Several Suggestions for Bargain Hunters Ready to Shop

TIMES STAFF WRITER

As the world's financial markets have shuddered in the last several weeks, individual investors have been treated to a pair of new experiences.

One is that many newcomers to the stock and other securities markets have lost money--at least on paper--for the first time. The second, however, is that they're also probably eyeing some of the juiciest bargains they've ever seen.

"This is a time to be buying if you have excess cash available for the long term," said Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington, N.Y.

Indeed, for aggressive investors willing to assume risk, potentially lucrative opportunities may exist today not only in stocks but also in such areas as emerging-market bonds and real estate investment trusts, experts say.

Of course, no one knows how deep or long-lasting the world's financial troubles will be. If the U.S. economy is dragged into recession by the economic conditions afflicting Asia and Russia, U.S. investors are almost certain to face more losses.

Certainly, investors shouldn't dump all their available cash into trouble spots, experts say. But those who have confidence in the U.S. economy and are unfazed by doomsday predictions may want to identify attractive areas and begin nibbling at them.

The easiest way for many investors to take advantage of the opportunities is through mutual funds. For that reason, The Times asked experts to pick funds in various market sectors they believe could provide sizable returns in the next two to three years.

Here are some ideas in four sectors:

Small-Cap Stocks

In the stock market, there's almost universal agreement that the best value is in small-company stocks, which have been battered terribly.

That doesn't mean small-capitalization stocks will go up soon. They've been inexpensive compared with larger issues for several years, but investors have still flocked to the larger stocks because of their supposedly steadier earnings and greater liquidity.

And many experts believe small stocks will continue to lag until big stocks finally collapse and a full-blown bear market occurs.

Their reasoning: If the market stabilizes, investors will continue to favor large caps. But if large caps finally give way, all stocks will be in a bear market. Small stocks, then, will only recover once the bear market is over and a new bull market begins.

Nevertheless, small-cap valuations have become so attractive that investors may want to begin establishing their positions now, some experts say, even if small stocks have further to fall.

The Russell 2,000 index of smaller stocks is down almost 21% this year and has gained a meager 39.6% cumulatively in the last five years. That compares with 111% over the last five years for the blue-chip Standard & Poor's 500 index.

If you can look out two to three years, it's not inconceivable that small stocks could provide returns of 50% or better from these levels. Once they start to rally, their gains often are dramatic--and happen like lightning.

It's hard to say which of the two broad sectors of small-capitalization equity funds, value and growth, is in worse shape today.

Growth funds, which aim to buy fast-growing companies even at rich prices, have lagged badly for several years and are down an average of 22.5% this year through August, according to fund tracker Morningstar Inc.

But value funds, which seek undervalued stocks, have fared little better, losing 19.6% this year. Many are top-heavy in financial and cyclical issues that have suffered because of concerns about the U.S. economy.

Among small-cap value funds, Christine Benz, a Morningstar equity analyst, recommends Pimco Micro Cap Growth (phone: [800] 927-4648; year-to-date total return: -12.3%), Berger Small Cap Value ([800] 333-1001; return: -15.3%), and Scudder Small Company Value ([800] 225-2470; return: -14.4%).

The Pimco fund is aimed at institutions, but individuals can buy it through so-called fund supermarkets run by discount brokers such as Jack White & Co.

The Berger fund has been extremely consistent, Benz said, and the Scudder offering is a promising new fund. A so-called quant fund, which relies heavily on computer-aided number-crunching to choose its stocks, Scudder's fund is less than 3 years old. But on a monthly basis, it has trailed its peer group only a few times.

As for growth stock funds, Benz likes Franklin Small Cap Growth ([800] 342-5236; return: -23.3%) and Robertson Stephens Emerging Growth ([800] 766-3863; return: -11%). The latter is a "real pedal-to-the-metal fund" that buys stocks with high valuations and has been heavily invested in Internet stocks.

Emerging Market Bonds

Few mutual fund classes have been hurt as badly as developing-country debt funds. The J.P. Morgan emerging markets bond index is down almost 28% this year and the funds themselves are down an average of 37%.

Emerging-market bonds were hurt by the Asian financial crisis last year, but have suffered far worse losses as a result of Russia's recent currency devaluation and default on some of its debt.

That crisis caused big investors to dump not only Russian bonds, but also the debt of many other developing countries. Even among bonds that didn't experience heavy selling, values plummeted anyway as buyers all but dried up.

With no end in sight to the turbulence that has roiled foreign economies, the debt picture could worsen, particularly if Latin America is severely infected by others' problems. That was pointed up last week when a major U.S. credit-rating service downgraded Brazilian and Venezuelan bonds.

"It could be a very long, hard road," said Alice Lowenstein, associate editor of the Morningstar Mutual Funds newsletter.

However, aggressive buyers also may find good bargains now. Bulls point out that many emerging-market bonds are issued by governments, not companies, and thus are more likely to be paid back, Russia notwithstanding.

Also, most emerging-market mutual funds hold only dollar-denominated foreign bonds, so they are less vulnerable to the risk of currency fluctuations.

Most important, yields on many of the funds now are around 14% to 15%, editor Jacobs said. "That's nice and healthy," he noted, and may compensate for what is admittedly high risk.

