Fear That Funds Won’t Recover May Be Eased by Lessons of ’87
“What if it never comes back?”
That’s a fear investors in individual stocks have had to face over the years as shares have periodically tumbled. Now, some mutual fund investors may be asking the same question, in the wake of a bear market that has walloped many technology funds and even some supposedly diversified growth-stock funds.
If a fund was among last year’s biggest losers, could it now be down for the count--never to revive?
A look at the aftermath of the market crash of 1987 offers some solace: On average, that year’s 50 worst-performing stock funds have matched the typical fund’s return in the 13 years since.
There is, however, a caveat: Some of the worst funds of 1987 have since been merged out of existence or liquidated. So there is a “survivorship bias” in the returns of those funds that kept going, while investors in the funds that died out may have suffered much weaker returns.
In a typical year, 3.6% of all funds are lost through attrition, research shows.
Still, a look at the big fund losers of 1987 reveals some portfolios that were hit hard that year wound up handsomely rewarding investors who stayed put. Those names include Kaufmann Fund, MAS Small Cap Value and Fidelity Select Brokerage funds.
Overall, the 50 U.S. stock funds that lost the most in 1987 and are still around today produced an annualized average return of 14.4% from Jan. 1, 1988, through March 8 of this year, according to fund tracker Lipper Inc., which generated the numbers for The Times.
By contrast, the average annualized return for all U.S. stock funds in that period was 14.3% and the blue-chip Standard & Poor’s 500 index return was 16.1%.
However, some analysts noted that investors in any of the 50 worst funds needed to do much better than the average fund over time to make up for their greater-than-average loss in 1987.
“Generally, what happens [with hard-hit funds] is they tend toward mediocrity” in the aftermath, said Sheldon Jacobs, editor of the No-Load Fund Investor newsletter. “They become just another fund.”
For some, there can be a worse fate. “The true dogs of 1987 are gone, either shut down or merged into other funds,” said Jonas Ferris, editor of Maxfunds.com, a Web site that covers the fund industry.
That’s happening in this bear market as well. Last year, a record 226 funds were liquidated and 451 were merged out of existence, according to Wiesenberger/Thomson Financial. There are now about 12,000 stock funds.
“I expect it will be worse [in 2001] considering all those Internet funds,” said Mark Carhart, a managing director and co-head of quantitative strategies at Goldman Sachs Asset Management.
“These things can come in waves,” Carhart said. “In the late ‘60s and early ‘70s, all these ‘oceanographic’ funds were created when those stocks were the craze. When the market crashed in 1973 and ‘74, they went out of existence.”
Funds are usually merged or liquidated when assets shrink. Wiesenberger noted that a fund typically needs minimum assets of $25 million to $50 million to be profitable.
Liquidations tend to hurt fund investors more than mergers, which can land them in a better fund. “If you’re down 50% year-to-date and you get merged into a fund that’s up 50%, as an investor you’re still way down--but at least you’re likely to be in a better-managed fund,” said Wiesenberger analyst Ramy Shaalan. “It’s natural selection.”
Interestingly, some of the big losers of 1987 that went on to heady gains over the subsequent 13 years were narrowly focused funds--in particular, Fidelity Select funds, which focus on single industry groups.
The Fidelity Select Transportation fund, for example, dived 17.5% in 1987, then produced an 18.3% average annual return from 1988 through March 8 of this year.
Focused funds have become increasingly popular. Sector funds account for about 10% of the stock fund universe, versus about 8% a decade ago, according to Morningstar. And 6% of “diversified” U.S. stock funds could be defined as focused, meaning they have 30 or fewer stock holdings.
Often, the best time to buy sector funds is when everybody else is selling them, said Morningstar Inc. analyst Scott Cooley.
But many analysts said that this time, the most narrowly focused tech funds won’t mount the kind of long-term comeback that some Fidelity Select portfolios did after 1987. One key difference is that the Fidelity Select funds were invested in shares of the major players in their industries--firms with substance and financial staying power.
Today, “the worst problem would be with an Internet [stock] fund,” Jacobs said. “There’s no reason some of those stocks will ever come back. I don’t see Yahoo getting back to $200.”
The Jacob Internet fund (not related to Sheldon Jacobs) has fallen 87.7% in the last 12 months. At Morningstar’s message board, one investor called it “a fund where ailing stocks go to die.”
Some Net-focused funds, such as De Leon Internet 100, have already been liquidated or have changed their focus.
For deeply depressed stock funds in general, future performance will depend on many factors, of course--including the market’s general trend, and the fund managers’ stock-picking abilities.
The math can be daunting for an investor hoping to get back to even in a devastated fund.
“I have successfully turned my initial $2,500 into $500 in only one year,” lamented one investor at Morningstar’s Jacob Internet board. “Peanuts to some, but an expensive lesson to me.” That investor, down 80%, would need a 400% return to get back to the peak.
