Some Fund Experts Begin to Reevaluate Strategies

The conventional wisdom is to spread your holdings among different types of investments and to include--or maybe stock up on--categories of mutual funds that didn’t fare so well in the most recent quarter.

The experts at making these allocation decisions are professional advisors who need to tell their clients what funds to buy or are managers of funds that are designed as dynamic allocation vehicles for investors.

Since the first quarter was again a tough time for many categories that have been underperforming the overall market for several quarters, we were curious about whether these experts are beginning to change their traditional diversification plans.

A close look at these five fund pickers shows changes are indeed afoot. Several of the advisors reveal a desire to search for bargains among investment categories that haven’t been hot lately.

Sheldon Jacobs

No-Load Fund Investor newsletter

Irvington-on-Hudson, N.Y.

(800) 252-2042

$135 a year

LIKES: Large U.S. stocks

AVOIDS: Small-cap and real estate stocks

Jacobs generally recommends fairly broad diversification among various asset groups--large and small stocks, foreign equities and bonds. But during the first quarter he found it hard to justify much exposure to mutual funds that focus on small companies, preferring to concentrate on large-stock portfolios. “We’re not buying any pure small-cap funds anymore,” he says.

Also losing favor with Jacobs were his modest recommendations for real estate funds for moderate and conservative investors. Although popular for years as a high-yielding category that added diversification to stocks, bonds and cash, “they just haven’t done anything,” says Jacobs, who in his model portfolios advised cutting both the Fidelity Real Estate and Cohen & Steers Realty funds.

He also dropped Neuberger & Berman Partners, a growth fund, and Dodge & Cox Balanced from some model portfolios early in the quarter, but these were modest changes and didn’t reflect changing overall asset allocations.

Overall, Jacobs moved his portfolio recommendations more heavily into large-stock funds during the first quarter. Large companies have been on a roll and Jacobs thinks that trend will continue. He also believes they would hold up better than small issues in a bear market, although he’s not expecting to see one any time soon.

Jacobs particularly likes those large-stock funds that own a concentrated mix of perhaps two dozen or fewer companies.

“The fewer stocks you have, the better your chances of beating the market indexes,” he says. His favorite large-stock funds include Marsico Focus, PBHG Large Cap 20 and Strong Growth 20.

Paul Merriman

Merriman Funds

Seattle

(800) 423-4893

LIKES: Large U.S. stocks, cash

AVOIDS: Foreign stocks

A market timer, Merriman follows more than 20 timing indicators that track such things as price trends, volume readings, ratios of advancing and declining stocks, new highs versus new lows and a whole lot more. “It’s a mechanical, trend-following system from which we hope to generate decent returns while protecting people, one day at a time, against a massive bear market that might never come,” he says.

Merriman runs five market-timing mutual funds that invest in other mutual funds on a no-load basis. He made only a few changes in his portfolios during the first quarter.

For example, the Merriman Capital Appreciation portfolio started the year 55% in U.S. stocks, 24% in foreign equities and 21% in cash.

Today, its posture is a bit more guarded at 50% in U.S. stocks, 13% in foreign stocks and the remainder in cash. When fully invested, Capital Appreciation can hold 65% of its assets in U.S. stocks and the rest in foreign equities. Current investments range from American Century Ultra, Stein Roe Growth Stock, T. Rowe Price Europe and Colonial Newport Tiger--all added during the quarter--to Montag & Caldwell Growth and Hotchkis & Wiley International.

The Merriman Flexible Bond portfolio applies a market-timing system to the bond market--specifically foreign, junk and high-grade U.S. government and corporate issues. The fund has been totally out of high-grade issues since last year. Junk-bond and foreign-bond funds each make up a quarter of assets, a moderate increase from the end of 1998.

Note that Merriman invests in funds that are performing well; beyond that, he doesn’t do fundamental research and he doesn’t harbor strong preferences for his choices. “When you’re a mechanical, trend-following market timer, the particular funds you hold don’t really mean anything.”

Stephen Janachowski

Brouwer & Janachowski

San Francisco

(415) 435-8330

WHAT HE LIKES: Large U.S. stocks

WHAT HE AVOIDS: International stocks

Janachowski and partner Kurt Brouwer manage portfolios of mutual funds for clients with $1 million or more in assets. They favor funds whose managers seek capital appreciation at a reasonable price, a philosophy that shifts them toward a mix of both growth and value stocks.

“If you didn’t own large growth stocks, it has been a tough year,” Janachowski says. “But it would be a mistake to thrown in the towel and move entirely into this area now.”

Two of their favorite holdings, Selected American Shares and Pimco Capital Appreciation, have been steady performers but not market leaders.

