Style Sticklers : Pension Consultants Policing Fund Managers to See That They Invest as Advertised

NEWSDAY

The mutual fund style police seem to be out in force lately. But don't worry, it has nothing to do with the way you dress when you buy a fund (though we're not too sure about that tie).

"Style" is a mutual fund term that is supposed to tell investors how a fund will invest their money--i.e., the kinds of securities the portfolio manager will own.

If a fund says it is a "large-cap value fund," you wouldn't expect it to be investing heavily in small technology companies. If a fund bills itself a "small-cap growth fund," you expect it to own up-and-coming stocks, not blue chips. At least that's the theory.

But style drift has become a big issue in the fund industry. Drift occurs when a fund manager buys securities other than the ones the fund's investors think they're buying. It can lead to unexpectedly poor results--or to a spectacular performance a manager may not be able to replicate. And drift can mean unexpected volatility that upsets investors.

Now, some fund companies are promising to use something called institutional analysis to avoid style drift among their managers and to make sure their funds do what they say they're supposed to be doing. Some fund companies see this policing pledge as a marketing advantage.

"We were always extremely conscious of making sure our funds stuck to their charters," said Steven Norwitz, vice president at fund firm T. Rowe Price Associates.

The funds are being pushed in the direction of strict style adherence by consultants who advise companies on their 401(k) pension plans, by financial planners who handle investors' portfolios, and by fund-tracking services like Morningstar Inc., which recently revamped its fund style categories to more tightly define individual funds.

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They all are following the lead of large, traditional pension plans. Those plans often invest on an asset-allocation basis, choosing specific money managers for specific investment styles, and monitoring them closely.

"If you hired a small-cap manager who is supposed to invest in companies with revenue under $100 million, that manager has to report to your analyst, who will check the portfolio on a periodic basis," said Steven Treadway, executive vice president of Pimco Advisors, a Newport Beach-based company that manages institutional money as well as retail mutual funds. "If the . . . manager drifts into the mid-cap [company] range of $300 million to $500 million, they won't be able to get away with it."

Why? Because the pension plan may specifically want 10% of its assets in small-company stocks. By changing styles, "the manager has destroyed that mix and now there may be only 8% in small-cap" stocks, Treadway said. "They can, and do, fire you as a money manager" for such style drift.

It is that type of analysis--and pressure to stay on point--that some fund companies want to bring to bear on their managers now because so much money is coming to the funds from third parties, such as 401(k) pension consultants and financial planners.

"More and more [fund] companies are touting institutional analysis because they are selling the fund to a third party and that third party says, 'We don't have time to police this,' " said Don Phillips, president of Morningstar Inc.

In other words, the consultants and planners don't want surprises; they want to set up a particular asset mix and have the individual component funds within that mix act as expected.

Financial planner Ron Roge of Centereach, N.Y., agreed that style drift has been a problem. "In the past, we had some funds which had outstanding performance, and we wondered why it was so good compared to its peer group," he said.

Roge cited the Robertson Stephens Growth and Income stock fund, whose name implies a conservative-type investment and that did remarkably well a couple of years ago. "One-third of its assets were in gold stocks, not what I expected from a growth-and-income fund," Roge said. "But they made a timely bet on the gold market. The question is: Do people who buy [conservative] growth-and-income funds expect one-third of the money to be in gold stocks?"

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The fund cited most often as having had serious style drift is Fidelity Magellan, the $53-billion behemoth.

Magellan started 1995 as a diversified growth fund, then invested more than 40% of its assets in technology stocks. Then it sold the tech shares and jumped into government bonds in a big way.

The bond bet was a bad one, sharply limiting the fund's performance in the first half of this year and leading to manager Jeff Vinik's departure.

But when the issue is style adherence, the first problem is categorizing a fund's style. Fund companies and those evaluating them often disagree on style definitions.

Fund tracker Lipper Analytical Services, for example, lists Magellan as a "growth" fund. But Fidelity says Magellan is a "capital-appreciation" fund, a style typically allowed a lot more leeway in investments.

"You should expect more volatility in a capital-appreciation fund, which is allowed to seek the best total return," said Robert Reynolds, president of Fidelity's Institutional Retirement Group, which manages about $180 billion in 401(k) and other retirement money.

New York financial planner Joel Isaacson argues that Magellan's shifts "made it a market-timing fund and not a true growth investment. With each manager change, it changes. It seems to have no mandate."

