Some Conventional Wisdom Is Just Plain False
One challenging aspect to investing is that the ground rules seem to change soon after you master them. Just when you think you have the principles and theories figured out, somebody comes along and upsets the conventional-wisdom apple cart.
It seems as if studies, surveys and statistics are always coming out to question the consensus view on this or that aspect of mutual fund investing. Presented below are four conventional-wisdom tidbits that have come under recent scrutiny.
* Avoid high-turnover funds. Turnover is the rate at which fund managers buy and sell stocks or bonds for their portfolios. A rate of 100% would imply that each security is replaced once a year on average, while 200% would indicate the entire portfolio gets revamped every six months or so.
Many financial advisers recommend that investors steer clear of funds with turnover rates of 150% to 200% or higher, because such heavy trading activity would tend to drive up costs to shareholders.
Yet the Value Line Mutual Fund Survey came to a somewhat different conclusion after studying the performance of more than 500 domestic stock portfolios during the last five years, with emphasis given to the 1990 bear market.
“Contrary to popular belief, high turnover can be a positive trait in an aggressive equity fund,” argues the New York publication. One explanation suggested by Value Line is that high turnover managers are able to react more quickly to changing investment climates.
But Value Line also found that low turnover managers enjoyed the edge when it came to more conservative types of stock funds. (Bond portfolios were not studied.) In support of the conventional wisdom, the publication cautioned investors to view turnover as a secondary rather than primary consideration when choosing among mutual funds.
* The rush of bank customers and other novice investors into mutual funds will destabilize the financial markets.
This notion has become widespread recently in the wake of the fund industry’s rapid growth. Particularly worrisome was a January report from the North American Securities Administrators Assn. and the American Assn. of Retired Persons that found that the “vast majority” of bank customers fail to realize that mutual funds sold at banks do not carry federal insurance.
But Donald P. Morgan, senior economist at the Federal Reserve Bank of Kansas City, has found little evidence to suggest that the markets have become more volatile, even with a larger mutual fund presence. Nor should Americans be considered such investment novices, he maintains.
While the ownership of stock and bond mutual funds has surged, direct ownership of securities has declined. The net result: Households now hold about the same share of their financial assets in stock and bond investments as in the 1950s and ‘60s, Morgan wrote in a recent report.
He dismisses the idea that investors are fickle and will flee the markets during a downturn. Instead, the recent shift into stock and bond funds is primarily explained by demographic trends.
“The share of household assets in stocks and bonds follows very closely the share of workers aged 35 or older,” Morgan argues. “As workers age and begin to contemplate retiring, they save more and their investment horizon stretches.”
Pressed by the need to build up a retirement nest egg, investors are willing to accept greater short-term risks in exchange for superior long-term returns, which explains the shift toward stock and bond funds and away from traditional bank products.
* No-load investors are less likely to hang tough in rough markets than people working with a broker or financial planner.
Because do-it-yourself investors don’t receive hand-holding from a financial professional, they’re less inclined to ride out storms, the theory goes. A correlating and more cynical argument is that investors in load funds stay put because they recently paid a commission or would face one to redeem shares.
There is truth to these notions, yet no-load investors hardly abandoned ship during the rough first half of 1994, when domestic stock funds tumbled 5.8% and bond funds fell 3.5% on average.
In fact, “direct-marketed” funds, which are primarily commission-free products, have gained about one percentage point in market share at the expense of their load rivals over the past year, according to data compiled by the Investment Company Institute in Washington. They’ve gained four points of market share over the last four years.
More telling from a tough-times standpoint, direct-marketed funds accounted for 44.6% of total sales (excluding reinvested dividends) during the first half of 1994 but only 41.5% of redemptions. By contrast, funds marketed by commissioned salespeople accounted for 55.4% of first-half sales but 58.5% of redemptions.
Six months of poor results might not be a sufficiently long period to scare investors into the arms of brokers. Yet these numbers also suggest that the commission-free share of the business is growing--and that do-it-yourself investors are more resilient than skeptics think.
* Avoid new mutual funds. One compelling reason to shun upstarts is that there are plenty of proven portfolios out there, so why take chances? A second rationale involves cost: If a new fund is unable to attract many investors, its pro rata expenses will stay fairly high, eating into shareholder returns.
But a separate Value Line study found some evidence to suggest that avoiding new funds might not always be a wise policy. The publication determined that new stock portfolios have a “strong tendency” to outperform their more-established peers during the first full calendar year of a fund’s existence.
The explanation is that new and thus smaller funds might be better able to take advantage of attractive initial stock offerings. In support of this view, Value Line discovered that the first-year edge is most pronounced among mutual funds that invest in small companies.
The upshot of this study is that investors should keep an open mind toward new stock funds, especially those run by established portfolio managers, according to Value Line.
But the publication found little evidence to suggest that new bond funds were bargains.
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It might be a case of putting the cart before the horse, but the Templeton Vietnam Opportunities Fund is scheduled to open for business this week. The fund, a closed-end portfolio, has been in the process of raising up to $120 million in a stock offering. Its shares will start trading on the New York Stock Exchange on Tuesday.
However, investors may have to wait a while to benefit from any increase in trade or production in the Southeast Asian country, one of the world’s poorest. “There exist only a limited number of Vietnam companies available to the fund for investment,” says its prospectus. “Securities markets are in the process of being established.”
In the meantime, lead manager J. Mark Mobius has leeway to invest in non-Vietnamese companies likely to benefit from their participation in the development of the country’s economy. Eventually, the fund will have at least 65% of its assets in local stocks and bonds.
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T. Rowe Price Associates of Baltimore ((800) 638-5660) has unveiled a series of asset-allocation funds.
Most aggressive is the Personal Strategy Growth Fund, which will normally maintain an 80% weighting in stocks, with the rest in bonds and cash. Most conservative is Personal Strategy Income, with 40% stocks, 40% bonds and 20% cash. Straddling the middle ground is Personal Strategy Balanced, with 60% stocks, 30% bonds and the rest in cash.
There are no sales charges on the funds.
