MUTUAL FUNDS / YEAR-END REVIEW : Whom Can You Trust? After a decade in which almost every manager could claim success, 1994 proved that most gains aren’t automatic--reminding investors that some strategies are better than others. : Bottom Line Is, It’s Up to You
People who like to put a good face on things say that 1994 was the year investors got educated about the risks in the financial markets. Less positive pundits maintain it was the year when nearly every investment strategy fell apart.
For mutual fund managers, it was largely a year of defeat. Funds with long histories of profitability fell into the negative columns--often for the first time ever. Managers who waxed fantastic about fail-safe “economic modeling” and “computerized strategic timing” stood agape as the risks in their portfolios--or errors in their computer programs--were exposed to the world. And investors big and small took it on the chin.
The average stock fund’s “total return”--price change plus any dividend income--was a negative 2.26% in 1994, according to fund-tracker Lipper Analytical Services in New York. Those who concentrated on bonds and bond funds fared even worse: The average taxable bond fund had a negative total return of about 3.3%, according to preliminary year-end data.
Even those who diversified--prodded by promises that one market would rise when another fell--were disappointed. In 1994, diversification allowed you variety only in losses. Balanced funds dropped about 2.5%. Growth funds were down 1.97%, environmental funds down 6.21%, financial services funds down 2.62%, and real estate funds down 2.06%. Gold funds plunged 12.13%.
Indeed, of 34 investment categories tracked by Lipper, only five were in the plus column.
In the end, 1994 shattered the trust of many fund investors. After all, if you can’t trust a fund manager who has never before had a bad year, if you can’t trust the planner who told you to diversify, if you can’t trust the bond market to be a haven for the risk-adverse, who can you trust with your money?
The answer is resounding, but not astounding: You can’t blindly trust anyone.
“More than anyone else, you have to trust yourself,” says Donald Phillips, publisher of Morningstar Mutual Funds in Chicago. “Even if you are using a financial planner, even if you are using a professional money manager or investing through mutual funds, you still need to have some appreciation of how different investments fare in different environments.”
“You have to take responsibility for your own future,” adds Joan Payden of the Los Angeles money management firm Payden & Rygel.
Indeed, the people who were hurt most in 1994’s bloodletting were those who were unaware of the risks they were taking, says Warren Lammert, portfolio manager of Janus’ Mercury fund--one of the few to post gains last year.
“It was the people who had unrealistic expectations and who were taking inappropriate risks who really suffered,” he says. “You have to commit some time to thinking about the nature of the investments that you purchase. If money market funds are all paying 2.5% but yours is paying 6%, you have to realize that there’s greater risk. To think anything else is to suspend disbelief.”
Self-reliance, always important, had been largely forgotten over the last decade while investors in a vast variety of stock and bond funds were earning double-digit returns. Investors became complacent, thinking that their managers--or simply the strength of the U.S. markets--would take care of them, some experts maintain.
Now investors must closely heed warnings to investigate their options and to never invest in funds they don’t understand. Those who don’t could be skewered, the experts say, because the bad times could get worse.
“Somewhere in the next 18 months, I think we will have an equity market that’s down by double digits,” says A. Michael Lipper, president of Lipper Analytical.
There is certainly a dissenting opinion. Although many people agree that stock prices are somewhat high, they disagree about whether the market will crash, drift lower or grow slowly until conditions catch up.
But these are simply the short-term predictions. If you have a long time-frame, you don’t have to worry about market conditions during the next few years. Those with shorter horizons would be wise to either examine the various predictions or keep their cash in bank deposits and short-term Treasuries until it’s clear which way the wind is blowing.
What caused the fund losses in 1994? Largely the good times that preceded them, experts say. Until fairly recently, returns in both the stock and bond markets had substantially surpassed their annual averages for several years running. Many expected a “correction” that would bring average returns closer to their long-term norms.
But it was postponed, thanks largely to rapidly declining interest rates during the early 1990s, which inspired investors to bail out of savings accounts and pour their money into stock and bond funds.
This massive shift of assets caused the mutual fund industry to double in size in less than five years. And it was largely credited with creating the upward momentum that spurred the now-evaporated double-digit annual returns and new market highs--even during the depths of recession.
It is also why many experts are so nervous about the stock market.
Now that interest rates are rising, individuals have other options, including savings accounts and Treasury bills, that are likely to offer a reasonable inflation-adjusted return--and the backing of the federal government to boot.
Certainly, over the long haul, equity mutual funds have proven to be better investments. But in the short term, they’re riskier.
When safer investments were paying too little to keep up with inflation, it was easy to justify taking the additional risk necessary with corporate stock funds. Now it is not. And all it takes for a stunningly deep bear market is for enough investors to pull enough money out of stocks.
Others worry about politics.
“The real wild card is on the political front,” says Christian Thwaites, vice president of Aetna Mutual Funds in Hartford, Conn. “If you get another impasse in Congress or a President who may change policies again, who knows what will happen.”
Political upheavals in Japan and, more recently, Latin America have underscored how important a stable government is to a stock market, Thwaites adds.
In years past, market experts said a way to get around one bad market was to invest in funds of another. “U.S. stocks looking thin?” they asked rhetorically. “Then put your money overseas.”
Europe, Asia and South America were supposedly on different economic cycles, sure to be going strong when the domestic market fell flat. Not so in 1994--and some say never.
In fact, world markets moved largely in concert last year, as they have many times in the past, says John Hickling, portfolio manager of several international stock funds at Fidelity Investments in Boston.
Why? The world’s largest companies--and often most attractive investment prospects--are already global, says Lipper. Coca-Cola is in Mexico. It’s in the Philippines. It’s in Europe and Japan--as are Ford, Mitsubishi and Daimler-Benz.
In other words, the prospects of companies no longer rely solely on the economy of their headquarters nation.
In the end, mutual fund investors in stock and bond markets must remember that they’re taking risks with their principal--and not to panic and pull out at every dip.
“Investors in stocks need to be aware that they can lose money,” says Lammert. “We have been through a 10-year bull market that has been one of the best bull markets of all time. To a certain extent, 1994 is a wake-up call to the fact that stocks are risky investments.
“They are appropriate for people who have a long time-frame, Lammert adds. “But in a two- to three-year time-frame, it is not uncommon to see the averages down 10% to 20%.”
If there’s a lesson to be learned from 1994, it’s that every risk eventually comes home to roost, says Phillips.
The good thing is that many of those risks were revealed last year. Smart investors can use 1994 as a guide to better evaluate whom to trust with their money--and just how far they can trust them.
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Can You Rely on the Numbers?
If you had spread your investments among the top long-term performers from last year, you would not have done particularly well in 1994. These were the ten mutual funds with the highest returns for the 10 years ending last December, and how they did in the last year.
10-year 1-year return return 1983-93 1994 Twentieth Century: Gift Trust 637.37% +13.5% CGM Capital Development Trust 617.07 -22.9 Merrill Pacific: A 479.58 +2.9 Fidelity Select Health 471.65 +21.4 Fidelity Magellan 441.67 -1.8 Prudential Utility: B 426.59 -8.5 Acorn Fund 421.02 -8.4* GT Pacific Growth: A 417.08 -19.7 Seligman Communication: A 411.31 +35.3 AIM Equity: Constellation: RTL 410.22 -1.3 AVERAGE OF 10 FUNDS 473.36 +2.59
* As of 12/23/94
Source: Lipper Analytical Services