Both favor medium and large stocks, but not the behemoths that have led the market’s charge of late. In Janachowski’s view, there are still plenty of quality U.S. stocks selling at attractive prices these days. “I think we’ve had a huge correction in many of the small and mid-cap stocks, and even some of the larger issues over the last few years,” he says. “The U.S. is still a great place to invest.”

This preference for American companies helps to explain why Janachowski and Brouwer during the first quarter reduced the proportion of international funds in client accounts to between 10% and 15% of assets from 20% to 25% previously. Large-stock funds make up the rest of their portfolios, except for a modest 10% toehold in the small-company area.

Their unenthusiastic response toward international funds reflects a belief that Japan remains stagnant and the European economies appear to be slowing down.

David Menashe

Fundline newsletter

Woodland Hills

(818) 346-5637

$127 a year

LIKES: Large U.S. stocks, energy, income and technology issues

AVOIDS: Small-cap, airlines

Newsletter publisher Menashe’s approach to mutual funds is dominated by two factors: He’s a “partial” market timer and he sticks exclusively with Fidelity portfolios. Menashe aims to deliver market-beating returns by picking funds with strong records over the last one- and three-year periods. He normally stays close to fully invested but isn’t reluctant to flee heavily into cash.

Menashe currently has 80% of his model portfolio invested in stock funds and 20% in cash--a fairly optimistic outlook. Among his recent moves was selling Fidelity Small Cap Selector, a small-company portfolio, and unloading Fidelity Select Air Transportation, an airline sector fund that has been hurt by rising oil prices.

Menashe moved some of the proceeds into Fidelity Select Energy Service to capitalize on the oil price rally. Other holdings include Fidelity Large Cap Stock and Dividend Growth, among the diversified funds, and Fidelity Select Health Care and Select Computers in the sector area.

Menashe’s generally bullish stance belies his concerns about the longevity of the stock market’s rally. He notes that relatively few stocks have been rising in price with the big blue chips. “The bulk of the market hasn’t been keeping up,” he says.

So why hasn’t Menashe moved to the sidelines? Partly because it’s still early spring. “Bear markets don’t start at this time of the year,” he says. “Instead, they tend to set in either in January or around July or August.”

Bob Markman

Markman Multifunds

Minneapolis

(800) 707-2771

($25,000 minimum for funds; lower if purchased through brokerages such as Charles Schwab, Fidelity Investments or Jack White.)

WHAT HE LIKES: Large U.S. stocks, high-yield bonds

WHAT HE AVOIDS: Pure-play international stocks

Markman manages three mutual funds that invest in funds offered by other families. He picks what he considers to be the best offerings from such groups as Invesco, Janus, Oakmark, PBHG and Pimco.

The Markman Conservative, Moderate and Aggressive portfolios split their holdings among roughly six to 10 funds at a time.

Markman made some portfolio adjustments during the first quarter, but they pale compared with the broad changes he made in mid-1998, when he essentially jettisoned the funds’ holdings in the international, small-stock and value-equity areas, a move that turned out to be wise.

Large U.S. growth companies have been pacing the market’s advance and Markman doesn’t feel that will change any time soon: “I think we’re in a Jurassic era, where big stocks are better than small stocks and U.S. companies are better than foreign ones.”

Markman’s anti-international posture doesn’t mean he’s given up on global economic growth. Rather, he feels large U.S. corporations are the best ways to play it, which explains his preference for such funds as Marsico Focus and Papp America Abroad. “In a global economy, large companies have the resources to go where they need to go and to survive the storms that inevitably occur.” His avoidance of funds that hold value stocks reflects his view that technology increasingly will drive the economy. “The market leaders in the technology area won’t be value stocks,” he says.

Markman Aggressive is entirely invested in funds that hold large U.S. growth stocks.

The Moderate and Conservative portfolios have a similar stance, but with some bond funds thrown in to reduce volatility. Markman is particularly enthusiastic about high-yield or junk bond funds. After having been beaten down last fall amid worries about deflation and a global recession, they’re offering yields in the neighborhood of 9% to 10%. Junk bonds “were priced for a recession that never came,” Markman says. His portfolios hold both the Invesco and Pimco high-yield funds.

Aside from some minor adjustments, the only significant change Markman made during the quarter was dropping ProFunds UltraBull and ProFunds UltraOTC, two portfolios that make use of leverage (borrowed cash or options) in an effort to enhance returns. The proceeds from these moves went into White Oak Growth Stock, another large-cap fund. Although Markman says he’s no less bullish than before, the leverage of the ProFunds products made him uncomfortable: “We didn’t want to tempt the stock market gods.”

Russ Wiles is based in Phoenix. He can be reached by e-mail at russ.wiles@pni.com.