Although style adherence has many fans, there is also a downside: Fund managers may lose the ability to make investment shifts that can produce above-average returns for investors.

"I think you will get a leveling off of performance" as more funds stick to specific styles, said Morningstar's Phillips. Investing only with money managers who follow very tight standards could cause you to exclude some great managers, he noted.

"Look at Warren Buffett. If you were investing with him, you would think he buys beat-up textile companies [like Berkshire Hathaway], but what do you do [to categorize him] when he starts buying Coke and Gillette?

"Some of the best managers can't be defined and won't work for you if they are going to be reined in," Phillips said.

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Even so, Morningstar has just changed the way it categorizes U.S. stock funds. Instead of traditional, often fuzzy categories--like growth or small-company--funds now are categorized according to the size and style of the stocks they buy: large-value, for example, or small-growth, or medium-blend.

Because of the growing power of 401(k) consultants and financial planners, the trend toward limiting style drift is only likely to accelerate. For investors, that should mean more predictability--more conformist funds, in other words--and perhaps fewer fund-manager rebels.

In the long run, are you better off with a conformist or a rebel, anyway? A study earlier this year by Morningstar found there is no conclusive evidence favoring either in terms of beating the market. "There's just no way to argue that tightly defined funds offer better performance," wrote John Rekenthaler, publisher of Morningstar's Mutual Funds research service. At the same time, he said, "eccentric funds haven't consistently outdone their plain-vanilla rivals."

Times staff writers contributed to this report.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Mutual Fund Style Analysis

A look at how one style analysis breaks down the largest U.S. mutual funds. This describes each fund based on how its performance compares with various benchmarks, rather than by its actual portfolio. Funds will rarely disclose what's in their portfolios except in semiannual official filings.

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12-mos. thru 10/31: Style Selectn Fund Fund name Ticker return return return Fidelity Magellan Fund FMAGX 20.26% -12.06% 8.20% Investment Co. of America AIVSX 20.76 0.05 20.81 Vanguard Index Trust: 500 Portfolio VFINX 24.15 -0.17 23.97 Washington Mutual Investors Fund AWSHX 22.61 2.73 25.35 Fidelity Contrafund FCNTX 18.84 1.22 20.06 Fidelity Growth & Income Portfolio FGRIX 21.04 2.23 23.27 Fidelity Puritan Fund FPURX 17.37 0.59 17.96 Twentieth Century Inv: Ultra Investors TWCUX 17.15 -6.37 10.79 Vanguard Windsor Fund VWNDX 23.25 -0.09 23.16 Income Fund of America AMECX 11.43 5.02 16.45

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CATEGORIES Fixed Large-val Large-gro Med-val Med-gro Fund name cash income stock stock stock Fidelity Magellan Fund 0.00 0.05 0.33 0.00 0.19 Investment Co. of America 0.00 0.13 0.46 0.31 0.00 Vanguard Index Trust: 0.00 0.00 0.49 0.50 0.00 500 Portfolio Washington Mutual 0.00 0.07 0.75 0.18 0.00 Investors Fund Fidelity Contrafund 0.00 0.00 0.23 0.00 0.16 Fidelity Growth & 0.05 0.00 0.41 0.19 0.03 Income Portfolio Fidelity Puritan Fund 0.13 0.17 0.43 0.00 0.00 Twentieth Century Inv: 0.00 0.00 0.00 0.00 0.00 Ultra Investors 0.00 0.00 0.00 0.00 0.00 Vanguard Windsor Fund 0.00 0.00 0.76 0.00 0.00 Income Fund of America 0.00 0.58 0.26 0.03 0.11

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CATEGORIES Small-val Small-gro Fund name stock stock Stock Foreign R2 Fidelity Magellan Fund 0.32 0.00 0.00 0.11 0.83 Investment Company 0.06 0.00 0.00 0.03 0.97 of America Vanguard Index Trust: 0.00 0.00 0.00 0.00 1.00 500 Portfolio Washington Mutual 0.00 0.00 0.00 0.00 0.94 Investors Fund Fidelity Contrafund 0.31 0.17 0.01 0.12 0.88 Fidelity Growth & 0.00 0.22 0.01 0.10 0.94 Income Portfolio Fidelity Puritan Fund 0.00 0.15 0.00 0.13 0.89 Twentieth Century Inv: 0.84 0.00 0.16 0.00 0.80 Ultra Investors Vanguard Windsor Fund 0.00 0.24 0.00 0.00 0.79 Income Fund of America 0.00 0.00 0.02 0.00 0.87

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Chart explanations:

Style return: The total 12-month return of a hypothetical portfolio invested in these benchmark indexes in the percentages indicated.

