Stock Funds: What Does the 2nd Half Hold?

For most stock mutual fund owners, the second quarter might as well have never happened. The average fund showed little net change, leaving the big gains of the first quarter intact.

The funds’ dead-in-the-water status as of June 30 is causing rising anxiety for shareholders and fund managers. With the powerful rally from the Persian Gulf War still built into the funds, shareholders are eager to protect their gains in what could be a difficult second half of 1991.

Many fund managers, aware that the odds are against them in the second half, are shuffling their stock portfolios to weed out the perceived losers and bolster holdings of potential winners. It’s not an easy time to be running a fund, especially a winner. “I’m nervous as heck,” admits Tom Maguire, manager of the Safeco Growth Fund, one of the first half’s top stock funds.

Fund-tracker Lipper Analytical Services, in second-quarter data released Tuesday, reported:

* The average general stock fund slipped 0.86% during the quarter after soaring 17.2% in the first quarter. The second-quarter loss was the equivalent of a $15 fund share price at March 31 falling to $14.87 now--a very minor move.

* For the six months ended June 30, the average general stock fund was up 16.17%, historically a well-above-average gain for a six-month period.

* For the quarter, the average fund performed worse than Standard & Poor’s 500-stock index, the market benchmark, but still out-distanced the index for the first half. The hot performance of small-stock funds in the first quarter helped the average fund beat the blue-chip S&P; in that period; in the second quarter the trend reversed, as big stocks held up better than small.

When you make 16% in six months, is it time to take your profits to the bank--or at least to another fund? Most fund managers concede that the market usually is a tougher game in the second half of any given year. For a variety of reasons, investor optimism historically soars early in the year and comes back to Earth in the second half. This year, with investors highly suspicious about the economy’s recovery, the risk is so much greater.

The problem that experts face in recommending fund switching these days is that stocks overall remain near their record highs, and few depressed fund categories look promising short-term. “It’s hard to find areas (of the market) that have been neglected” unfairly, says Don Phillips, editor of Mutual Fund Values letter in Chicago.

For example, funds that specialize in European stocks were the big losers in the first half, off 4.3% on average. But the dollar continues to rise, and that bodes poorly for foreign-stock holdings of American investors over the next few months, even if the foreign funds appear cheap.

Likewise, funds that buy oil stocks and other natural-resources issues gained just 3.1% in the first half. But still-soft oil prices suggest no turnaround soon.

Rather than chase speculative fund ideas, experts suggest that investors use common sense. If you’ve got a long-term time horizon, don’t be panicked into selling just because your fund is up 16% in the first half. Over the past 10 years, the average general stock fund has gained 235%. Obviously, there were a lot of 16% moves in that decade, over varying periods.

By the same token, investors who’ve been in funds that have had extended hot streaks--such as health-care funds--shouldn’t be afraid to take some profits, perhaps by selling 30% or 40% now. “Health care has been on a roll for two and a half years,” Phillips notes. “I’d be lightening up on those areas that are fully valued.”

Before you make any move, though, consider whether your fund manager has already shifted gears to protect first-half gains. Managers tend to fall into one of two groups when it comes to portfolio strategy, and you ought to know which type you’ve got:

* The cash raisers. When their market outlook turns bearish, this group will sell stocks to boost their funds’ cash balances to 20%, 30% or more of the portfolio. So they essentially take profits for you. If the stock market takes a big hit, these funds will be sheltered from a severe loss. Of course, if the market zooms, they’ll regret they didn’t keep their stocks.

Heiko Thieme, who runs the first half’s best stock fund--the $2.5-million-asset American Heritage Fund in New York, up 52.8% in six months--has boosted his cash balance to 25% of the portfolio, he says. He made big money in the first quarter in technology stocks, then was wise enough to sell them in the second quarter before their May crash. He’s now betting that bank stocks and such “fallen angels” as IBM and Time Warner will pay off in the second half of the year and figures he’ll use his cash to pick up bargains along the way.