Yet some well-known tech-savvy fund families such as Van Wagoner and Janus have been through wild ups and downs before, Cooley noted. “They’ve had miserable years and even some truly horrible quarters buried in their longer-term records, but they’ve bounced back,” he said. “Van Wagoner still has the resources to weather the storm and Janus is just good at what they do. I’d be more worried about a third-tier firm.”
Indeed, some “third-tier” funds never recovered from 1987.
American Heritage, which lost 19% in 1987, has notched an annualized loss of 8.5% since then, according to Lipper. Manager Heiko Thieme recently held three-quarters of the fund’s assets in a British medical stock that trades for about $1 a share.
Ameritor Investment, which sank 17.5% in 1987, has since lost an annualized 2.9%. The Ameritor funds are now run by Max Katcher, but investors may remember them as the former Steadman group, whose late founder, Charles Steadman, was sometimes lampooned as the worst manager. The family was nicknamed “Deadman Funds” on the idea that you’d have to be dead to stay with them.
Though longtime fund laggards almost always change managers, that may not be reason enough for investors to stick around.
Russel Kinnel, Morningstar’s director of fund research, said he would drop Scudder Development, for instance, a mid-cap growth fund that ranks in the bottom decile of its category for three-, five- and 10-year performance.
The Scudder fund switched managers in mid-1999 but performance has remained lackluster. In fact, Morningstar has found that laggard funds generally continue to under-perform even after a manager switch.
But with the market overall now hovering near two-year lows, some analysts said fund investors considering dumping last year’s losers may at least want to wait for a market bounce.
Said Ferris: “Unless you’re dangerously overexposed to technology, throwing in the towel now after so much of the damage has been done is not much of an idea.”
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After the Last Crash
On average, the 50 worst-performing U.S. stock mutual funds of 1987 that still exist have notched subsequent returns nearly matching the typical fund - although individual returns have varied widely. Here are the 50 biggest losers of 1987 and their returns since then through March 8.
Fund types:
DH= domestic hybrid
LB= large-cap blend
LG= large-cap growth
LV= large-cap value
MB= mid-cap blend
MG= mid-cap growth
MV= mid-cap value
SB= small-cap blend
SP= specialty
SV= small-cap value
WS= world stock
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12/31/87- 3/8/01 Fund 1987 annualized Fund name type total return avg. return Matterhorn Growth LB -41.91% 13.00% Kaufmann MG -37.16 22.62 Fidelity Select Brokerage SP -37.09 21.10 Fidelity Select Defense SP -23.24 14.32 CornerCap Small Cap Value SV -22.98 8.91 Ameritor Security LG -22.73 3.50 Fidelity Select Air Transportation SP -20.72 17.35 American Heritage WS -18.98 -8.45 MAS Small Cap Value SB -18.74 16.88 Merrill Lynch Small Cap Value SB -18.52 13.72 Security Ultra MG -18.17 14.41 Bruce DH -18.09 9.81 Oppenheimer Capital Appreciation LG -17.94 18.38 Ameritor Investment LG -17.50 -2.86 Fidelity Select Transport SP -17.49 18.27 Fidelity Select Financial SP -16.67 19.39 Evergreen Aggressive Growth LG -16.51 16.83 Eaton Vance Utilities SP -15.82 13.84 Gintel MB -14.25 12.37 Fidelity Select Electronic SP -13.48 25.27 T. Rowe Price Small-Cap Stock SB -12.61 14.40 Heritage Income-Growth LV -12.54 11.66 Fidelity Select Const. & Housing SP -12.44 14.58 Fidelity Select Insurance SP -12.16 19.20 Fidelity Select Medical SP -12.15 16.38 Fidelity Select Technology SP -11.84 20.96 Fidelity Select Energy Services SP -11.80 16.36 Janus Twenty LG -11.65 19.98 Aim Aggressive Growth SG -11.52 18.68 Phoenix-Engemann Focus Growth LG -11.52 14.67 Pilgrim Small Cap Opportunities SG -11.43 17.23 Stratton Monthly Dividend REIT SP -11.40 8.70 PaineWebber Financial Services SP -11.05 18.43 Invesco Financial Services SP -11.02 21.54 Liberty Small Cap Value SB -10.76 12.27 CSWP Small Company Value SB -10.61 14.74 AXP Discovery SG -10.56 10.31 Legg Mason Special Investment MB -10.44 16.92 EquiTrust Value Growth MV -10.07 7.92 PC&J; Performance LG -10.03 14.35 Evergreen Growth SG -9.89 14.12 RSI Emerging Growth SG -9.63 15.54 T. Rowe Price New America Growth LB -9.40 15.43 DFA U.S. 9-10 Small Company SB -9.30 14.14 Fidelity Select Industrial Equipment SP -9.30 13.75 Federated Equity-Income LV -9.24 13.96 Fidelity Select Utilities Growth SP -9.24 15.75 Prudential Small Company SV -9.24 12.22 Babson Enterprise SV -9.15 13.66 Oppenheimer Growth LG -9.15 14.58 Average of 50 losers -15.0 +14.4 Average of all U.S. stock funds +1.0 +14.3 S&P; 500 index +5.0 +16.1
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Source: Lipper Inc.
