Some Mutuals Are Putting Most of Their Eggs in Very Few Baskets
It’s common knowledge that some individual stocks resemble mutual funds.
One can argue that General Electric is really a collection of aerospace, consumer electronics, financial services, industrial manufacturing and media companies all rolled into one. And Warren Buffett uses his publicly traded company, Berkshire Hathaway, as a vehicle to invest in other companies.
But what is less commonly known--and should be cause of great concern--is that some mutual funds are beginning to look like individual stocks.
Consider the huge bets some funds have made recently in an effort to boost returns:
* About 65% of the erratic American Heritage fund is one stock, Senetek, a British firm focusing on male impotence treatment. And another 25% or so is in ADM Tronics, a New Jersey-based medical technology company.
* More than 40% of Amerindo Technology’s fortunes were recently tied to Yahoo, the Internet directory firm.
* Pin Oak Aggressive Stock recently held about 15% of its $53 million in shares of Cisco Systems.
Even the so-called value managers, who are more conservative by nature, are at it.
For instance, nearly 24% of Legg Mason Special Investment Trust’s impressive returns were explained by its stake in America Online. And manager Bill Miller’s other fund, Legg Mason Value Trust, had nearly 16% of its stake recently in AOL.
They call these mutual funds?
Part of this has to do with a recent trend among fund managers to “concentrate” or “focus” their portfolios. That is, to put the greatest amount of money in their top picks.
On the face of it, this seems like a decent idea. “There is no substitute for knowledge,” said Don Yacktman, manager of the Yacktman Focused fund. And if a manager has done his or her homework and has greater confidence in some stock picks than others, why not invest more money in those?
One can argue that passively managed index funds that track the Standard & Poor’s 500 index of blue-chip stocks are somewhat concentrated, too, since the index is market-weighted, meaning big names like Microsoft and Dell Computer are responsible for a disproportionate percentage of the index’s movements.
But even Yacktman, whose Focused fund has more than 20% of its assets in Department 56, a maker of collectibles and home accessories, expresses concerns about how far some managers are taking this trend.
And why.
“What bothers me about this whole thing is people are doing it for the wrong reasons,” Yacktman said. “I think they’re doing it for marketing reasons.”
“Let’s say I were to diversify, and I produced 15% next year,” said Heiko Thieme, manager of American Heritage, a fund that lost 61.2% of its investors’ money last year.
In this era of high expectations, where it’s no big deal if an Internet stock doubles in a day, “people don’t give much credit for that,” he said. “You really have to make a spectacular recovery.”
He said that once his fund recoups much of its recent losses, he will broaden it on the belief that “if you want to maintain wealth, you diversify, but if you want to get rich, you have to concentrate.”
Pete Moran, the chief mutual fund marketing officer for Turner Funds in Berwyn, Pa., notes that while there is a strong case to be made for concentrating a portfolio, “if you start to own more than 20% in any one holding, you start to pick up a lot of stock-specific risk. If even one or two stocks blow up, it can take the fund with it.”
As was the case in 1998 with Thieme’s fund.
Considering that funds are required to detail their total holdings only twice a year, how can you make sure your fund isn’t making such big, risky bets?
* Learn your fund’s status. Call the fund company and ask if your fund is registered as a “diversified” or “non-diversified” portfolio with the Securities and Exchange Commission.
If it’s classified as a diversified fund, it won’t be able to make as many big bets on single stocks as non-diversified funds can make.
* Find out whether your fund is being marketed as ‘concentrated’ or ‘focused.’ To be sure, not all concentrated funds take bets as large as those mentioned above. But self-described concentrated funds are more likely than others to make big bets on single stocks.
* Find out how many stocks your fund owns. According to fund tracker Morningstar, the typical domestic stock fund owns 139 stocks. So it’s probably fair to say that a fund that invests in fewer than 40 stocks (especially if it’s a large fund, based on its total assets) is making some big bets.
* Determine how much of your fund’s assets are invested in its top 10 holdings. The average domestic stock fund has about a third of its assets in its top 10 holdings. Anything over half or two-thirds should alert you that this is a concentrated fund.
You can look up this information at https://www.morninsgstar.net or through Morningstar Mutual Funds, available at many large public libraries.
Obviously, some of you may want a concentrated fund. Given how the S&P; has behaved recently, your fund will probably need to be concentrated to some degree to meet or beat the index. If that’s the case, you can go through the same steps to find out if your fund is focused.
Others of you fall into a different group: You’re just looking for a fund that takes big positions in popular stocks like Yahoo, Amazon.com or Cisco Systems.
If that’s you, ask yourself why you’re not saving on fund expenses and fees by just buying those shares on your own.
Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.
