When to Say Goodbye

Many sources tell you what funds to buy--magazines, newspapers, brokers and friends among them.

But who tells you when to sell? What happens after your investment has languished for months or years? Those same sources rarely suggest what to sell, which explains why Roy Weitz is starting to gain attention in the investment world.

Weitz, a certified public accountant who is chief financial officer for a private foundation, also runs FundAlarm.com, a World Wide Web site that provides tips and signals on selling funds. The Web site is free and not affiliated with any fund company.

FundAlarm.com tracks 1,400 stock and balanced funds, evaluating manager tenure, asset size and risk. But Weitz’s decision to suggest selling a fund is entirely based on underperformance over time, relative to index fund benchmarks.

Weitz operates the site as a hobby. He hasn’t quit his day job. But he has experience with financial planning, including several years at Price Waterhouse.

Weitz’s approach to selling isn’t perfect. His choice of benchmarks is questionable for certain funds, and he doesn’t examine the impact of sales charges or expenses. Also, he tracks performance only over the last five years. Funds that have lagged in that bull-market period might fare better in a bear market.

But Weitz does provide a credible second opinion for investors who may be thinking about selling. At a minimum, his signals should encourage further digging by disgruntled shareholders in laggard funds.

Weitz was interviewed by Russ Wiles, a mutual-funds columnist for The Times.

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Times: What’s your system all about?

Weitz: It weighs and balances multiple factors. I provide some of the most important tools that people need in the sell decision, such as information on whether your manager has left and whether the assets of the fund have increased dramatically, which can influence a fund’s “style consistency” [ability to stick to the kind of stocks it says it will buy].

Probably the most important factor is performance, and I evaluate this for each fund against both a benchmark and a peer group of similar funds. Risk is another factor I consider.

Times: What prompted you to start this Web site?

Weitz: I wanted to learn more about the Internet through a real-life project. At the same time, I realized I didn’t know a lot about some of my own mutual funds. I owned Neuberger & Berman Guardian at the time, and I noticed its performance was deteriorating somewhat, but I didn’t know why.

While there’s a lot of information about buying, there are comparatively few tools that people can use to make sell decisions.

Times: In comparing performance, you use index mutual funds rather than the indexes themselves. For example, the Vanguard Index Trust 500 Portfolio is one of your benchmarks, rather than the S&P; 500 itself. How come?

Weitz: Partly, it’s because performance information is easier to come by on the funds. Also, there’s a bit of unreality associated with the actual indexes [since most people can’t invest in them directly].

Also, the use of a real fund highlights an opportunity cost for shareholders in a bad fund. That is, they could have been invested in a better benchmark fund that really exists.

Times: Which performance benchmarks do you use?

Weitz: For large-stock funds, I use the Vanguard Index Trust 500 Portfolio. For mid-cap funds, I use Dreyfus Mid-Cap Index. For small-cap funds, I use Vanguard Index Small Cap.

Schwab International Index Fund is my benchmark in the international area, and Vanguard Balanced Index for balanced funds.

For specialty funds, which invest in companies in specific industries such as financial, health care or real estate, I’ve created my own benchmark, which is the average performance of all of these specialty funds. I also examine a fund’s peer groups, focusing primarily on investment style. For example, I compare value-oriented large-stock funds to other value-oriented large-stock funds.

Times: Do you look at bond funds too?

Weitz: No. I may add those down the road, but I haven’t yet.

Times: How does manager tenure factor in as a potential sell criterion?

Weitz: What I suggest to people is that if they bought a fund because a specific manager was on board and that manager suddenly leaves, then this is something they should be concerned about. But if they never cared much about a manager, his or her departure shouldn’t be a big issue.

Times: How about rapid asset growth--wouldn’t that be of concern only for certain types of funds?

Weitz: Yes. For S&P-index; funds, which invest in large stocks, asset growth is basically irrelevant. It’s most relevant for small-stock funds. But even then it’s hard to know exactly what to make of rapid asset growth. If you see a fund’s size swelling over 12 months and notice that its performance has worsened, it’s tempting to attribute the poor performance to asset growth, but you can’t prove it.

Times: Briefly describe your alarm system.

Weitz: I have a term, “three alarm,” to highlight those funds that have underperformed one of their benchmarks for the past 12 months, three years and five years. This is the only signal I give. I just want to highlight the most serious underperformers.

