Star-Studded Laggards List No Reason to Bottom-Fish
A lot of big-name funds put a disappointing third quarter into the record books.
It’s not surprising that funds followed the broad stock market into the tank in June and July, but it’s eye-catching to see which funds have been unable to halt the skidding during the August and September recovery.
Among the bottom 5% of all stock funds for the third quarter were media darlings Van Wagoner Micro-Cap (-6.3%), Mid-Cap (-0.4%) and Emerging Growth (-4.9%); Navellier Aggressive Small Cap (-3.9%); Baron Asset (-3.1%); Artisan Small Cap (-4.2%); Putnam OTC Emerging Growth (-1.3%); John Hancock Special Equities (-0.4%); Dominion Insight Growth (-2.5%); and Govett Smaller Companies (-4.9%), the last two having been the top growth and small-company funds, respectively, for 1995.
Some investors get nervous seeing so many studs on the laggards list, taking it as proof that the sky is falling. Others believe it makes this a good time for “bottom fishing.”
But this is neither a time for panic nor a time to search for the afflicted in hopes they will soon heal.
For starters, one quarter is far too little time on which to base judgments.
“When the quarter is a mixed affair, you won’t get a good measure of what funds have done,” says Thurman L. Smith of Equity Fund Research in Malden, Mass. “This quarter’s information really has been muddled, so a lot of people won’t find the numbers terribly useful. Worse yet, they will read the wrong things into the numbers and make mistakes.”
There is one major similarity in the big-name funds dotting the laggards list: This crop of fallen angels includes a host of aggressive-growth and small-company funds.
That trend brings us to bottom fishing--or buying current laggards in the hope they will turn around. It’s a stock-picking technique that some folks try to apply to mutual funds, with one big problem: It doesn’t work for funds.
With stocks, bottom fishing is a form of “value investing,” looking for a company that is undervalued--based on how the market feels about the company or industry--but is showing signs of an impending turnaround. Fund share prices, however, are based on the value of the securities in the fund and thus are priced fairly each day. Even a fund with downtrodden stocks ripe for a turnaround has shares that reflect the current market value of the securities and not the market’s sentiment.
In other words, a hot manager’s bad quarter is no indication that good times lie ahead.
“There is no guarantee you will get a bounce from a great manager who has done poorly for a quarter or two,” says Value Line Editor Stephen M. Savage. “You don’t know if the manager has held on to stocks that have declined or whether the manager has gone off and picked new lousy stocks.”
If you still believe in bottom fishing, focus on the asset class rather than on individual funds. Jon Fossel, chairman of Oppenheimer Funds, is noted for rolling his retirement monies each year into the two funds in his family with the worst performance from the previous year. His returns have beaten broad market averages, but even Fossel notes that his strategy was less bottom fishing than “sector rotation,” moving into arenas in the dumps for a year or more just as the economic cycle was taking over and bringing the assets into favor again.
“The third quarter might be disappointing, but it’s not worth making a change--especially when a lot of the current laggards did well earlier in the year,” says James Stack of the Investech newsletter. “Sit tight and expect a volatile roller coaster. If you aren’t in these funds right now, don’t assume that a fund going out of favor, as small caps seem to be right now, presents an immediate buying opportunity. Things could get worse before they get better, and if you try to bottom-fish with mutual funds--especially in this market--you may just get the bottom.”