Fund return: The fund's 12-month return.

Selection return: The difference, positive or negative, between each fund's actual return and the 12-month style return.

Categories: The fund's estimated portfolio in percentage terms based on the analysis. Several bond and mortgage security categories using Lehman Bros. indexes as a benchmark are combined. Small value and growth categories are based on the Russell 2,000; medium categories are based on the S&P; MidCap 400; larger categories are based on the S&P; 500. The "value" portion of each index is the portion with a lower price-to-book ratio. Foreign stocks are based on the Morgan Stanley EAFE index.

R-squared: A measure of how closely the analysis explains the fund's behavior. The program finds the "best fit" but rarely fully explains the fund.

Source: Advisor Software, Orinda, Calif., (510) 253-5090. For more information, go to http://ww.advisorsw.com on the World Wide Web.

For the Record Los Angeles Times Wednesday December 11, 1996 Home Edition Business Part D Page 11 Financial Desk 19 inches; 674 words Type of Material: Infobox; Correction; List Mutual fund chart--Several columns were mislabeled in a chart in Tuesday's Business section. The corrected chart appears at right. (The data in accompanying stories were correct.) The chart outlines a computer-generated estimate of what categories make up each fund's investment portfolio, or its "style." The style analysis is indirect--usually you can't find out what is in a mutual fund except in official filings twice a year. The computer program does the analysis by juggling the actual return numbers of a fund for various periods with the returns on various benchmark indexes, and searches for the best "fit"--the combination of index components that would best explain the performance of the fund. In other words, regardless of what a fund actually owns, the computer determines that it has behaved as if its holdings were categorized as indicated. (BEGIN TEXT OF INFOBOX / INFOGRAPHIC) Mutual Fund Style Analysis A look at how one style analysis breaks down the largest U.S. mutual funds. This describes each fund based on how its performance compares with various benchmarks, rather than by its actual portfolio. Funds will rarely disclose what's in their portfolios except in semiannual official filings. *--* 12-months through Style Selectn Fund name Ticker return return Fidelity Magellan Fund FMAGX 20.26% -12.06% Investment Company of America AIVSX 20.76 0.05 Vanguard Index Trust: 500 Portfolio VFINX 24.15 -0.17 Washington Mutual Investors Fund AWSHX 22.61 2.73 Fidelity Contrafund FCNTX 18.84 1.22 Fidelity Growth & Income Portfolio FGRIX 21.04 2.23 Fidelity Puritan Fund FPURX 17.37 0.59 Twentieth Century Inv: Ultra Investors TWCUX 17.15 -6.37 Vanguard Windsor Fund VWNDX 23.25 -0.09 Income Fund of America AMECX 11.43 5.02 Oct. 31: Fund Fund name return Fidelity Magellan Fund 8.20% Investment Company of America 20.81 Vanguard Index Trust: 500 Portfolio 23.97 Washington Mutual Investors Fund 25.35 Fidelity Contrafund 20.06 Fidelity Growth & Income Portfolio 23.27 Fidelity Puritan Fund 17.96 Twentieth Century Inv: Ultra Investors 10.79 Vanguard Windsor Fund 23.16 Income Fund of America 16.45 *--* *--* Categories Fixed Large-val Large-gro Fund name cash income stock stock Fidelity Magellan Fund 0.00 0.05 0.33 0.00 Investment Company of America 0.00 0.13 0.46 0.31 Vanguard Index Trust: 0.00 0.00 0.49 0.50 500 Portfolio Washington Mutual 0.00 0.07 0.75 0.18 Investors Fund Fidelity Contrafund 0.00 0.00 0.23 0.00 Fidelity Growth & 0.05 0.00 0.41 0.19 Income Portfolio Fidelity Puritan Fund 0.13 0.17 0.43 0.00 Twentieth Century Inv: 0.00 0.00 0.00 0.00 Ultra Investors 0.00 0.00 0.00 0.00 Vanguard Windsor Fund 0.00 0.00 0.76 0.00 Income Fund of America 0.00 0.58 0.26 0.03 Med-val Fund name stock Fidelity Magellan F
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