Today’s Volatile Market Rewarding Growth Managers Who Trade Often

Conventional wisdom says that active trading of stocks is a loser’s bet. One recent study, in fact, found that households that trade in and out of stocks frequently enjoy only about two-thirds of the stock market’s buy-and-hold returns over time.

But is the same true for mutual fund managers who churn their portfolios?

Once again, conventional wisdom says yes. In recent years, for instance, equity index funds that simply buy all the stocks in a market benchmark such as the Standard & Poor’s 500 index--and hold them--have trounced active fund managers.

That explains why trading “has become a dirty word on the Street,” says Arthur Bonnel, manager of the $121-million Bonnel Growth fund, which sports a 190% turnover rate--meaning the fund changes virtually all of its stock holdings two times over in a year.

But have you looked at the numbers lately? Among small-company growth stock funds, mid-cap growth funds and large-cap growth funds, managers who actively move in and out of stocks and sectors are now beating the buy-and-holders. That’s on a year-to-date, one-year, three-year and five-year basis, according to Morningstar Inc. data through Oct. 31.

And the list of the top-performing domestic stock funds year-to-date is filled with high-turnover portfolios, including Van Wagoner Emerging Growth (annual turnover: 668%; YTD total return: 228%); Orbitex Info-Tech & Communications (turnover: 360%; return: 122%); and Turner Midcap Growth (turnover: 304%; return: 82%).

“This is vindication for the active managers,” says Bonnel, whose fund is up 71% over the last 12 months, versus the 26% advance for the S&P; 500.

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To be sure, over past-10-years and longer periods of time, low-turnover funds still fare better. And the better performance of high-turnover funds over the last one, three and five years is on a pretax basis. That’s fine if you own these funds in a tax-deferred account such as a 401(k) or an IRA, but the returns may not be so great if the funds are in a taxable account.

(To be fair, though, a “600%-turnover manager isn’t doing any more harm when it comes to taxes than a 100%-turnover manager,” assuming they both deliver the same net return, says Robert Arnott, managing partner of Pasadena-based money manager First Quadrant. “Of course, there will be more taxes if the higher turnover leads to higher returns. But there will also be more profits.”)

Why are funds that are active traders doing better right now?

Stock market volatility is on the rise. In 1996 the S&P; 500 swung 2% or more in a day (in either direction) 5% of the time. This year, the index has swung 2% or more in a day 26% of the time.

This increased volatility is creating pockets of opportunities for managers who know how to trade well (emphasis on the word “well”). Says Louis Navellier, manager of the Navellier Aggressive Small Cap Equity fund: “We’re now in a momentum market once again. It’s a go-go market.”

Adds John Wallace, co-manager of the $115-million RS Diversified Growth fund: “There are two things you can do with that volatility. You can sit there and watch it, or you can try to take advantage of it.”

Wallace takes advantage of it by setting extremely high expectations for his stocks. For instance, he won’t buy a stock unless he thinks the shares can double in the next 18 to 24 months. But he doesn’t necessarily wait a full 18 to 24 months for his stocks to reach that goal.

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If a stock falls 15% from his purchase price--which isn’t unusual for small technology names, especially in this volatile market--he’ll start selling. If there are any fundamental disappointments by the company, he might start selling. Even if the stock gets 90% of the way to meeting his goal, Wallace will still sell if he doesn’t think the stock has the potential to bust past his original target.

“We’re opportunistic,” says Wallace, whose fund has a turnover rate of 403%. “In a volatile market, if I can make you more money by buying stock B over there rather than sticking with stock A, then we’ll get rid of A.”

Robert Turner, manager of the $142-million Turner Growth Equity fund, with an annual turnover rate of 250%, agrees with that line of reasoning.

In September, for example, after the devastating earthquake in Taiwan--home to many PC-parts makers--Turner’s fund sold shares of Dell Computer at around $44 a share. Over the next month, the stock fell to as low as $38 (a drop of nearly 15%). In the meantime, many other tech stocks continued their runs.

“If I came in and added to a stock that went up 15% as Dell was going down, that would represent a 30% spread on that position,” Turner said, adding that he still thinks Dell is a good long-term holding.

As Bonnel puts it: In the stock market, “there’s always another trolley.”

Is active trading working now just because the market is volatile? The question is moot, argues Turner, who believes that the market has entered into an indefinite period of volatility. “There’s a new set of rules now,” at least when it comes to so-called “new economy” tech and communications stocks, he says.

That may be debatable. What isn’t is the fact that high-turnover managers, ironically, need buy-and-hold shareholders to do their job well.

“You may be a great trader, but if your underlying asset base is not stable [if the fund is in net redemption, for instance], then you may not be able to deliver superior returns,” notes Geoff Bobroff, a fund consultant based in Rhode Island. For example, a manager might want to dump a stale stock to buy a better idea. But if the fund’s shareholders are selling out, the manager may have to use cash to meet redemptions.

Which is why Turner, who’s perfectly willing to move into and out of the same stock in a short period, tries to weed out so-called market-timers who want to do the same with shares of his funds.

For actively trading fund managers to rack up great results, then, many things have to fall into place: The markets must be sufficiently volatile; a fund’s shareholders must be sufficiently patient; and, of course, the manager’s stock picks must be on the mark.

“If active managers add 4 to 5 percentage points to performance over the index [to cover transaction costs and taxes caused by their trading], then their investors will be fine,” says First Quadrant’s Arnott. “The problem is, the sustainability of those results is extremely poor.”

For investors who are willing to bet that active traders can stay on top well into 2000, here are some top-performming funds to consider:

Large-cap growth funds:

* Strong Growth 20 (1-yr. total return: 97.8%; portfolio turnover: 541%; phone: [800] 368-1030).

* Alger Capital Appreciation (1-yr. tot. ret.: 75.4%; turnover: 184%; [800] 992-3863).

* Turner Growth Equity (1-yr. tot. ret.: 52.0%; turnover: 250%; [800] 224-6312).

Mid-cap growth funds:

* Van Wagoner Mid-Cap (1-yr. tot. ret.: 139.9%; turnover: 787%; [800] 228-2121).

* Turner Midcap Growth (1-yr. tot. ret.: 109.9%; turnover: 304%; [800] 224-6312).

* Bonnel Growth (1-yr. tot. ret.: 70.8%; turnover: 190%; [800] 426-6635).

Small-cap growth funds:

* RS Emerging Growth (1-yr. tot. ret.: 186.4%; turnover: 291%; [800] 766-3863).

* RS Diversified Growth (1-yr. tot. ret.: 132.6%; turnover: 403%; [800] 766-3863).

* Navellier Aggressive Growth (1-yr. tot. ret.: 60.7%; turnover: 237%; [800] 887-8671).

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Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.