Stock Funds’ Cash Rise Has a Downside
Small investors have flooded stock mutual funds with a record amount of cash this year, creating an unprecedented boom for the industry.
But as the first quarter ends this week, some of the nation’s most popular stock funds will report painful losses that may shock unwary shareholders. The results will resurrect an old debate: whether too much new cash can ruin a good stock fund.
The money dam broke early in January, as the stock market soared, bank CD rates hit new lows and newspapers were filled with stories about stock mutual funds’ average 36% gains last year. That confluence of events caused individual investors to pour dollars into stock funds at a rate most have never experienced.
Managers of the Wheaton, Ill.-based Monetta Fund, for example, were gratified enough with their growth in 1991, when assets rose from $6 million to $57 million. But since 1992 began, money has been pouring into Monetta at a rate of more than $1 million a day, boosting the fund to $142 million.
At some funds, cash has been coming in at the rate of $1 million every few hours . Assets of the Denver-based Janus Fund have rocketed from $2.98 billion at year’s end to $3.79 billion, a gain of $810 million in 90 days.
Yet as the dollars have rolled in this quarter, the performance of many stock funds has waned badly. In fact, the unpleasant surprise for many new fund investors will be that they’ve already lost money on their first foray into stocks.
Though the Dow Jones industrial average, at 3,231.44 Friday, is up 2% year to date, the “growth” stocks favored by last year’s top-performing stock funds have plunged since the year began. Result: Some of the funds most popular with investors in the first quarter will show the biggest declines in value when quarterly numbers are reported this week.
Twentieth Century Growth fund in Kansas City, Mo., for example, has surged by more than $200 million in assets this year to $4.05 billion, helped by January publicity on the fund’s 69% return last year.
But as growth stocks have tumbled, the fund has lost 5% of its value since Dec. 31. In contrast, the average general stock fund is up 1.1% year-to-date through last Thursday, according to fund tracker Lipper Analytical Services.
Could Twentieth Century be a victim of its own success? In theory, any fund could be hurt by a flood of new money if its managers feel pressured to quickly invest that cash without thoughtfully evaluating each stock pick. Also, a hoard of new dollars can lead a money manager to bend his own investment rules about what constitutes a “great” stock.
George Michaelis, whose Los Angeles-based Source Capital stock fund is known for its conservative yet highly successful long-term track record, says the deluge of dollars facing some fund managers is unquestionably a handicap.
“I don’t think (investing huge sums) can be done very intelligently at all,” he says. “I would not want to be in that position.”
But James Stowers III, head of Twentieth Century group, says his funds’ first-quarter results haven’t been penalized by the surge of new money. Despite the cash avalanche, Stowers says, his fund managers face no shortage of good stocks to buy.
At Twentieth Century Growth, much of the new money has been used to buy more of the stocks already in the fund’s portfolio, Stowers says--names such as biotech firm Amgen, drug firm Merck and retailer Wal-Mart. That isn’t because fund managers have been too swamped to look for better ideas, he says. Rather, “we still have the same stocks because they still make sense,” he argues. As those stocks get cheaper in a falling market, Stowers says he’s only too happy to buy more.
The story is different at Twentieth Century’s $3.8-billion Ultra fund, which had focused mostly on small-company stocks. There, record asset growth has changed the rules governing what the fund will buy, Stowers admits. Last year, Ultra typically bought stocks with a market capitalization (stock price times shares outstanding) of $500 million or less.
Today, Ultra is buying companies with market capitalizations of up to $1 billion, Stowers says. Changing the rules means that the fund can choose from a bigger mix of stock ideas, of course. But that shift also means that Ultra shareholders won’t be owning truly small companies anymore. What that will mean for the fund’s long-term performance--which has been brilliant over the past decade, when the fund was much smaller--remains to be seen.
It’s true that fast growth isn’t necessarily a liability for a fund. Legendary money manager Peter Lynch proved that with the Fidelity Magellan fund in the 1980s, which he took from $60 million in assets to $15 billion, all the while outperforming the average stock fund.
A key issue in the debate over stock-fund growth is individual funds’ investment style--and whether shareholders understand and support that style. Twentieth Century, for example, believes in staying fully invested in stocks at all times, no matter how the market fluctuates in the short run. Hence, the firm feels obligated to put to work whatever cash it gets.
Other fund managers take a more opportunistic view of the market: If they feel good about stocks, they’ll buy. Otherwise, they’ll let new dollars just build up until the time seems right.
Jim Craig, who manages the Janus Fund, says he’s been in no hurry to invest the money new shareholders have tossed his way. About 17% of Janus Fund’s assets were held in cash at the end of 1991. Today, the fund is 30% cash. Craig can’t find enough bargains in the market after having sold out of some growth stocks that he felt had peaked, including Merck and Waste Management.
“I don’t mind sitting around with 30% cash,” Craig says. “I just haven’t found the next ‘big things’ yet.” By limiting his exposure to stocks in a dicey market this year, Craig has held Janus to a 2.2% decline so far.
For some money managers, however, there’s only one legitimate solution when a fund is growing faster than it can find decent stocks to buy: Close it.
Stuart Roberts, who runs the Montgomery Small Cap fund in Denver, closed the fund to new investors earlier this month after it jumped to $175 million in assets from $75 million at year’s end.
“We decided that’s what we could feasibly run within our universe of stocks,” while staying true to the concept of investing in only the best ideas among small-company stocks, Roberts says. So far this year, his fund is up 2.7%.
Another recent closure: Fidelity Low-Priced Stock fund, which has doubled in size this year.
Closing a fund is a painful decision for a manager, of course. Because management fees are charged as a percentage of a fund’s assets, the bigger a fund, the bigger the take for the manager. For that and other reasons, few funds ever close. Of 1,416 stock funds tracked by Lipper Analytical, only 27 now are closed to new investors.
But if cash continues to pour into the funds at a record pace, closing will have to be weighed as an option by more managers. After all, their first obligation should be to existing shareholders, not to potential shareholders. If good stock ideas are harder to find, new cash becomes a major distraction--and it may already be past the point where some fast-growing funds should have admitted that fact.
Stock Mutual Funds: Can They Manage the Growth?
Many stock mutual funds have experienced record cash inflows in the first quarter, as investors have fled bank CDs in search of more lucrative returns. How some of the most popular funds grew last year and in the first quarter of this year, and their returns in those periods:
Total assets 1st (in millions): quarter per Stock fund 12/90 12/91 Today asset gain 1991 20th Century Ultra $456 $2,905 $3,853 +$948 +86% Janus Fund $1,156 $2,979 $3,792 +$813 +43% Janus Twenty Fund $244 $1,322 $1,840 +$518 +69% Fidelity Low-Priced $89 $375 $798 +$423 +46% Financial Industrial Income $550 $1,596 $1,913 +$317 +46% Kemper Growth $348 $985 $1,200 +$215 +67% 20th Century Growth $1,908 $3,866 $4,053 +$187 +69% Berger One Hundred $15 $192 $326 +$134 +89% Montgomery Small Cap $19 $75 $175 +$100 +99% Monetta Fund $6 $57 $142 +$85 +56% Average stock fund +36%
Fund formance: Stock fund 1st Qtr. 20th Century Ultra -3.6% Janus Fund -2.2% Janus Twenty Fund -7.0% Fidelity Low-Priced +13.0% Financial Industrial Income -2.9% Kemper Growth -5.0% 20th Century Growth -5.0% Berger One Hundred -0.1% Montgomery Small Cap +2.7% Monetta Fund +0.9% Average stock fund +1.1%
First quarter returns through Thursday.
Source: Lipper Analytical Services Inc.; funds listed