* The always fully invested. Safeco Growth Fund’s Tom Maguire in Seattle, whose $120-million fund soared 37.9% in the first half, figures his shareholders chose him because they want to own stocks--not cash. So he keeps the fund virtually 100% in stocks at all times. “I don’t like to market-time; I don’t know how,” he says.

Rather than raise cash, managers like Maguire continually move from expensive stocks to issues they view to be cheaper. He scored major gains in the first half with highway-builder Granite Construction, for example, but decided that the stock had gotten ahead of itself. He’s out of that issue now and has moved into perceived better values in such stocks as Dole food owner Castle & Cooke and cosmetics giant Avon Products.

Another winner who avoids cash is Stu Roberts, who manages the Montgomery Securities Small Capitalization fund. His $28-million fund focuses on small stocks and built up a gain of 41.6% in the first half. His portfolio is an eclectic mix of companies, ranging from Harley-Davidson to biotech firm Synergen to pork-products firm Thorn Apple Valley.

“I don’t sit around trying to predict interest rates or when the economy might turn,” he says. Instead, he sets target prices for his stocks when he buys them and continually monitors their progress. While other money managers worry about the overall market, Roberts just looks for good companies whose products are gaining market share, and figures the rest will take care of itself--if shareholders will stick with him.

Tortoise or Hare?Led by small-stock funds, higher-risk mutual funds are back in vogue. One sign of that is the tilt in asset share among key stock fund categories.

Lipper Analytical’s “big-five” fund types, 791 funds in all, are: capital appreciation; growth; small-company; growth and income, and equity income.

Funds in the first three categories in that list focus more on higher-risk stocks that also offer potentially greater reward. The growth-and-income and equity-income funds, meanwhile, focus more on bigger stocks that often grow more slowly but pay significant cash dividends over time.

The riskier three categories now hold 51.3% of the $229 billion in big-five assets, taking the asset crown from the two conservative categories.

As the chart on page D1 shows, the market’s gains over the past 10 years have been centered in the more conservative blue chip stocks favored by the growth-and-income and equity-income funds. But many experts now believe that it’s time for smaller stocks to shine.

That may be. Even so, for many investors, the extreme volatility involved in owning smaller stocks may not be worth the stress. And in any case, conservatism has always paid OK in the stock market. If you earn 600% over 15 years in a blue chip fund instead of 700% or 800% in a growth-stock fund, you’ll have missed some gains, but you’ll probably have slept a lot better at night in the interim.

Quarterly Stock Mutual Fund Report In The Second Quarter: The typical fund eased slightly. . . Average total return, by fund category Gold: +8.04% S&P; 500 Index: -0.23% Growth & Income: -0.38% Average Stock Fund: -0.86% Growth: -1.08% Small-company: -1.41% International: -2.69% European: -5.76% Technology: -6.49% FIRST HALF RESULTS: leaving most up sharply year-to-date: Average total return, by fund category Small-company: +23.74% Technology: +16.70% Average Stock Fund: +16.17% Growth: +16.17% S&P; 500 Index: +14.24% Growth & income: +13.81% Balanced: +10.07% International: +3.96% Gold: +0.79% FUND Investors take more risk. . . Growth, capital appreciation and small-company funds-typically, the more aggressive, higher risk funds-now hold the bulk of fund investors assets, over the more conservative growth &income; and equity-income funds. Assets of general stock funds (billions of dollars)

Assets Category (billions) Pct. of total Capital appreciation $20.46 8.9% Small company $13.03 5.7% Growth & income $87.22 38.0% Equity income $24.55 10.7%

. . .but conservatism, pays off, long term: More conservative growth & income and equity-income funds, which focus on blue-chip stocks,have fared best over the past 10 years. Average total return, 10 years ended June 30 Growth & income: +260.9% Equity income: +250.7% Average stock fund: +234.5% Growth: +233.9% International: +229.7% Technology: +197.1% Small-company: +161.8% Gold: +62.5% Source: Upper Analytical Services Inc.