Mutual Funds: THIRD-QUARTER REVIEW FOR INVESTORS : FIVE WAYS TO FIGHT FLAT RETURNS

By KATHY M. KRISTOF

Oct. 2, 1994 12 AM PT

Even if you are frustrated by the stock market’s lackluster performance, you don’t have to throw in the towel. You can earn respectable returns on mutual funds in flat or bad markets, experts say, and you needn’t give up diversification to do it.

Today, many fund managers are looking to overseas markets and investments shunned in better times--namely, commodities such as gold, oil, paper and industrial metals. Others are making money by betting against stocks.

Here’s a look at the approaches of five successful fund managers.

T. ROWE PRICE SPECTRUM GROWTH

Peter Van Dyke, president of the T. Rowe Price Spectrum Growth Fund, doesn’t have to search far to scan his universe of potential holdings. Instead of investing in particular stocks and bonds, Van Dyke invests his fund’s assets in seven other T. Rowe Price funds. These seven funds specialize in everything from foreign equities and domestic growth stocks to income-producing stocks and cash.

The point of managing a fund that invests in other funds is diversification, Van Dyke says. Diversification limits stomach-churning market swings and, over the long haul, should provide a healthy return to investors.

Van Dyke is currently promoting three “themes” with Spectrum’s investments: International, growth stocks and natural resource companies.

The choices reflect Van Dyke’s conviction that many parts of the U.S. stock market have become overheated, but that stock markets in other parts of the world are another story. Many foreign economies are still battling their way through economic downturns. Some are just beginning to recover. Their stock markets haven’t fully accounted for the coming recoveries, he says.

“By going to the international markets, you can pick up some equity returns that beat U.S. returns,” Van Dyke says. And you can reduce the overall volatility of your portfolio, because domestic and foreign markets are functioning on different economic cycles, he adds.

The Spectrum Fund is limited to investing no more than 20% of its assets overseas. Van Dyke has been staying close to that limit for two years. If he could invest more of the fund’s assets internationally, he would, he says.

The Spectrum fund is limited to investing no more than 20% of its assets overseas. Van Dyke has been staying close to that limit for two years. If he could invest more of the fund’s assets internationally, he would, he says.

In the domestic market, Spectrum is most heavily invested in T. Rowe Price funds that target fast-growing small companies, because Van Dyke thinks small firms’ prospects are better than those of bigger firms. He is also hot on funds holding natural resource companies that tend to do well toward the end of economic cycles.

So far this year, Van Dyke’s fund has done only slightly better than the market as a whole. Some experts say that’s nonetheless impressive--mainly because the fund has proved to be less volatile, and thus safer, than similar stock investments.

* Assets: $843.1 million

* Objective: Long-term growth by investing primarily in a diversified group of T. Rowe Price mutual funds that invest in equity securities.

* Top three investments:

T. Rowe Price International Stock Fund

T. Rowe Price Growth Stock Fund

T. Rowe Price New Horizons Fund

* Sales charge: None

* Annual expenses: 0.0%

* Performance: +2.9% YTD

* Phone: (800) 638-7980

SOGEN INTERNATIONAL

When domestic interest rates ticked up this year, Jean-Marie Eveillard, manager of SoGen International Fund, bought fixed-income securities. Now 11% of SoGen International’s assets are in U.S. corporate bonds and dollar-denominated South American notes that pay double-digit yields.

Historically, returns in the stock and bond markets have averaged between 9% and 10%, he explains. “So, if I can get a five-year piece of paper with a 10% yield, I’m going to just sit and clip coupons.”

The rest of the fund’s assets are in cash (22%), foreign stocks (35%) and gold-related securities (10%). Only 22% of SoGen International’s assets are invested in the domestic stock market. Why? There are few bargains in the U.S. stock market today, Eveillard says.

Some foreign markets look better, but today’s “synchronized worldwide economic recovery” is sure to spur some inflation. And, as far as stock and bond markets go, inflation spells n-e-r-v-o-u-s in all languages. The few stocks Eveillard is still buying are in businesses that do well when inflation is rising: base metals, forest products and real estate. And because he considers himself cautious, he is maintaining a healthy cash cushion to soften market blows.

“We have always been on the side of caution,” Eveillard says. “When the markets are strong, that was not so good. But we hold up well in a difficult market.”

Eveillard’s strategy proved so attractive to skittish investors that they were pouring roughly $2 million a day into SoGen International earlier this year. Given the lack of opportunities in today’s market, Eveillard says, he couldn’t invest the money fast enough. He closed the fund to new investments and plans to keep it closed until investment opportunities improve.

“Otherwise we would begin to look like a money market fund, with 40% to 50% of our assets in cash,” he explains.

* Assets: $1.9 billion

* Objective: Long-term growth primarily through investments in common stocks of U.S. and foreign companies.

* Top three investments:

Bank for International Settlements bonds

Freeport McMoran, preferred B, C & D

Carter Holt, NZ

* Sales Charge: 3.75%

* Annual expenses: 1.28%

* Performance: +6.1% YTD

* Phone: (800) 334-2134

DREYFUS SPECTRUM GROWTH

If you think other experts sound negative about the market, you should talk to Robert K. Jermain, who manages Dreyfus Corp.’s Strategic Growth Fund.

“We are calling for a real live bear market--not an 8% to 10% correction like we had earlier this year,” Jermain says.

Translation: U.S. stock prices should fall 25% to 35% from their current levels before trending back up, he says. “There are signs out there that things are getting a little choppy. In our opinion, the next move of any significance will probably be down.”

How does a stock fund manager handle such a bleak scenario?

