Mutual Funds Don’t Always Practice What They Preach
Don’t time the market. Invest long-term. Pay attention to an investment’s fundamentals, not short-term price gyrations.
These maxims have been pounded into Americans’ heads in the ‘90s, not the least by mutual funds eager to get, and keep, investment dollars. And there’s little doubt that most fund shareholders have followed this advice.
But what about your fund? Does it practice what it preaches?
The question is more than academic. With the stock market swinging wildly this year and long overdue for some kind of meaningful pullback, mutual fund managers may be facing their most challenging year since 1990.
And because of the sheer size of the stock fund industry, with assets now of $1.3 trillion, the funds aren’t simply affected by the market--they often make the market.
Do you know how your fund would react to a steep decline in stock prices? You may abhor the thought of trying to time market swings, but your fund manager may think it’s his or her duty. Likewise, you may be a true long-term investor while your fund is anything but.
Take the case of the country’s largest mutual fund, $56-billion Fidelity Magellan. Most people think of it as a stock fund, which it is, generally. But for his own reasons, manager Jeffrey Vinik sold many of the fund’s stocks near the end of 1995. As of Jan. 31, fully one-third of Magellan’s assets were in bonds and money market securities.
Some analysts describe Vinik’s move as a “conservative shift,” perhaps because he thinks stocks are overpriced. But given the carnage in the bond market this year as market interest rates have surged, “that bond position is not a conservative position,” argues William Dougherty, a principal at Boston-based mutual fund consultant Kanon Bloch Carre.
Vinik’s market-timing move may yet pay off, but that shouldn’t be what really matters to his shareholders. Rather, they should be asking whether they bought Magellan as a stock market investment or as an asset-allocation fund. If you wanted the former, right now you own the latter.
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There are some funds that pledge never to invest anywhere with your money except in stocks. The Twentieth Century stock funds, for example, are always fully invested, even when the market plummets.
“Our thinking is that people are paying us to have them invested in common stocks, not make a market-versus-cash decision,” says Gunnar Hughes, Twentieth Century’s veteran spokesman.
Yes, that means the funds will dive in a bear market. But Hughes also notes that staying 100% in stocks means there’s no chance of missing lightning-quick upward market moves, which is often how bull markets begin and how they periodically reassert themselves.
What’s more, historically “the market is up two years for every one down year, and the up years are twice as powerful as the down years,” Hughes says. “History and mathematics are on our side.”
It may come as a shock to many fund owners that relatively few stock funds take such an absolutist view of the market. In fact, most fund charters are written so broadly that managers could in effect sell all of their stocks if confident enough in their timing abilities--or if frightened enough by a market plunge.
How many would do so, in practice? Nobody knows. Half the stock funds in existence today weren’t around for the last bear market, in 1990. And that one was over pretty quickly.
Robert Markman, whose Markman Capital Management in Edina, Minn., picks funds for individual clients, makes a distinction between stock funds purchased more for their managers’ total market sense and those purchased more as specific asset choices.
With what he considers “core” funds, Markman says, “we’re buying in for the brains of the manager”--such as Mutual Shares fund’s Michael Price or Oakmark fund’s Robert Sanborn. Markman trusts them to make the right stock calls and the right overall market (asset-allocation) calls.
Other funds, such as Twentieth Century’s, are owned specifically because Markman knows they will always afford a bet on stocks.
What about your funds? Do your fund managers show a propensity for trying to time the market’s swings? If so, are you comfortable with that? Because the truth is, few market timers get it right--just as the mutual fund companies have been admonishing us for lo these many years.
There’s a related question worth asking: If you’re a long-term investor, is your fund also?
Most funds, in their annual reports, will list a figure for “portfolio turnover.” That tells you how long, on average, securities stay in the fund. A fund with 100% annual turnover essentially holds its stocks one year, on average. Generally, the higher the turnover rate, the more rapid the fund’s pace of trading, although turnover can be skewed by factors such as heavy cash inflows from investors.
There’s nothing inherently wrong with high turnover, of course. Those funds will usually admit that they are momentum-chasers, constantly hunting for the next hot market sectors, and sometimes paying little attention to companies’ long-term prospects.
But is that how you want your dollars invested? “The greatest hypocrisy in professional money management is that [funds] tell people, ‘Look long-term; judge us only over five to seven years.’ Yet they don’t extend that courtesy to Corporate America,” says Don Phillips, principal at fund-tracker Morningstar Inc.
The point is, you have a choice as an investor. Many funds adhere to buy-and-hold philosophies. And their returns, short- and long-run, can be just as good or better than those of high-turnover funds.
It’s not a case of right or wrong--just of knowing what you own, and why, and the risks. Spend time reading your funds’ 1995 annual reports. And if you still have questions, call the funds direct.
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The Funds: Investors -- or Traders?
You may be long-term investor in your stock fund, but does the manager invest for the long term, or does he or she actively trade the portfolio? The turnover rate of a portfolio tells you how often the investments are replaced in a given year. A 100% turnover rate means the average stock in the portfolio is held one year; a 200% rate indicates an average six-month holding period; a 50% rate, a two-year average holding period. Turnover rates for selected funds, and their 1995 and five-year total returns:
Low-Turnover Funds
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Annual Total return: Fund turnover 1995 5-yr. Franklin Growth 1% -38% +99% Vanguard Index 500 4 +37 +114 Mairs & Power Growth 5 +49 +173 Domini Social Equity 6 +35 n/a Oakmark 18 +34 n/a Inv. Co. of America 21 +31 +98 Clipper 31 +45 +142 Baron Asset 35 +35 +174 IAI Midcap Growth 51 +21 n/a Fidelity Destiny I 55 +37 +189
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High-Turnover Funds
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Annual Total return: Fund turnover 1995 5-yr. SunAmerica Small Co. 351% +50% +233% Founders Special 244 +26 +146 Brandywine 194 +36 +187 Maxus Equity 184 +22 +138 Fidelity Blue Chip Growth 182 +28 +189 Janus Twenty 147 +36 +127 AIM Weingarten 139 +39 +97 PBHG Growth 119 +50 +350 Robertson Steph. Value+ 115 +43 n/a Fidelity Magellan 97 +37 +153
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