Calculated Risks

Sheldon Jacobs wrote the book on mutual funds--or at least one of the first such books, back in 1974.

“Put Money in Your Pocket,” a how-to book about no-load (no sales charge) funds, preceded by five years Jacobs’ founding of his newsletter, the No-Load Fund Investor, which he has since built into one of the most respected and best-performing fund advisory letters.

It’s also one of the most complete newsletters devoted to funds, tracking nearly 800 no-load and low-load portfolios.

Jacobs’ model portfolio fund recommendations earned a 14.1% average annual return over the 10 years through March 31, according to the Hulbert Guide to Financial Newsletters in Alexandria, Va.

That put Jacobs in the third-best spot, in terms of risk-adjusted performance, among 68 newsletters Hulbert tracked over that period.

Although the stock market overall, as measured by the Wilshire 5,000 index, gained 18.1% a year in that period, Jacobs’ portfolio was 33.5% less volatile than the market, according to Hulbert. Managing volatility, and risk, are key elements of Jacobs’ strategy.

For Jacobs, a South Dakota native who earned a bachelor’s degree from the University of Nebraska, investing was a second career. He started out as a media researcher for the ABC and NBC television networks.

Jacobs, who also manages $400 million in mutual fund assets with partner Bob Brinker, lives in Irvington-on-Hudson, N.Y. He was interviewed by Russ Wiles, a mutual fund columnist for The Times.

Times: You made an unusual career switch going from a job in television to investments.

Jacobs: I always was interested in investing. I bought my first stock at age 17--Homestake Gold Mining, which was the local business where I grew up. At one point, I even tried to find a job as a securities analyst.

It sounds like an unusual transition, going from television to investing, but it really wasn’t that difficult. Because what I did in television was forecast audiences. Once you learn how to do forecasting, it’s not that big of a change going from audiences to mutual fund performance.

(Forecasting) is being able to look at the past and decide what factors in the past are relevant for the future.

Times: You have three “model portfolios” of recommended no-load funds. What types of investors are they geared to?

Jacobs: Our Wealth Builder portfolio is designed for growth investors and typically stays 100% in equity funds. Pre-Retirement is for people within 10 years of retirement and has been running about 20% in bond funds (the rest in stock funds). The Retirement portfolio, which I characterize as for young retirees, has been roughly 35% in bond funds.

While these portfolios appeal to people at various life stages, they also represent three different risk levels. Right now, the average beta on Wealth Builder is 0.74, meaning the portfolio is roughly one-fourth less risky than the market. Pre-Retirement is even less risky, with an average beta of 0.6 and Retirement, even more so at 0.44.

Times: You continue to use beta as a risk-measuring statistic, when a lot of advisors have stopped paying attention to it. Why do you still think it has value?

Jacobs: Beta has a lot of faults and can be misleading. But I use it because it’s so understandable. I’d rather use beta, for which somebody can grasp the concept quickly [of relative volatility], rather than other measures, which in many respects are better but are more difficult to comprehend.

Times: Explain how and when you change your mix of funds and thus the total portfolios’ expected price swings relative to the stock market overall.

Jacobs: What I do is simply alter the risk level of the model portfolios depending on my general outlook for the stock market. In 1991, for example, the average beta in Wealth Builder was as high as 1.10. Then I brought it down gradually until it neared 0.70 or so by 1994. Later, I brought it way up again, then brought it down a little bit last week.

My long-term forecast, however, is extremely bullish. I’m predicting the Dow index will hit 21,200 by the year 2010. So basically I want to stay fully invested. But if the market’s high like it is today, I just bring down the riskiness of the model portfolios. That makes more sense than trying to time the market.

Times: How, specifically, do you pick individual mutual funds?

Jacobs: First, we have two sets of recommendations. In our tables, we boldface and recommend about one-fourth of the funds in each category, based on best-of-category performance.

But in our model portfolios, we’re trying to achieve certain overall risk and diversification levels. We have about nine funds in each portfolio, and we want each portfolio to be a complete investment program at a given risk level.

These funds are selected not just because they’re among the best performers, but also because we think they fit together well with the other funds.

