Dizzying number and types of new funds call for sober selectivity
Boston — Oh, what a wonderful year to be in the mutual fund business. And oh, what a . . . well, passable . . . year to be a mutual fund investor.
If you were in the fund business this year -- as a salesman, manager, adviser, or newsletter publisher -- you could celebrate sales of stock, bond, and income funds surging to record highs. Helped by a fast-climbing stock market and descending interest rates, sales this year will easily double those of 1984. Nearly 300 new funds were created in the last 12 months, with more than a dozen new ones coming to market every month. One newsletter picked up more than 12,000 subscribers in a year and a half, whi le another did even better, swelling to 48,000 readers since it started in February.
If you were an average equity fund investor, however, you saw your portfolio gain 14.77 percent, compared with a 17.63 percent gain for the Standard & Poor's 500 average. For the 12 months ending Sept. 30, some funds gained as much as 39 percent, while others lost 47 percent of their value.
Investors were also faced with a dizzying variety of new types of funds. Instead of just three or four varieties of stock funds, a couple of bond funds, and money market funds, there are now dozens of more-volatile industry-sector funds, government bond funds, and several new international funds.
On the domestic front, this year's hottest new entry was the government bond fund. With a double-digit yield that appeals to people longing for the old mid-teen money fund rates, along with government guarantees, these funds seemed like the perfect alternative. The fact that the value of these funds could drop through the floor if interest rates went up was not often mentioned prominently in promotional literature.
In all, investors pumped more than $89 billion into equity and bond funds through October, compared with $45.9 billion sold in all of 1984, which was another record year.
``I expect we'll do $100 billion this year,'' Alfred P. Johnson, vice-president and chief economist at the Investment Company Institute, says happily. Adding the last $11 billion in two months should not be too difficult, since these funds gained $12.3 bilion in October alone, according to the institute.
While the funds have had the happy task of coping with a flood of cash and talking about high yield, government guaranteees, diversification, and sectors, one word -- ``caution'' -- seemed conspicuously absent. Yet the growth of the mutual fund business and the heavy promotion designed to stimulate even more growth demand a careful look at investment objectives and risk tolerances before one adds his money to the flow.
First, however, why has so much money been poured into the funds this year?
``It's obvious,'' says Gary Pittsford, a fee-based financial planner in Indianapolis. ``People feel good. Their jobs seem secure, their income is pretty good, they may get a bonus this year, and families are just making more money.''
One reason families are making more money, of course, is that more of them have two people earning full-time salaries. Although some of that extra money is being spent, much of it is being saved or invested for new homes, college, vacations, and retirement.
Several years ago, that money would have been put in a bank. Then money market funds became the vehicle of choice and introduced many people to the mutual fund business. Now, with money funds paying a paltry 7 to 8 percent and interest rates on bank certificates of deposit under 10 percent, people are looking for new places for their old savings.
The mutual fund companies have played a part, too. ``The funds have had the products the people wanted at a time when the investment climate was favorable,'' Mr. Johnson said.
``This has been an income-driven year for the mutual fund business,'' says Steven E. Norwitz, vice-president at T. Rowe Price Associates Inc., a Baltimore fund company. ``That's reflected in the growth of government income funds.'' Sales of these funds leaped from $3.2 billion in the first nine months of 1984 to $23.1 billion in the same period this year.
Marketing also played a role. ``Marketing has been very important this year,'' says Gerald Perritt, publisher of the Mutual Fund Letter, which has gained more than 12,000 subscribers in less than two years. ``Fidelity, for instance, is a champ among funds in marketing. They've attracted tons and tons of money.
``Then there's the explosion in so-called financial planning. You can find a financial planner under every rock, and the majority of them are on commissions, so they're pushing people into load funds.'' These funds take a sales charge (usually 81/2 percent) off the top of every investment, as opposed to no-load funds, which do not impose a sales charge. Sales of load and no-load funds are about even, Mr. Perritt says.
Next year, thanks to continuing marketing efforts and a good investment climate, some $20 billion a month could move into mutual funds in the first few months of the year, investment analysts believe. For individual investors, finding the best places for their share of that money means trying to guess the direction of the stock market (or various sectors of it), plus the overall direction of the economy and interest rates.
Or, says Michael Lipper, president of Lipper Analytical Services in New York, you can avoid guessing and diversify among different types of funds. He suggests a five-way split.