As for specific funds, several experts recommend Fidelity New Markets Income ([800] 544-8888; year-to-date return: -35.1%; current dividend yield: 13.4%) and T. Rowe Price Emerging Markets Bond ([800] 638-5660; return: -35.7%; yield: 14.8%).

Investors who don't want complete exposure to emerging markets but still are looking for an aggressive all-around fund might consider the Loomis Sayles Bond fund ([800] 633-3330; return: -3.7%; yield: 8.2%) run by noted bond pro Dan Fuss, Lowenstein said. About 19% of the fund is now in emerging markets, Fuss says.

U.S. High Yield

High-yield, or junk, bonds have suffered lately as concern has heated up that the U.S. economy could be in for tough times if world economic problems spread.

Junk funds invest in lower-quality corporate bonds that pay high yields. The bonds suffer in uncertain economic times because they are issued by companies that have a greater possibility of defaulting in a recession.

An index of junk bond funds tracked by Lipper Analytical now is down 3.4% year-to-date on a total return basis (meaning interest income adjusted for the change in bonds' prices). Junk bond values plunged in August.

In recent years, amid a strong economy, corporate default rates fell and investors piled into the sector, pushing junk bond yields relatively low compared to Treasury bond yields.

But the uncertainty has caused yields to rise again. The current average yield on junk bonds is 10.01%, or 5 percentage points over 10-year Treasuries, according to Merrill Lynch. That compares with an 8.64% yield--and a spread over Treasuries of 3.14 points--at the end of July.

If the U.S. economy softens, junk bonds could be hurt worse. But many experts believe that the perceived threat to the U.S. economy from overseas troubles is overblown. If no recession develops, current high junk yields could be attractive.

"It's a better time to get in now rather than earlier in the year," Lowenstein said. However, she adds: "I certainly wouldn't get in with the expectation that it's going to rebound quickly."

Among funds, Lowenstein likes Northeast Investors Trust ([800] 225-6704; year-to-date return: -3.1%; yield: 9%), Invesco High Yield ([800] 525-8085; return: -2.5%; yield: 8.3%) and Fidelity Advisor High Yield (T shares) ([800] 522-7297; return: -5.7%; yield: 9.3%).

The Invesco and Fidelity funds have done well in the past, in part because of their investments in telecom bonds.

Northeast Investors, meanwhile, has "shown a great record of picking bonds," Lowenstein said.

REITs

Real estate investment trusts, or REITs, are publicly traded companies that own properties ranging from apartments to office buildings and hotels. REIT mutual funds hold a collection of individual REITs.

REIT shares generated strong returns in recent years. Dividend yields rose as strengthening residential and commercial markets nationwide boosted occupancy rates and rents.

Investors had high hopes for the group this year, but instead REIT funds have plunged nearly 21% so far this year, on average.

Part of the problem stems from REITs' recent success. For years, REITs, which for tax purposes pay out 95% of their earnings, were prized for their income yields.

But in recent years, many REITs went public and later issued additional shares to raise funds to buy more properties. That attracted a new type of investor who favored REITs more for growth potential than for income.

But when market conditions changed and many REITs dropped off the acquisition trail this year, those growth investors fled--yanking down REIT prices.

Other problems also hurt REITs. As the economy strengthened, new construction kicked in, thus threatening to dampen rents at existing buildings.

REITs could be in for more trouble if the economy weakens and rents fall. "If the economy really gets into serious trouble, REITs are going to have trouble," said Susan Belden, editor of the No-Load Fund Analyst newsletter. "To invest in REITs, you have to feel confident the economy is not going into recession."

But if the economy remains solid, REITs boast attractive yields that now average about 7.5%.

"They're risky in that people don't like to buy things that have been beaten up so badly," Belden said, "but they have high dividend yields that are pretty secure."

Belden likes American Century Real Estate ([800] 345-2021; year-to-date return: -22.1%) and Longleaf Partners Realty ([800] 445-9469; return: -21.2%).

Kim Redding, co-manager of the American Century fund, notes that in 1996 and '97, REIT stocks traded at premiums of 5% to 30% over the value of their underlying assets. Now, the stocks trade at 5% to 45% less than the value of their properties, he said.

What's more, "we don't have nearly as much [new construction] coming on line as we did in the '80s," he said. "The growth in rents has slowed, but it hasn't turned negative and we don't expect it to turn negative," which means many REITs still should do well.

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Buying Low--or, at Least, Lower

Just because an investment has fallen doesn't necessarily mean it's a bargain. But beaten-down investment sectors at least present investors with places to begin looking for assets that might be undervalued, amid the markets' emotional swings. How certain sectors have tumbled this year, and their five-year annualized returns:

(Total investment return)

*--*

Sector Since 5 years Jan. 1 (annualized) U.S. corporate junk bond funds --3.4% +8.0% Global bond funds --4.0 +4.6 U.S. small-stock funds --19.0 +9.4 U.S. micro-cap stock funds --19.0 +10.1 U.S. real estate funds --20.8 +5.9 U.S. natural resources funds --29.3 +1.3 Emerging-market stock funds --37.4 --8.7 China-region stock funds --40.2 --10.9 Latin American stock funds --45.8 --6.6 S&P; 500 stock index funds +1.9 +18.5 Avg. general U.S. stock fund --8.0 +13.1

*--*

Source: Lipper Analytical Services

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