.S. investors are continuing to shun funds that invest in large stocks, according to Chicago-based Morningstar Inc.
In the first 11 months they pulled $65.8 billion from large-cap funds, $2.5 billion from mid-cap funds and $90 million from small-cap funds.
Morningstar defines the top 70% of stocks by market value as large-cap and the bottom 10%, small-cap.
"Small stocks generally do better when you are coming out of a recession," said Michael Mullaney, a portfolio manager at Fiduciary Trust Co. in Boston, where he helps oversee $9.5 billion. The last recession ended in June 2009, according to the National Bureau of Economic Research in Cambridge, Mass., which is the official arbiter of economic cycles.
Jack Ablin, the chief investment officer at Bank of Montreal's Harris Private Bank in Chicago, where he helps oversee $55 billion, said smaller stocks will continue to outperform in early 2011 as they benefit from an expanding recovery.
Growth is proving better than many economists had expected, Ablin said in a telephone interview, and smaller companies are disproportionately reliant on the domestic economy.
Pacific Investment Management Co., the Newport Beach, Calif., company that manages the world's biggest bond fund, said the U.S. economy should grow 3% to 3.5% this year, up from an earlier forecast of 2% to 2.5%.
Miller, a fund manager at Legg Mason Inc. in Baltimore, said in a July newsletter that investors have a "once-in-a-lifetime opportunity" to buy large-cap U.S. stocks at the cheapest prices in almost six decades. Known for beating the S&P 500 a record 15 straight years through 2005, Miller, 60, trailed the index for the next three years.
Robert Hagstrom, a Legg Mason portfolio manager, reiterated the case for buying large stocks in a report saying that they are attractively valued and have exposure to fast-growing, emerging-market economies.
In a subsequent telephone interview, Hagstrom said U.S. multinationals are as cheap as they have been since 1982. "The market is giving these companies no credit for future growth," he said.
Miller declined to comment, Legg Mason spokesman Mary Athridge said in an e-mail.
Investors are paying a premium to own small and mid-cap stocks compared with their larger counterparts, said James Floyd, a senior analyst at Leuthold Group LLC, a research firm in Minneapolis. Leuthold defines small stocks as those with market capitalizations from $305 million to $1.5 billion and large stocks as those with more than $9.7 billion.
The average price-to-earnings ratio for large stocks was 13.2 at the end of November, compared with 14.7 for both small and mid-cap stocks, Floyd said.
"Currently we think most of the best values are in the highest-quality companies," Yacktman, 69, wrote in a letter to shareholders after the second quarter.
Yacktman, the founder and chief investment officer of Yacktman Asset Management Co., said he views stocks as if they were bonds and measures a company's prospective returns against its current price. The Yacktman Focused Fund returned 13% a year in the 10 years through Nov. 30, Morningstar data showed, topping 99% of similar funds.