Best Mutual Funds And ETFs End 2021 On High Note, Led By Midcap Value

Despite increased volatility, stocks ended 2021 and December with strong returns as investors readied for a year of higher inflation and rising interest rates. Some of the best mutual funds and ETFs included midcap, value, real estate and other cyclical stock funds.

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As predicted by many experts, interest rates finished the year higher than where they began. The 10-year U.S. Treasury yield picked up 9 basis points in December, and a whole 59 basis points on the year, ending 2021 at 1.52%.

“We believe Covid-19 is still the investor narrative,” said Greg Bassuk, CEO at AXS Investments, an alternative investment management firm. “When we look back at this calendar year, while in general, historically we would look at corporate earnings and corporate data, we’ve seen markets have their greatest moves when news has come out, positive or negative, relating to Covid. And we’re seeing this again in December with the most recent variant.”

Best Mutual Funds And ETFs Gain In December

U.S. diversified equity funds advanced 3.69% on average in December, gaining 6.35% and 21.34% for Q4 and 2021, respectively, according to Lipper Refinitiv data. Among the major stock indexes, S&P 500 was the best performer on the year, up 28.71%, followed by Nasdaq with 22.18% and the Dow with 18.73%. For December, however, the order was different, with the Dow jumping 5.38%, the S&P 4.48% and the tech-heavy Nasdaq just 0.74% as cyclical stocks took over the leadership.

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“December was a very strong month for most factors,” said Christopher Huemmer, senior vice president and senior investment strategist for FlexShares ETFs, a subdivision of Northern Trust Asset Management. “Factors such as quality, value, low volatility, and dividend yield have all been very positive, as has momentum, another of the six main factors.”

In the U.S., midcap value and multicap value funds were among the best mutual funds in December, up over 6%. They delivered 7%-plus returns in Q4 and are up 29.82% and 26.22% on the year, respectively. Large-cap value and equity income funds also did well.

Within sectors, real estate, commodities energy, utility and basic materials funds were among the best performers in December. They were up between 17% and 77% in 2021.

Global, India Funds Rack Up Gains

Internationally, a similar picture unfolded, with global large-cap value and global equity income funds racking up 6%-plus returns last month and in Q4. They surged more than 17% last year. The big winners on the year, however, were India region funds, up 25.85%.

On the bond front, general domestic taxable bond funds delivered a positive return on average in December and Q4, despite the uptick in rates. They’re up 2.25% on the year. Some of the best bond funds in 2021 were inflation-protected bond, high yield and loan participation funds. Short-term bond funds sold off in December, resulting in negative returns.

Some of the best ETFs followed a comparable path to their mutual fund peers. Among U.S. diversified stock ETFs, Invesco S&P 500 Low Volatility (SPLV) and First Trust Morningstar Dividend Leaders (FDL) were the top two funds in December, up 8.84% and 9.71% respectively. They both returned more than 24% in 2021.

For the year, Invesco S&P SmallCap Value with Momentum, Pacer Lunt Large Cap Alternator (ALTL) and Pacer US Cash Cows 100 (COWZ) were the best performing U.S. diversified stock funds, up 56.39% and 45.3% each.

Sector, Value, Dividend ETFs End Year With Gains

Top sector ETFs in December included Invesco KBW Premium Yield Equity REIT (KBWY), Consumer Stables Select Sector SPDR (XLP), Pacer Benchmark Industrial RE Sector (INDS) and Real Estate Select Sector SPDR (XLRE) with 10%-plus returns.

Fidelity director of quantitative market strategy Denise Chisholm pointed out three themes that are driving the markets in this cycle: high fear, inflation and technology headwinds.

She said that because valuation spreads have been persistently very high, indicating elevated investor fears, it means the market has already discounted lots of these headwinds. As a result, she maintains a bullish outlook for 2022.

“You have to be conscious as an investor that despite the fears that we see in the headlines, that there is this math behind that discounting mechanism that shows you a constructive outlook in 2022,” she explained. Regarding inflation, Chisholm believes we’re “in the process of peaking in the sense that the tailwinds that we’ve seen for inflation over the last year not only dissipate but turn to headwinds in 2022.”

Fidelity’s Chisholm Is Bullish On 2022

Chisholm expects an average deceleration of inflation this year in comparison to last year. In addition to the above dissipating inflationary headwinds, an appreciating dollar would further curb inflation. She also believes inventories are likely to catch up with sales in 2022 — another positive to slow down inflationary pressures.

That said, investors can expect leadership rotation in the markets away from tech stocks, she noted. “The story behind tech is unique from a historical perspective, in that during the pandemic, their stocks actually got cheaper on a relative basis vs. the market.”

But now, she added, “we basically unwound all of that valuation. So, for the first time since 2005, we’re in the top quartile of technology’s relative valuation. That is usually when you see, on average, underperformance.” Other factors playing against tech stocks include the end of margin expansion and inflation.

Financials, Energy Could Lead Best Mutual Funds And ETFs In 2022

Chisholm sees leadership shifting toward value stocks, and specifically energy and financials. “For value stocks, what inflation decelerates to is very critical,” she added. She explained that if inflation remains above the historical average of 3%, “there’s much higher odds for financial stocks and much lower odds for technology stocks (to outperform), and vice versa.”

According to a recent report by Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, “U.S. cyclical sectors were once again favored (+$4.4 billion) in December — as they had been all year. … Financials, energy and real estate led cyclical flows in December and for all of 2021, and they were three out of the top four sector asset gatherers (in 2021).”

AXS’ Bassuk says volatility and uncertainty will continue this year: “We think 2022 will be a very strong year for liquid alternative strategies. These are stocks funds that provide upside potential but with some downside protection.”

REITs And Inflation-Sensitive Stocks Seen Gaining

He’s also bullish on inflation-sensitive stocks: “Not only do they provide protection against devaluation tendencies of inflation, but they also allow investors to profit from rising prices.” Real estate and REITs are also his picks as diversifiers in portfolios.

The recently launched AXS Astoria Inflation Sensitive (PPI) is an actively managed, broadly diversified ETF that invests in cyclical stocks, commodities and TIPS to provide inflation-adjusted returns.

FlexShares senior VP Huemmer is bullish on quality, low-volatility equities for 2022. In addition, he also likes natural resource equity as an inflation hedge in the current environment.

FlexShares Morningstar Global Upstream Natural Resources (GUNR) is FlexShares’ largest fund with $6.7 billion in assets. “It’s a good example of getting into the upstream portion of the supply chain,” he said. “Another reason we like natural resource equities over commodities is getting the dedicated access to timberland and water.”

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