Times: What factors do you focus on?

Jacobs: Obviously, we use past performance as the starting point. Then, I add in any number of subjective factors. I’ve been around a long time. I know many portfolio managers personally. I have opinions on management companies.

Also, portfolio size is a factor. A fund’s cash position is a factor. My viewpoint on the market’s direction is a factor. For example, if I’m bearish, I wouldn’t keep speculative funds in a model portfolio.

Times: What time periods do you favor in judging fund performance?

Jacobs: In the newsletter we look at seven periods ranging from one month to five years. I like funds that do well over the short, intermediate and long terms, up to five years. But I pay most attention to the latest year’s performance.

Times: That’s at odds with the conventional wisdom in evaluating funds, which seems to favor lengthier track records.

Jacobs: I think the conventional wisdom is changing. Originally, this whole idea of looking at five- or 10-year records was, to some extent, promulgated by salesmen who were trying to justify loads. I never thought there was a lot of research to back it up.

Times: So you don’t think it’s necessary to stick with a fund through a full cycle of bull market and bear market--maybe five to seven years--to assess its performance?

Jacobs: Absolutely not. As a matter of fact, it makes more sense to shorten your focus these days because if a fund is any good, it will have ballooned past its optimum size if you wait two or three years. And if you’re buying an aggressive-growth fund, for example, you don’t expect it to do well in a down market, so why would a long record matter?

Times: What are some of your favorite funds?

Jacobs: I like the Marsico Focus Fund (phone: [888] 860-8686) very much, and a similar fund, PBHG Large Cap ([800] 433-0051). Both are concentrated portfolios. I think the time when [every stock] goes up is drawing to a close, so focused funds run by people who are great stock pickers offer advantages.

For overseas investing, Scudder Greater Europe ([800] 225-2470) is doing a phenomenal job. And for the core of their portfolios, I think people should be in index funds.

Times: Do you mean index funds pegged to the Standard & Poor’s 500?

Jacobs: No. I don’t recommend S&P; 500 index funds because they’re too heavily weighted toward large stocks. My two favorite index funds are Vanguard Total Stock Market ([800] 662-7447), which replicates the Wilshire 5,000 index [the broadest market index], and Schwab 1,000 fund ([800] 435-4000), which covers 1,000 companies.

Schwab 1,000 was launched in 1991 and has never paid a capital-gains distribution. Under the new tax law, I’m much more concerned about tax efficiency.

Times: You didn’t mention expenses. Do they factor into your fund-selection process?

Jacobs: One reason I like index funds for a core portfolio holding is because of the low expenses.

Expenses are very important over the long run. We generally avoid recommending stock funds with expense ratios over 1.5%. Occasionally, there might be exceptions among international funds, for which expenses tend to run higher.

Times: What’s the most basic advice you would give fund investors?

Jacobs: I think they need to avoid getting caught up with the latest fad in the market. It’s very important to stick to the basics, which means getting proper diversification and making sure you’re comfortable with the risk level.

Times: Let’s talk about the load versus no-load issue. When you started your newsletter, it was easy to distinguish between load and no-load funds. Now it’s not. It also seems that the no-load share of the market has reached a peak. Do you agree?

Jacobs: I think so. What we’re seeing is the development of series of funds. Companies like Robertson Stephens, which started with no-load funds only, have opened new classes of shares, with some sold by advisors.

The load/no-load debate has never been an ideological thing among fund companies. To them, it’s nothing more than a marketing problem, trying to figure which way brings in the most assets.

Times: Do you get the feeling that a lot of people, once they accumulate a sizable sum--perhaps $100,000 to $250,000 or more--do seek professional guidance and therefore are willing to pay a sales charge in some form?

Jacobs: It seems to be the trend. If you include this new phenomenon of advisors putting people into no-load funds, what’s happening is that perhaps two-thirds of investors are now getting some sort of personal advice and paying for it.

Part of this reflects the increasing number of funds. It’s bewildering for the average person to try to pick a fund. I find that this is a rather sad development because it’s not difficult to pick no-load funds, and there are many ways to do so. In fact, I once did a study showing that you wouldn’t do that badly simply by buying funds that were advertised in newspapers or personal-finance magazines because companies tend to advertise their best funds.

