For Fund Investors, a Lot of Issues on the Calendar

As technicians in Pittsburgh continue to check whether mutual fund firm Federated Investors’ computers are free of Y2K glitches, a separate team of Federated analysts and portfolio managers is huddling over that other Y2K problem: What to do with clients’ money in the days leading up to Jan. 1?

At most fund companies, the latter group arguably has the tougher job. After all, 90% of mutual funds completed or were close to finishing Y2K technical preparations for “mission critical” systems as of June, according to filings with the Securities and Exchange Commission. But the portfolio managers still face a host of questions, only some of which they can answer easily.

At Federated, fund managers won’t alter their buy, sell or hold decisions just because of Y2K, officials insist. However, that’s not to say they haven’t taken the computer bug into consideration.

Federated has combed through the hundreds of stocks held in the company’s 130 mutual funds, in hopes of identifying companies vulnerable to Y2K-related problems.

Thus far, says J. Thomas Madden, Federated’s chief investment officer for U.S. equities, the team has found that about 2% of those companies--many of them energy companies and old-line manufacturers--have yet to file paperwork indicating that they’ve fully debugged their systems. “In some of those cases,” Madden says, “we have sold.”

The company also has focused on the liquidity issue: the need to be prepared in case some shareholders want their money back in a hurry.

“We have reviewed fund liquidity among our managers and fund trustees, and we have specific action plans in place for each fund which do contemplate slight increases--and I underline the word ‘slight’--in cash positions,” Madden says.

Obviously, Federated isn’t alone. The question is how such marginal moves will add up in coming months within the $6-trillion asset fund industry, and what effect they could have on financial markets.

What’s more, some mutual fund newsletters are telling individual-investor subscribers to do much the same thing--specifically, to increase cash holdings (e.g., assets in money market funds) in their portfolios, not necessarily because there’ll be a Y2K computer meltdown worldwide, but because of the potential for market volatility leading up to the turn of the year.

Gerald Perritt, editor of the Mutual Fund Letter in Largo, Fla., for example, says, “Given potential market volatility, a 20% cash stake may not be a bad way to go.”

That’s about double the cash holdings that Perritt had been recommending at the start of the year. “To me, the Y2K hype is absolutely overblown,” Perritt says. “But I’ve suggested to people to have a little cash just in case Y2K fears are pronounced.” Plus, having that extra cash may “give you a couple of spot buying opportunities.”

Sheldon Jacobs, editor of the No-Load Fund Investor newsletter in Irvington-on-Hudson, N.Y., agrees. In his “model” portfolios for clients, he recently upped his cash stake by 10 percentage points, from 15% to 25% for working investors and from 10% to 20% for retirees.

But should individual investors be raising cash if the managers of the funds they own are doing the same thing?

For many investors, their fund managers’ caution may provide enough of a safeguard against Y2K trouble, financial planners say.

Fidelity Magellan fund, for example, had 7.8% of assets in cash at the end of July--though Fidelity officials deny this was due specifically to Y2K.

The question of whether and how fund investors should prepare for Y2K is complicated by another issue: normal end-of-year investing concerns.

For a variety of reasons, fund investors tend to put less new money into the stock market in the fourth quarter anyway. Some hang onto extra money to pay for holiday gifts. Some are more inclined to sell funds to realize losses for tax purposes.

Still others don’t invest any new money in stock funds in the fourth quarter to avoid buying into annual capital gains distributions.

Mutual funds are required by law to distribute to shareholders all of the capital gains they’ve realized over the course of a year--in that tax year. Typically, funds distribute the majority of those gains in late November and in December.

Recently, as investors have become more knowledgeable about this, many more tend to hold off on end-of-the-year stock fund purchases to avoid getting slapped with an immediate tax bill. (If you buy after the distribution, you avoid a tax liability for that year.)

“That’s why we won’t typically invest any new client money [in funds] for most of November and December,” says Culver City financial planner Eric Bruck.

“Early indications are there are going to be some pretty hefty gains distributed by a number of funds this year,” Perritt warns. Investors looking for buying opportunities in the fourth quarter may want to focus on individual stocks instead, he said.

What do most individual investors think about making Y2K-related portfolio moves?

In a just-completed survey conducted by T. Rowe Price, only 9% of its shareholders said they would alter their investment strategies because of Y2K. Only 1% indicated they would withdraw money from their funds.

A June Securities Industry Assn. survey found that 2% of investors with household incomes of at least $50,000 and total financial assets of at least $100,000 had taken money out of the stock market because of concerns about Y2K. But 6% said they would probably do so.

Of course, what people tell pollsters and what they actually do may differ. What if fellow shareholders of your fund redeem in droves? Won’t that affect your returns? Yes, but many large funds have provisions to deal with short-term liquidity crunches like that.

For example, large fund companies such as Fidelity Investments, Vanguard, Invesco and T. Rowe Price all have long-standing lines of credit in place with banks to help them fulfill shareholder redemption requests so that they need not sell stocks in the portfolio, which could hurt performance and trigger taxes). In addition, many funds are able to borrow from other funds in the same family.

It may well be, then, that the best advice is to do nothing.

Earlier this year, Gerald Appel, editor of Systems & Forecasts investment newsletter, said he toyed with the idea of liquidating his entire stock position in December, fearing Y2K-related volatility. He has recently changed his mind, he says now, deciding only to avoid emerging-markets funds, which may be disproportionately affected by Y2K glitches.

As Appel notes, the stock market traditionally rallies in January. Selling late in the year, he figures, could mean bailing out at the lows only to have to buy back in at higher prices in January if Y2K passes without much hullabaloo.

Do you have ideas for mutual fund and 401(k) topics for this column? Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.