Market Slide Shows Risk in Hot Funds

Nasdaq’s huge slide Tuesday showed just how dangerous it can be to blindly chase last year’s hottest mutual funds.

As the tech-heavy Nasdaq composite index fell nearly 230 points, many of 1999’s best-performing stock funds-- which doubled or tripled investors’ money in a single year-- turned out to be the day’s big losers.

ProFunds Ultra OTC, for instance, which returned 233% in 1999, lost nearly 13% of its value-- a stock-like tumble that few would have thought possible in the world of mutual funds a few years ago.

Meanwhile, PBHG Technology & Communications, one of 1999’s best-performing tech-sector portfolios with a gain of 244%, fell 6%, versus 5.6% for Nasdaq.

“That’s the risk that goes along with all the reward you’ve seen in these funds for the last 18 months,” said Thomas McDowell, partner at money manager Rice Hall James in San Diego.

The important thing, said David Masters, senior analyst with Standard & Poor’s, is to understand what drives the performance of your funds.

For most of last year’s big winners-- and Tuesday’s big losers-- the answer is simple: They made huge bets on soaring technology stocks, including shares of Internet start-ups with little in sales and no profits.

Fund tracker Lipper Inc.’s tech fund index fell 5.2% on Tuesday, versus the 3.8% drop in large blue-chip funds. Lipper’s mid-cap growth-stock fund index and its small-growth fund index fell nearly 5% each.

Because so many funds are making increasingly big bets on highflying tech stocks, “you’re probably going to see some wild swings this year” in fund share values, warned Art Bonnel, manager of Bonnel Growth fund.

To be sure, it’s too soon to tell whether the sell-off is a sign of things to come or a bit of profit-taking. But because many stock funds have been taking on greater risk, expect them to lose money faster than usual during any market downturn, analysts say.

What’s more, fund managers are at their shareholders’ mercy: If investors begin to redeem money from their funds, that could force managers to sell stocks in a falling market. This could be particularly harmful for managers who invest in smaller stocks because those are thinly traded relative to blue chips.

In such cases, “the bids just aren’t there,” Bonnel said. “When a fund with a large position in a small stock comes in to do some selling, the market sees it and starts marking down the price of the stock. So it’s a real disadvantage [for a small-stock manager] to have to do some selling in a down day.”

Bill Dougherty, a fund analyst with consulting firm Kanon Bloch Carre in Boston, notes that in the summer of 1996, Nasdaq swooned nearly 20% in a month “and that scared all small-cap managers because the liquidity in small-cap tech stocks went to zero.” That made it impossible or costly for many managers to sell out of certain positions.

How can you tell if a fund is likely to fall a little-- or a lot-- in the event of a severe market downturn? Check out the following characteristics:

* Cash. Does your fund keep a reasonable amount of its assets in cash? Not only does cash cushion a portfolio in a downturn, but it also gives fund managers the luxury of not having to sell stocks on down days even if some shareholders are pulling out. According to fund tracker Morningstar Inc., the average tech sector fund recently held 6.8% of its assets in cash.

* Sector bets. A fund that invests in only tech stocks, for instance, will almost assuredly fall if that sector gets slammed.

Similarly, a fund manager who invests in just small stocks will be handcuffed if the market tumbles and liquidity dries up. “It’s a real disadvantage to be just in small stocks,” Bonnel said.

* Morningstar risk. Morningstar measures “downside volatility” of all funds it tracks as “Morningstar risk” (the figure is available on its Web site at https://www.morningStar.com).

The lower a fund’s score, the less it’s likely to lose when the market drops. The Vanguard Index 500 fund, which invests in blue-chip stocks, for instance, has a Morningstar risk score of 0.84, versus 2.12 for Van Wagoner Emerging Growth.

* Concentration. A simple way to see if your fund might be taking undo risk is to see how concentrated the portfolio is-- that is, to see whether it’s making big bets on a small number of companies. For instance, although the average stock fund holds 138 stocks and invests 35% of its assets in its top 10 holdings, the Strong Growth 20 fund recently held just 29 stocks and staked 63% of its assets in its top 10 holdings. That fund, which surged 110% last year, fell 6% on Tuesday.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Air Out of the Bubble?

World markets tumbled on the second trading day of 2000, as some investors cashed out of last year’s spectacular gains. The sell-off left the Nasdaq composite index with its worst-ever one-day point drop and eighth-largest percentage drop. Still, indexes’ losses were modest compared with how much they rose in 1999.

*

How Key Indexes Fared

Percentage changes for 1999 and on Monday and Tuesday:

*--*

1999 Mon. Tues. Market/index change change change U.S./Internet* +168.3% +4.9% -6.6% Brazil/Bovespa +151.9 -0.9 -6.4 Mexico/IPC +80.1 -0.7 -5.7 U.S./Nasdaq composite +85.6 +1.5 -5.6 France/CAC +51.1 -0.7 -4.2 U.S./S&P; 500 +19.5 -1.0 -3.8 U.S./Russell 2,000 +19.6 -1.7 -3.6 U.S./Dow industrials +25.2 -1.2 -3.2 U.S./NYSE composite +9.2 -1.7 -3.2 Germany/DAX +39.1 -3.0 -2.4

*--*

* Interactive Week Internet stock index

*

Worst Point Drops for Dow, Nasdaq

The five biggest one-day point drops in the Dow Jones industrial average and the Nasdaq composite:

*

Dow

*--*

Point Pctg. Date drop drop 10/27/97 -554.26 -7.2% 08/31/98 -512.61 -6.4 10/19/87 -508.00 -22.6 01/04/00 -359.58 -3.2 08/27/98 -357.36 -4.2

*--*

*

Nasdaq

*--*

Point Pctg. Date drop drop 01/04/00 -229.46 -5.6% 08/31/98 -140.43 -8.6 04/19/99 -138.43 -5.6 10/27/97 -115.83 -7.0 09/23/99 -108.33 -3.8

*--*

*

Revisiting 1999’s Hottest Funds

Here’s a look at Tuesday’s losses in the 10 U.S. stock mutual funds that racked up the biggest gains among all stock funds in 1999. Most of these funds are heavily invested in tech stocks.

*--*

1999 Tues. Fund gain loss Nicholas-Applegate Global Tech +493.7% -5.2% MAS Institutional Small Cap Growth +313.9 -5.0 Van Wagoner Emerging Growth +291.2 -3.0 Nevis Fund +286.5 -2.9 Monument Internet +273.1 -5.1 Amerindo Technology D +248.9 -5.5 PBHG Technology & Communications +243.9 -6.0 Van Wagoner Post Venture +237.2 -2.1 ProFunds Ultra OTC Inv. +233.3 -12.9 Van Wagoner Technology +223.8 -2.5

*--*

*

Sources: Morningstar Inc. and Bloomberg News

*

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