Times: So a fund either would be rated a three-alarm sell candidate or it wouldn’t have a rating. In other words, you don’t highlight one- or two-alarm funds.

Weitz: That’s correct.

Times: Why don’t you also track performance using 10-year or 15-year results--isn’t a longer record better?

Weitz: I think five years is enough time to give a fund the benefit of the doubt. For someone to be patient through five years of bad performance, that’s remarkable. I don’t think there are many people who would suffer through 10 years of bad performance.

Times: Is yours an approach that promotes market timing?

Weitz: I hope not. Personally and professionally, I’m a buy-and-hold investor. I think people should buy very carefully, for reasons that they can articulate. Then, they should give a fund at least three years to show what it can do. I’m a strong disbeliever in market timing or chasing hot funds based on short-term performance.

Times: How does your system account for risk?

Weitz: For each fund, I take its three-year median return, then subtract its three-year standard deviation [a measure of how widely the fund’s performance tends to fluctuate over time] to come up with a number that reflects what I call the “potential down year.”

I then calculate the potential down year of a fund’s benchmark, and I compare them. To the extent that a fund’s potential down year is significantly worse than that of the benchmark, I label that fund as risky.

Times: But you don’t recommend that people sell funds based on their riskiness.

Weitz: No. But it’s a factor that people should look at. If you own a three-alarm fund, that’s a signal. The idea isn’t necessarily that you should sell the fund now, but you should look at it closely.

Times: You mentioned earlier that Neuberger & Berman Guardian was the fund that got you to thinking about selling. Do you still own it?

Weitz: No. I finally sold it on Jan. 2, so that the tax bill would come this year.

Times: What funds do you own personally?

Weitz: I have Longleaf Partners, FDR Financial Services, T. Rowe Price Science & Technology, Vanguard Specialized Health, T. Rowe Price Europe and MAS High-Yield Institutional. Also, I just bought Vanguard Index 500 to replace Neuberger & Berman Guardian.

Times: You don’t own a lot of funds.

Weitz: No. I focus on funds that fit a place in my portfolio and are good performers. When people own too many funds, it’s too easy for them to dismiss mediocre performance here and there. I’d rather insist that each fund performs well because I’ve got a lot riding on each one.

Times: Do you think there’s an optimal number of fund holdings, above which it’s self-defeating for an investor to add more?

Weitz: There probably is. I think most investors should have exposure to large, medium and small U.S. stocks, plus a broadly diversified international fund and maybe a foreign-regional fund. So that’s maybe five funds. I don’t have a diversified international fund, but I feel pretty good about Europe.

You might also want to add one or two sector funds--maybe geared to gold or an industry with a promising future. I certainly think that health care, technology and financial services all are industries of the future. If those sectors don’t do well long-term, I don’t know what will.

Times: You are a CPA, so I can’t help but ask about your feelings regarding selling and taxes.

Weitz: I think people need to consider taxes before selling. You often can make a compelling case to sell a fund but you need to be sensitive about not making a foolish decision from a tax perspective. Sometimes, if the tax burden is potentially painful, you may have to bite the bullet and hold an underperforming fund a bit longer.

Personally, I have decided to hold my bond fund in a taxable account and my stock funds in my IRA because it gives me more freedom to sell my stock funds when they need to be sold, without having to worry about tax considerations. I almost didn’t sell Neuberger & Berman Guardian because it was in a taxable account, and I didn’t want to pay taxes. From now on, I will hold in my IRA those funds that I might want to sell in the future. I like the flexibility of being able to make changes whenever I want.

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Profile

Who: Roy Weitz

What: Runs FundAlarm.com, an independent Internet site dedicated to mutual fund sell signals. Address: https://www.FundAlarm.com

Full-time job: Chief financial officer of a family foundation in West Los Angeles. Formerly worked for Price Waterhouse, most recently as a director in charge of financial planning.

Quote: “I think five years is enough time to give a fund the benefit of the doubt.... I don’t think there are many people who would suffer through 10 years of bad performance.”

Current sell recommendations: FundAlarm.com now has sell signals on about 350 funds, including such well-known names as American Century Ultra, CGM Mutual, Fidelity Magellan, Growth Fund of America, Janus Fund and Vanguard Windsor.