Hard lessons for mutual funds and their investors. Oct. 19 silenced marketing blitz; looking for bargains
Boston — Ralph Wanger did not have to make any great changes in his advertising as a result of October's stock market plunge. Mr. Wanger is president of the Acorn Fund Inc., a mutual fund in Chicago, and his entire advertising this year consisted of ``a $320 advertisement in the program for my daughter's high school drama production.'' Other mutual funds, however, have had to spend time and money explaining what happened to their shareholders' investments on and shortly after Oct. 19.
Many of those investors were introduced to the business through money market funds in the late 1970s and early 80s, when those funds were paying yields in the mid-teens and above. When money fund yields fell, those investors moved to stock and bond funds where they enjoyed a five-year bull market, which ended abruptly this fall, wiping out more more than a third of the value of some portfolios.
Now, the funds have some explaining to do, and their investors have lessons to learn.
``Most mutual fund families really shot themselves in the foot the first six months of the year as far as longer-term shareholder relations were concerned,'' says Gerald Perritt, editor of the mutual fund letter in Chicago. ``They were all marketing on the basis that they were number one. Every ad contained a great big percentage sign. They were the No. 1 growth fund, during the last 6 months, the last 12 months, or during the bull market.
``And those who couldn't say they were No. 1 but still had tremendous returns were coming up with ads with huge numbers. They were attracting a great deal of people on the basis of numbers ... instead of talking about long-term growth, and diversification, and risk reduction.''
Many of those investors who didn't have long-term experience with the ups and downs of mutual funds and the stock market have probably left - the stock funds, at least - never to return.
``In every market cycle you always end up losing some group of investors,'' observes Norman G. Fosback, president of the Institute for Econometric Research, which publishes the Mutual Fund Forecaster in Fort Lauderdale, Fla. ``They become discouraged, they sell out, and they never come back again. So every cycle has its own new class of investors.''
``We've had a tremendous explosion in mutual fund popularity over the last five years,'' says Eric Kobren, who publishes ``Insight,'' a Needham, Mass., newsletter that follows funds issued by Fidelity Investments in Boston. ``It happened 20 years ago and now it's happening again. There were a lot of not very financially sophisticated people who shouldn't have been in the market. They were new investors. They weren't used to taking risks.''
``Most of the people who wanted to make 20 percent but were unwilling to lose 20 percent in a given time frame, I think those guys are out,'' Mr. Kobren adds. ``The people who are still in will remain in.''
At some funds, particularly those who did have more sophisticated investors, the reaction was somewhat better.
``In the first few weeks [after Oct. 19] our investors were generally supportive,'' Acorn's Mr. Wanger says. ``They were calling us and telling us not to panic, things would work out.'' This was despite the fact that the fund's net asset value, or share price, dropped more than 25 percent from an Oct. 2 high of $41.30 to a low of $29.19 on Oct. 28. The fund now stands at about $32, a little higher than where it started the year, Wanger says.
For a while, at least, the market's plunge has changed the industry's advertising and marketing strategies.
``I think the funds' overall advertising budgets will go down significantly,'' Kobren says. ``They've already cut them dramatically. And certainly their orientation is away from the aggressive funds, towards municipal bonds, money markets, brokerage services, retirement accounts, and other service-oriented things.''
``Well before the crash, Fidelity was talking about a model portfolio and suggesting diversification of mutual fund assets,'' says Rab Bertelsen, vice-president at Fidelity. He believes that investors are now hearing some of those messages.
Also, investors are now looking for conservative places for their money, such as money market funds, municipal bond funds, and conservative stock funds, so that's what Fidelity and other fund companies are talking about in their ads, Mr. Bertelsen says.
Within the funds themselves, investment strategies and portfolios have changed since Oct. 19. Some of those changes came because the market's plunge created bargain-basement buying situations.
``When the downdraft came, we revised the portfolio quite a bit,'' says Roger Engemann, who manages the Pasadena Growth Fund in California. ``We got out of mediocre companies and bought some great companies at mediocre prices.''
Some of the bargains included Reuters, a communications company whose price fell from over $90 a share to around $40; Circuit City, a retailer, which went from $42 to $17; and Eli Lilly & Co., a pharmaceutical maker that fell from over $90 to less than $30.
Fortunately, Mr. Engemann says, ``we were very heavily in cash since June. We saw that interest rates were high and going up, so we began moving out of the market.'' By the time Oct. 19 hit, the fund was about half cash or cash equivalents, so it could pick up those bargains. It is now about one-quarter cash.
Funds that had low cash positions before Oct. 19 experienced bigger declines because they had to sell many stocks at loss when shareholders pulled out or moved their money to money market funds. Now, many of these funds have increased their cash positions and plan to keep them up there, both to meet redemptions and to be able to pick up bargain stocks. Fidelity's Magellan Fund, for instance, went from having 0.5 percent to 2 percent of its assets in cash to a 4 percent cash position, fund manager Peter Lynch has said.
Ben Niedermeyer, president of the Janus Value Fund in Denver, sees the coincidence of the stock market's plunge and the falling dollar as a chance to invest in some ``dollar-decline beneficiary stocks.'' These include stocks in industries like steel and some manufactured goods that are now more competitive because they are cheaper overseas, while competing imports have become more expensive in the United States.
``With most of the fund managers, the thing you hear is that they're looking for values, says Don Phillips, editor of Mutual Fund Values, an investment advisory service in Chicago.
``Also, a lot of the funds became defensive before the crash and invested in things that had gone up less,'' he says. ``So they were in a lot of financial services and utilities. This has given a lot of them more breadth. Now there are a lot more things that are less expensive that they can invest in.''
For income funds, the market's fall was a boon, Mr. Phillips says. Before Oct. 19, he explains, very few quality companies were available - at reasonable prices - with the dividends the funds wanted. Now, he says, ``many managers are investing in companies they hadn't been able to invest in for some time.''
Now that they've bought the bargains, some of the funds are trying to educate their shareholders about the risks of investing in the stock market - and mutual funds - and the need for diversification.
A simplified strategy is suggested by Mr. Niedermeyer at Janus. He would start by putting one-third of mutual investment assets in a bond fund. ``The maturity you select depends on your tolerance for risk,'' he says. ``If you can stand some risk and want to lock in a return for a few years, select a bond fund with long maturities. If you don't like that, pick a shorter term.''
Another third would go into one or more stock funds and another third into cash or money market funds. He would then keep each group balanced as market conditions changed. ``If there's an enormous jump in the stock market again, take some of your profits from stocks and put it in bonds and the money fund, to keep the same proportions,'' he says.
Down the line, Perritt says, many funds will go back to touting high current yields over the need to balance risks and long-term goals.
``If the market went back up to 2,700, they'd be pulling out the same ads and just revising the percentages,'' he says.
Most fund managers hope this doesn't happen.
``The managers I talked to weren't happy [with the marketing and advertising], Phillips says. ``They don't want shareholders that panic and all of a sudden sell out, because then the fund managers have to sell at inopportune times. So an educated base is a very nice thing to have for a manager.''