Ready-to-Wear Isn’t Always a Good Fit
John Rekenthaler’s mother-in-law recently asked for some help investing in mutual funds.
It was a smart request. As president of industry rankings giant Morningstar Inc., Rekenthaler has abundant resources for making choices. He could confer with analysts and spend days picking just the right mix of assets.
Instead, Rekenthaler quickly picked one fund that was “all she needed.”
Rekenthaler put his mother-in-law into a mutual fund that invests entirely in other funds.
“She doesn’t want to build a portfolio of five different funds, and I don’t think she should be in a narrower fund,” says Rekenthaler, who picked T. Rowe Price Spectrum Income, which invests only in T. Rowe Price funds. “A fund-of-funds offers broad diversification, relatively predictable performance, and, presumably, you won’t get clocked in any given period.”
That sounds like a panacea for investors facing data overload and selection paralysis, which is precisely why funds-of-funds are increasingly popular, along with asset-allocation and life-cycle funds. But, as those other types of funds have proved, creating something that is one-size-fits-all doesn’t mean that all investors will like the fit.
Funds that essentially offer a ready-to-wear portfolio have for years been a fringe offering made mostly by small companies and newsletter publishers. A 1960s scandal in which the most infamous fund-of-funds, Investors Overseas Services, lost investors’ money created a long-standing image problem. Securities and Exchange Commission rules also made it tough to establish funds-of-funds.
But the biggest problem may have been performance, which suffers from paying two management fees, first to the manager of the hybrid fund, then to the underlying funds. The nearly 50 funds-of-funds in existence have, on average, above-average expenses and below-average returns.
In October, however, a new securities law removed some of the regulatory barriers, and fund groups have jumped in with lower-cost entries. Fidelity and Scudder both recently announced new hybrids that will choose from the best of their company offerings, and discount broker Charles Schwab is opening three funds that will invest only among funds available in the company’s OneSource mutual fund marketplace.
By the end of 1997, industry watchers agree, most investment firms with $10 billion or more under management will create funds-of-funds or offer life-cycle or asset-allocation choices aimed at a similar audience.
“House” funds-of-funds, which invest only in funds run by their management, beat the expense problem. Vanguard STAR, T. Rowe Price Spectrum and Scudder’s Pathway funds do not charge extra fees, for example, and Fidelity’s new Freedom funds are adding 0.1% to the expenses paid to the underlying funds.
Fund-of-funds investment strategies are varied. Most come in conservative, moderate and aggressive flavors, although Fidelity’s offerings, for example, are life-cycle funds designed for investors with a certain time horizon and the funds automatically grow more conservative as shareholders near those long-term goals.
Independent funds-of-funds typically offer asset allocation with a bit of market timing, a large-scale, low-cost version of what a professional money manager might do with private clients.
That said, funds-of-funds are ideal only for novice investors or people who want to keep things simple. They are not “the deliverance” that some people will make them out to be.
Either a fund-of-funds is your only investment or a core holding for money with a specific objective--retirement or college savings--or it has no part in your portfolio. Notes Robert Markman of the Markman Multi-Funds: “It’s a legitimate alternative for someone who says, ‘I don’t know enough’ or ‘I don’t want this hassle anymore.’ ”
For anyone who has made asset-allocation or investment strategy decisions, a fund-of-funds is redundant. Funds-of-funds are not an asset class unto themselves; they are only worth owning if they serve their intended purpose.
“If you have five growth funds and three bond funds, or you have already allocated your money, a fund-of-funds just confuses what you have done with your money,” says Dan Gross, a principal with Scudder. “These are funds for people who don’t want to make those choices.”
Adds Rekenthaler: “It’s a concept that works for my mother-in-law but not for me personally. Once you establish that you want more funds and want to do more of the work yourself, it’s goodbye to the fund-of-funds. Until you get to that point, a fund-of-funds can be worth looking at.”
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Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.