A whopping 63% of Strategic Growth’s assets are now in cash; about 25% is bet against the market in so-called “short” positions. The remainder is invested in the shares of commodity-producing companies--oil, gas, paper, lumber, gold and other metals.

Why is Jermain so sure the market is on its way down?

Historically, market meltdowns come when stock prices become overvalued as measured by a plethora of gauges, such as price-to-book values, price-to-earnings, price-to-cash flow and dividend yield, Jermain says. All those gauges indicate that U.S. stock prices are currently at pre-crash levels. Stock prices are more overvalued than they were before the 1987 crash; more overvalued than before the corrections in 1969, 1972, and 1990. They’re even more overvalued now than they were before the crash in 1929, Jermain says.

Also ominous are rising interest rates. That’s bad for the market simply because it gives investors other viable investment opportunities.

By and large, Jermain is most negative about small, fast-growing companies and health care concerns that have rocketed in price over the past several months. He’s “short-selling” these issues. That means he agrees to sell borrowed shares and repay those shares later. If the share price goes up, he loses. If it goes down, he collects a handy profit.

Largely because of his short positions, Jermain’s fund was the top-performing “flexible portfolio” fund during the market’s midyear slide. But when stock prices rose strongly in August, Dreyfus Strategic Growth took it on the chin. For the first nine months of 1994, the fund is up only 5.9%.

* Assets: $97.9 million

* Objective: Long-term growth by investing in domestic companies, foreign companies and governments, as well as speculative techniques such as short selling, leverage and options.

* Top Three Investments:

Standard & Poor’s 500 (short position)

Oxford Health Plans (short)

Cash (short-term instruments)

* Sales charge: 3%

* Annual expenses: 1.62%

* Performance: +5.9% YTD

* Phone: (800) 896-2649

FRANKLIN EQUITY INCOME FUND

Find an industry in trouble and Frank Felicelli is there. Whether it’s health care concerns threatened by reform or utility stocks that have fallen 30% from their highs, the manager of Franklin Management’s Equity Income Fund is willing to boldly go where others have fled.

“We have a fairly conservative strategy,” Felicelli says. “We invest in large companies. But we buy them when they are out of favor and we can get them at a very attractive dividend yield.”

Dividend yields on the Equity Income Fund’s shares average 5.4%, compared with an average yield of 2.7% for the S&P; 500, he notes.

The fund does shy away from companies and industries that appear unlikely to recover. But industries that have simply taken hits because political or economic tides have turned against them are standard fare.

How does he separate the underdogs from the underachievers?

“We look at a number of measurements--price-to-book, price-to-cash flow, price- to- normalized earnings,” Felicelli says. “If we do it right, we buy companies when they are so depressed that all they can do is go up.”

Health care stocks--particularly pharmaceuticals--are now among Felicelli’s favorites.

“We find that stocks move from extreme favor to extreme disfavor in a three-year cycle. Health stocks peaked in the fourth quarter of 1991 and are now approaching their three-year anniversary of being out of favor,” he notes. “Fundamentally, we think the companies have performed better than market expectations. Profit margins have stabilized and improved.

Felicelli also likes many of the major oil companies and numerous utilities, including Pacific Telesis and Dominion Resources. Utilities tend to get hit in times of rising interest rates, Felicelli notes. But utility stock prices have already plunged dramatically from their 1993 peak. It will take some time before the stock prices begin to come back, he adds, but in the meantime, investors can pick up some healthy dividend yields.

* Assets: $87 million

* Objective: High current income and capital appreciation through purchase of a diversified portfolio of common and preferred stocks.

* Top three investments:

Bristol Myers

American Home Products

Kmart

* Sales Charge: 4.5%

* Annual expenses: .79%

* Performance: -0.7% YTD

* Phone: (800) 342-5236

FIDELITY VALUE FUND

Jeff Ubben has been managing the Fidelity Value Fund since late 1992. In that time, the fund’s assets have doubled and it has handily outpaced the Standard & Poor’s 500 market average.

This year, while many other fund managers were twisting in the wind, Ubben produced a healthy 9.3% return for the Value Fund’s investors through Sept. 30. His secret?: World commodities.

Ubben believes that the financial markets have drastically underestimated the effects of a rising standard of living in underdeveloped countries such as China and India. And those improving standards are igniting an industrial and infrastructure buildup in the Third World.

“I don’t think many people appreciate the industrialization that we could go through in Third World countries,” Ubben says. “You always make money in commodities when demand surprises you.”

This year, Ubben has invested heavily in companies that produce oil, chemicals, aluminum and other industrial products. He’s also weighted heavily in Japanese exporters, who are suffering now but are likely to reap substantial rewards if the dollar gains ground, as Ubben is sure it will. He is convinced that currency markets have battered the dollar down further than any likely economic scenario would warrant.

Ubben has a significant amount of his money in foreign markets--9% in Japan, 7% in Canada and 5% to 6% in Europe. These investments are mainly in companies that are producers of commodities such as oil, paper and aluminum. And many of them sell their products in U.S. dollars, reducing currency risk. Still, the dollar’s recent pummeling “isn’t helping me at all,” Ubben complains. Nonetheless, he’s sure the dollar will come back, and his fund may benefit when it does.

He stresses that in tough markets, you’ve got to be light on your feet. Once the stocks in his fund hit particular targets, “I’m gone,” he says. “I always sell early.”

* Assets: $3.3 billion

* Objective: Capital appreciation through investments in undervalued companies.

* Top three investments:

Alcan Aluminum

British Petroleum

Schlumberger Ltd.

* Sales charge: None

* Annual expenses: 1.11%

* Performance: +9.3% YTD

* Phone: (800) 544-8888