Laggard Funds Are Trailing Inflation

By JOSH FRIEDMAN

May 27, 2002 12 AM PT

TIMES STAFF WRITER

The bear market has been tough on most investors, but some have suffered what could be called the ultimate insult: The performance of their stock mutual funds over the last five years now lags the inflation rate.

Roy Weitz, a self-appointed fund industry gadfly who runs the FundAlarm.com Web site (www.fundalarm.com), found that 416 stock funds--about 10% of those in his database--trailed the rate of inflation for the five years through the end of the first quarter.

“If you don’t invest in stocks to beat inflation, then what are you investing in them for?” Weitz asked rhetorically, noting that U.S. Treasury securities known as TIPs now offer guaranteed returns above the inflation rate, without the risk inherent in equities.

While Weitz’s list of dubious achievers is littered with niche investments such as sector funds and foreign funds that focus on long-suffering areas such as Japan, he said he was shocked to see many diversified equity funds with annualized returns below 2.25%, the approximate rise of the consumer price index in the last five years.

The Standard & Poor’s 500 index of blue-chip stocks returned an annualized 10.2%, roughly its long-term historical average, in the same span, which included both the bull market of the late 1990s and the steep slide of the last two years. The average U.S. stock fund rose 9.2% a year.

What’s more, many of the worst-performing funds of the period have slumped again this year, in some cases posting double-digit losses.

“I was surprised to see so many laggard funds across the board” in the five-year screen, said the Tarzana-based Weitz, who manages a private endowment along with his 6-year-old Web site. “If a so-called growth fund can’t beat inflation over a long stretch, that’s disconcerting.”

Although investors pick funds for different reasons and measure them in various ways, beating inflation is one of the most basic and easy-to-understand goals, Weitz said.

His list of poor performers includes prominent names such as Vanguard U.S. Growth, a $7-billion fund that gained an annualized 1.5% in the five years, and Invesco Growth, which lost an annualized 2.4%; onetime media darlings such as Gary Pilgrim’s PBHG Growth, which gained 1.8% a year, and Garrett Van Wagoner’s Van Wagoner Post-Venture, off an annualized 0.7%; and conservative-sounding funds such as Lindner Growth & Income, up 1%, Monetta Blue Chip, down 5.2%, and Comstock Capital Value, off 12.8%.

Deciding whether to cut loose a disappointing fund can be a difficult decision. Selling a stock, or stock fund, at a loss means admitting you made a mistake, financial planners say, and it cuts against the logical inclination to buy low and sell high.

As a rule of thumb, Weitz said, he would consider dumping a fund that has lagged its benchmark index in the trailing 12 months, three years and five years--his definition of a “three-alarm fund.” Many, but not all, of the inflation laggards on his list are tagged with three alarms, his worst rating.

“At some point you’ve given it a fair shot and the numbers speak for themselves,” Weitz said. If the fund is part of an asset allocation strategy, it could be replaced with a better performer from the same category, he suggested.

Weitz said highly volatile funds, such as the tech-heavy Van Wagoner offerings, can leave investors in a big hole because the math of recovery gets daunting. If a stock or fund loses 50% from the point of purchase, going from $10 to $5, it has to gain 100% from its trough just to recover.

Tax issues should be considered before selling if the holding is in a taxable account. Even with a slumping fund, you could still have an unrealized capital gain, depending on how long you’ve owned the fund. Conversely, you could have a tax loss worth capturing if you want to cash out for a better investment idea.

Most fund companies, of course, are aware of their worst-performing portfolios, and many eventually take action--for example, by merging laggards with other funds or by changing managers in an effort to revive performance.

At Vanguard U.S. Growth, Vanguard Group hired a new team in June 2001 after the board decided that the previous managers went overboard with technology stocks.

New managers Christopher Toub and John Blundin of Alliance Capital so far have struggled to right the ship, with a year-to-date loss of 16%, but analyst Christopher Traulsen at fund tracker Morningstar Inc. in Chicago said it may be too soon to give up on the experienced duo.

In March, Invesco Funds handed the reins of Invesco Growth to a team headed by Timothy Miller. Morningstar analyst Peter Di Teresa said the new team has softened sector bets and taken other steps to temper the fund’s volatility, although it’s “far too soon to tell” whether performance will improve.

Charles Rinaldi took over the Strong Multi-Cap Value Fund in May 2001. The fund, which gained an annualized 2.2% in the five years ended March 31, is up 4% year to date. Morningstar analyst Paul Herbert said Rinaldi, who has posted nifty gains at Strong Advisor Small Cap Value, may be able to turn things around.

In one of several recent moves aimed at revamping its sluggish fund lineup, American Express lured Nicholas Thakore from rival Fidelity Investments in April to take over AXP Growth, which gained an annualized 1.8% in the five years ended March 31.

Russ Kinnel, Morningstar’s director of fund analysis, said the move should give the large-cap growth fund a “much-needed boost,” noting that Thakore built a strong record running the Fidelity Fund. But Kinnel said he would wait for more evidence before cutting a check.

As with baseball teams, switching managers doesn’t always do the trick.

John Hancock Large Cap Growth, which lost an annualized 3.8% in the five years ended March 31, has had seven lead managers in the last eight years, Morningstar said.

Performance has yet to perk up under Paul Berlinquet, who took over in June 2001. The fund is down 10.4% year to date.

(BEGIN TEXT OF INFOBOX)

Lagging Inflation, and More

Many diversified stock mutual funds returned less than the annualized inflation rate of 2.25% in the five-year span through March 31, according to FundAlarm.com. Most of the funds also have posted losses so far in 2002, along with the major stock indexes. Here are some of the worst performers in the five-year period:

--Total return--

Fund 5 years ended 3/31* YTD ’02

Frontier Equity -18.2% -2.7%

Dreyfus Aggressive Growth -12.9 -4.4

Comstock Capital Value -12.8 +2.9

American Growth -11.7 -10.4

Van Wagoner Mid-Cap Growth -10.0 -24.2

Lindner Large-Cap Growth -9.5 -13.7

Comstock Strategy -7.5 -4.2

AIM Global Infrastructure -5.9 -12.7

Preferred Small Cap Growth -5.7 -13.3

Monetta Blue Chip -5.2 -13.0