Times: Do you think mutual funds, overall, will remain popular?

Jacobs: Yes. In fact, I think their popularity will continue to grow, although not at current rates. For most people, funds are the way to go.

Times: For what reasons?

Jacobs: More people are recognizing that if they buy stocks on their own, they’re competing against professional managers, who really control the market. They realize they’re better off hiring those managers.

Times: A minor theme running through your various portfolios involves real estate--you hold such funds as CGM Realty, Fidelity Real Estate and Cohen & Steers Realty. Why do you like real estate?

Jacobs: Real estate is a very attractive holding, especially in the retirement portfolio, because these funds pay higher yields even than utility funds and their correlation to the overall market is low, thus providing good diversification.

That may be significant given how high the market is. Still, we’ve cut our real estate back a bit, to a 5% stake in Wealth Builder and 10% in the other portfolios. This downgrade reflects sluggish performance for real-estate funds over the past quarter or so.

Times: What advice would you give investors who are shopping for an investment newsletter?

Jacobs: I think the most important thing is to find a newsletter whose philosophy mirrors your own. If you’re a gunslinger and like to speculate, there are newsletters for you. If you’re conservative, you can find newsletters for that too.

You also want to decide between newsletters that recommend trading every few weeks and those that tend to buy and hold. We fall into the latter group, with an average hold in our model portfolios of about 16 months.

One advantage that newsletters offer compared to, say, personal- finance magazines, is that they provide continuing portfolio advice, including sell advice.

Times: You said earlier you’re bullish on stocks for the long haul. What makes you bullish?

Jacobs: The underlying factors are the same broad factors that have propelled the market so far, including low inflation, peace throughout the world, demographic trends that encourage investing, technological improvements that increase productivity and the lack of any really good alternative investments to stocks and stock funds.

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Profile

Name: Sheldon Jacobs

Business: Editor and publisher, the No-Load Fund Investor newsletter

Personal: 67 years old; raised in Deadwood, S.D.; lives in Irvington-on-Hudson, N.Y., with wife, Liz; has two adult children

Education: Earned bachelor’s degree in business from the University of Nebraska and master’s degree in business from New York University

Career: Worked for 25 years as a researcher and in marketing for ABC-TV and NBC-TV. Wrote a book on no-load funds titled “Put Money in Your Pocket” in 1974, then founded the No-Load Fund Investor in 1979. In 1981 wrote “The Handbook for No-Load Fund Investors,” now in its 18th edition. Began BJ Group, a money-management business using no-load funds, with Bob Brinker in 1987.

Services: The newsletter, published monthly, costs $135 a year, the “Handbook” $45 and a guide to mutual funds $25. Subscribers can receive one year of the newsletter and both books for $129. For information, call: (800) 252-2042. BJ Group provides money-management services for investors with a minimum of $100,000. Source: No-Load Fund Investor

Building a No-Load Portfolio

In his newsletter, Sheldon Jacobs recommends three main model portfolios of no-load (no sales charge) mutual funds, each geared to different investor life stages and risk tolerance. The Pre-Retirement portfolio, shown here, is designed for people who are within 10 years of retirement. It is more conservative than the Wealth Builder portfolio and more aggressive than the Retirement portfolio. Pre-Retirement portfolio, recommended funds and suggested asset allocation:

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Asset allo- Fund Type Phone cation T. Rowe Price Spectrum Income Bond (800) 638-5660 20% T. Rowe Price Equity Income Equity income (800) 638-5660 15 Baron Growth & Income Growth & inc. (800) 992-2766 15 Safeco Small Co. Stock Aggr. growth (800) 426-6730 10 Gabelli Growth Growth (800) 422-3554 10 Vanguard Index Europe Intl. stock (800) 662-7447 10 Fidelity Real Estate Real estate (800) 544-8888 10 Third Avenue Value Growth (800) 443-1021 5 Montgomery Emerging Markets Intl. stock (800) 572-3863 5

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Source: No-Load Fund Investor