One-fifth would go to a strategic reserve in money market funds or a high-grade bond fund with short- to medium-term maturity. The second fifth would be in international or global funds; the third in small-company or technology funds; the fourth in funds that find companies out of the mainstream and have good value and growth potential; and the last into a broad-based mainstream growth or growth and income fund.
Instead of trying to guess which one of these five areas will perform better than another, Lipper would prefer to see investors keep the split pretty even, with about 20 percent in each area.
``I don't like to see investors try weighting,'' he says, ``because I take the point of view that most people get weighting wrong. The ability to foresee the future is just too low. If some of the 20s [percents] become 26 and some become 14, I would redress this.''
``I'm down on timing,'' agrees J. Randall Hedlund of Financial Management Consultants in Overland Park, Kan. ``You should decide how much you want to put in equities, how much in fixed-income or bond investments, and how much in money markets and allocate your money based on an overall strategy. Keep an eye on Federal Reserve policy and on what Congress is doing and on interest rates. But don't get caught up in the hurly-burly of every day-to-day event.''
For James Stack, publisher of InvesTech, a newsletter in Kalispell, Mont., there are enough signs of a slowdown in the stock market to suggest a defensive posture.
``We've moved our investors into cash at this point, because we don't like the risks,'' he says. ``We're paying much more attention to protecting capital in a down market. I'm not looking for the top-performing fund. I'm looking for funds that will hold up in a down market.''
Norman G. Fosback, on the other hand, describes himself as ``bullish on the market.'' Mr. Fosback, along with Glen King Parker, publishes the Mutual Fund Forecaster. Since the first issue of the newsletter was sent out of Fort Lauderdale, Fla., in February, it has picked up over 48,000 subscribers, more than the combined circulation of four other letters published by the two men. It has also become the largest mutual fund letter, Fosback says.
``I would suggest common stock growth funds up to whatever limit people impose on themselves,'' he says. ``I see common stocks beating bonds and the money markets.''
Fosback is not bothered by the fact that equity funds have underperformed the S&P 500 average this year.
``Over the long term they generally do underperform the market a bit,'' he contends. ``Most funds have to keep some cash reserves, so they're usually about 90 percent invested. You'd expect that in the long run funds would do about 90 to 95 percent as well as the market.''
Also, he says, mutual funds, particularly the bigger ones, tend to invest in larger, higher-capitalized companies where the price may be higher but the long-term yields are somewhat lower.
For fee-based financial planners who don't make their living off sales commissions, the funds most often mentioned are the sames ones they've been talking about for some time. Their records of long-term growth appeal to people making long-term plans for their clients.
For Richard Whitehead, a planner in Atlanta, names like the Nicholas Fund, Fidelity Equity Income Fund, and the Strong Funds fit this description.
Mr. Pittsford in Indianapolis moves his clients among Vanguard's Windsor Fund (it's now closed to new investors), the Wellesley Fund, Fidelity's Equity Income Fund, the Nicholas Fund, and the Lindner Fund (also closed).
The hottest group of funds this year, however, is not in stocks. It's those stodgy old bond and income funds, once considered the industry's equivalent of the neighborhood park wading pool. But this year, nearly 75 percent of equity and bond fund sales went into higher-yielding bond and income funds.
Yet it is precisely because these funds are so hot that many professionals are concerned. If interest rates go up even moderately next year, the value of these investments, especially the bond funds, will take a dive, even if their underlying bonds do have US government backing. The net asset value (NAV) of these funds is a combination of the bonds' yields and their prices. If the price falls dramatically, that will bring down the NAV.
The current rage in mutual funds reminds Mr. Stack of another ``hot'' period for the business, the ``go-go'' years of 1967 and 1968, when some equity funds gained 40 to 60 percent a year, he recalls. But when the stock market fell, the value of some of these funds fell, too. The Manhattan Fund, for example, dropped 68 percent, he says. It was eventually merged into another fund company.
Now, of course, there are many more choices for mutual fund investing. Large ``families'' of funds can protect investors by giving them the ability to move among stock, bond, and money funds as circumstances change. Also, the whole industry is watched much more closely, with more newsletters and more newspaper and magazine articles on the industry to help point out any weaknesses.
Still, if investors want to be a as happy next year as much as the professionals are this year, they will spread the risk and keep their eyes open. If you find a hot fund with an investment philosophy that seems to make sense, try it -- with part of your money. Fads are fun, but consistency is not one of their strong points.