Avoiding go-go funds that might go-go down in shaky markets
Boston — An economy that's slowing to a more ''normal'' pace presents a special problem for mutual funds - and the people who invest in them. When the economy is roaring along, as it did last year, mutual funds get a lot of attention. Newspaper stories talk about strong performance, while advertisements tout high yields. Almost all the funds look good.
But when the economy and business slow a bit, the real test for mutual funds begins. Many of them flunk. For five consecutive quarters, for example, mutual funds as a group have failed to outperform the Standard & Poor's (S&P) 500 index of major stocks, the standard by which funds measure themselves in those ads.
Now, asks the investor who prefers the diversification and reduction of risk a mutual fund offers, what do I do?
One answer, mutual fund experts and fund executives say, is even more diversity. True, each individual fund is a diversified collection of investments; some even have a wide mixture of stocks, bonds, and money market instruments in one fund. But when the choppy waters roll in, it may be time to spread the risk among several funds.
Also, these experts say, this is no time to get fancy. Those high-flying aggressive growth funds may have been fun at one time, but they can be downright dangerous to your portfolio now. It's time, they say, to look for funds invested in solid, blue-chip companies with a consistent record of dividends and steady growth. If the prices of companies like General Motors, International Business Machines, Du Pont, and 3M are too high for you, you can take part in their strength through mutual funds.
Michael Lipper, president of Lipper Analytical Services, a firm which tracks mutual fund performance, favors the diversification approach.
''I would spread my money out'' in four directions, he says.
First, Mr. Lipper would put one-quarter of the assets bound for mutual funds in a bond fund, either taxable or tax-exempt, depending on the investor's tax bracket.
Second, he would put one-quarter in a growth fund specializing in high-tech stocks. Even though these are the funds that got battered the hardest in the past year, having some money in them does make sense if, as Lipper believes, there is growth potential in these industries.
Third, he would put one-quarter in a more conservative growth-and-income fund , seeking earnings from a combination of rising stock prices in growing companies and dividends from established businesses.
The final quarter of assets, Lipper suggests, could be put in a money market fund. Now considered the most conservative of fund investments, most of these funds are yielding at least 10 percent, and they also serve as good holding pens for money waiting to move somewhere else.
A slowing economy means ''increasing competitive pressure as companies fight for share of market,'' says Monte Gordon, vice-president at the Dreyfus Group. For the fund investor, he believes this means steering toward the ''middle of the road'' - the growth-and-income funds that invest in companies best suited to withstand these competitive pressures.
''If we're talking about a slowdown,'' Mr. Gordon said, ''you don't want a fund that tries to be No. 1. But you don't want a fund to be No. 500, either. I'd stay away from funds in the high beta area.''
''Beta'' is a measurement of a fund's price volatility compared with the S&P 500, which automatically gets a beta of 1.00. An aggressive growth fund might have a beta of 1.24, while a bond fund's beta might be around 0.5. Beta on a growth-and-income fund, on the other hand, could be about 0.85 to 0.96.
In his own group, Gordon says, this preference fits the Dreyfus Fund, ''which provides reasonable income with reasonable growth.''
One effect of a slowing economy, he continues, can be lower interest rates. If this happens next year, ordinary money market funds are not going to be as attractive. But for people in 40-percent-and-over tax brackets, tax-exepmt money funds should stay competitive. They are now yielding around 8 percent, which means an effective return of 16 percent for someone in the 50-percent taxable income bracket. Even for in a 40-percent bracket, an 8-percent tax-exempt yield would be equivalent to a 12.8-percent taxable return.
Burt Berry, publisher of NoLoad Fund*X, a San Francisco newsletter, agrees this is no time to get adventureous.
''Our studies of performance over the long term clearly points to the fact that you do better in a conservative fund than you do in a high-flier,'' he says. ''An aggressive fund can go up a lot. But it can also go down even faster.''
Five funds, Vanguard's Windsor, Select American, Century Shares, Mutual Shares, and Northeast Investors Growth Fund, rate highly on Berry's list of funds with good long-term performance.
Then again, says James Hawkes, executuve vice-president of the Eaton Vance Group of mutual funds in Boston, the stock market may have already figured in and discounted any near-term future economic changes. This means, he says, that now may be just the time to be getting into the stock market through mutual funds, even in somewhat more aggressive funds.
''Investing in bonds now would be a normal response, because interest rates could decline,'' Mr. Hawkes says. ''But you may be shooting yourself in the foot by trying to be too clever.''
To avoid this, he suggests picking a mutual fund whose management is allowed more flexibility to move assets among various types of stocks, as well as bonds. Balanced funds like these usually aren't on the lists of top performers, but they usually manage to avoid leading the list of losers, too.