Large-Cap Growth Funds: 1 Is Not Enough

Editor’s note: In the story above, Josh Friedman looks at the merits of buying “blend” funds rather than growth-stock or value-stock funds. Here, staff writer Walter Hamilton explains how he came to the conclusion that one growth-stock fund wasn’t enough.

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When I set out recently to invest in a new large-cap growth-stock fund, I had every intention of following conventional fund-buying wisdom.

Having just dumped my sole large-growth fund because of its swollen asset size and weakening performance, I figured I’d simply buy another fund. I was well aware of the fact that people tend to accumulate funds as they age--buying but rarely selling, and thus diluting returns because of too many holdings with the same investment styles--and I was determined to have just one new fund.

It wasn’t long, however, before I changed my thinking.

I quickly realized that I had to buy a fund almost as if it were an individual stock. That is, instead of buying a single fund, I needed to diversify among several funds to limit the damage if any one fund should tank.

When I started looking at the holdings and performance of some large-cap growth funds, it was clear that many were quite risky even though this fund sector is a supposedly diversified and relatively stable investment category.

Not only did many of the funds have substantial exposure to the technology sector, but several also were surprisingly concentrated: They owned relatively few stocks and had a large percentage of their total assets in their top 10 picks.

Thus, even one or two bad stock picks could do a lot of harm to the portfolio.

This realization first dawned on me when I examined why my old fund, American Century Ultra, was trailing its peers this year.

Sixteen of the fund’s top 25 holdings are up for the year, a solid showing given the second-quarter market meltdown. But the fund had more than 13% of assets in its top two picks. Those stocks: Qualcomm, down 60% this year, and Microsoft, off 33%.

(Most of the figures cited here come from the free portion of fund tracker Morningstar.com, which I found to be quite useful for basic information on fees, holdings and performance. Go to: https://www.morningstar.com.)

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The concentration issue was hammered home soon after I found what I thought was an ideal large-cap growth fund choice, White Oak Growth Stock. This 8-year-old fund has a sterling track record, finishing in the top 25% of large-growth funds in six of the last seven years. It’s also up 34% this year, versus 8% for the average large-growth fund.

Better yet, I knew that White Oak’s manager, veteran stock picker James Oelschlager, is highly respected among his peers.

But when I delved a bit further, I was shocked to discover the number of stocks in White Oak’s portfolio: a mere 23. That’s the norm for so-called concentrated funds that have words such as Select, Focus or Core in their names, but I didn’t expect it from a supposedly diversified large-growth offering.

Although virtually all other large-growth funds have more holdings than White Oak--many claiming more than 100 stocks--I was nonetheless surprised that a fair number had fewer than 75. And a handful--including Excelsior Large Cap Growth, Navellier Large Cap Growth and Smith Barney Large Cap Growth--had fewer than 50 stocks.

I decided to tuck some money into White Oak anyway because I’m a strong believer in going with proven managers. But I couldn’t justify entrusting it with my entire large-growth allocation and felt compelled to keep looking.

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Next, I investigated the PBHG Large Cap Growth fund. I’m familiar with PBHG because I have money in a couple of its other offerings. I liked the fund’s moderate $300-million asset size and the fact that its top holdings had little overlap with White Oak’s.

But this fund had one thing in common with White Oak: a big reliance on tech stocks. The PBHG fund has two-thirds of its assets in tech, while White Oak has 56%.

It’s no surprise that the best-performing funds of the last few years are chock full of tech stocks. And like lots of other investors, I’m bullish on tech and am purposely aggressive with my actively managed large-growth funds. I’m 35 years old and have about 40% of my large-stock holdings indexed to the Standard & Poor’s 500.

But with the memory of this year’s tech sell-off fresh in my mind, I thought long and hard about the potential downside of committing too big a chunk to a single supercharged fund. The PBHG fund, for example, sank 25% in one April week. That’s startling for any fund, I thought, but particularly for a large-cap offering.

I decided to pick up a little of the PBHG fund, but felt I needed yet more diversification.

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My final choice among large-cap funds: Gabelli Growth.

Besides the factors I demand of any fund (good record, moderate expense ratio, solid manager), I like the Gabelli fund because it has a modest 32% of assets in tech stocks (that’s about the same tech weighting as the S&P;). Although the fund has only 61 holdings, only 32% of its assets are in its top 10 picks.

Officially, Morningstar now labels Gabelli Growth a “blend” fund.

A few final notes: First, I’m not suggesting that the specific funds that are right for me are right for others. Also, I hold my large-cap growth funds within an IRA and I limited my choices to funds available with no transaction fee through Charles Schwab’s OneSource supermarket. OneSource excludes several funds that I might have bought had they been offered.

In place of Gabelli Growth, I might have gone with Harbor Capital Appreciation, which has a strong track record and half the annual expense ratio (0.68% vs. 1.41%).

In place of White Oak Growth, I definitely would have gone with Target Large Capitalization Growth, which Oelschlager co-manages with highly regarded Tony Rizza. It has 66 holdings and a rock-bottom 0.68% expense ratio. (Minimum investment is $25,000.)

Finally, I earmarked a portion of the money I previously devoted to large-growth funds for mid-cap growth. Mid-cap stocks have beaten large caps this year, and could be at the start of a lengthier period of out-performance.

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Walter Hamilton can be reached at walter.hamilton@latimes.com.