Mutual Funds
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| | Mutual Funds
Now is the time to buy funds, not stocks
Good funds, of which there are plenty, are topping the major indexes. Try doing that by buying individual stocks.
By Timothy Middleton
Do you want to go on beating your head against a wall, or do you want to make money? If you choose the latter, choose outstanding mutual funds instead of picking your own stocks.
The fact is, top mutual-fund managers are better investors than you or me. So far this year, they're beating the rest of us -- that is, the market -- by 11.9%, according to Lipper, which tracks the industry. Since the bear market bottomed last summer, they've beaten it by 106%.
Individual investors are simply outgunned by even run-of-the-mill fund bosses. You take really smart professionals who do this for a living, and give them a lot of resources, and their net result is mediocrity, says Steve Savage, editor and publisher of the No-Load Fund Analyst newsletter. What basis do you have to believe that youre going to be able to do better, when you have less skill and far fewer resources?
But the net result of the best managers isnt actually mediocrity; its excellence. In this years first quarter, when the market fell nearly 8%, top funds cut those losses by more than half.
Owning funds makes sense, says Don Cassidy, a senior Lipper research associate. Many individuals lost so heavily in the bear market because they were tech-struck and didnt own anything else. If you go out and pick five or 10 stocks, youve got to be awfully good or awfully lucky to do better than a good fund, he says.
The correlation between size and performance
Lippers analysis is based on an index it maintains called the Lipper 1,000. These are the largest equity mutual funds. In the fund world, theres a strong correlation between size and performance. Good funds attract assets and bad ones repel them.
Lipper defines the market as the Vanguard Total Stock Market Index Fund (VTSMX). It faithfully tracks the Wilshire 5,000 Total Market Index ($TMW.X), less its own modest expenses of 20 cents on every $100 of assets. (The average is around $1.50.)
Lately, the Lipper 1,000 has been beating the pants off the Vanguard fund.
| Funds beat the average | | Year to date June 9 | From bottom to June 9 | 2003 first quarter | | Vanguard Total Stock Market Index Fund | 10.9% | 10.6% | - 7.9% | | Lipper 1,000 Index | 12.2 | 21.8 | - 3.3 |
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Notes: Bottom of bear market was 7/23/02.
Source: Lipper
Giant mutual funds tend to invest in giant companies. Finance- school orthodoxy, called the efficient markets thesis, holds that because all investors have equal opportunity to information, none of them can do a better job buying such stocks than everybody else.
This is the argument for indexing, and it's technically valid. Exceptional funds are what business schools call outliers; that is, they cannot exist, yet they do, so they are inexplicable.
You and I can call them good funds, and we dont even have to know what inexplicable means.
| Big funds, big returns | | Largest equity funds | Year-to-date return | | Vanguard 500 Index (VFINX) | 12.8% | | Fidelity Magellan (FMAGX) | 12.3 | | Washington Mutual Investors Fund (AWSHX) | 10.7 | | Amer Funds Growth Fund of America (AGTHX) | 14.7 | | Fidelity Contrafund (FCNTX) | 8.7 | | Fidelity Growth & Income (FGRIX) | 8.9 | | Amer Funds New Perspective (ANWPX) | 10.9 | | Amer Cent Ultra Investors (TWCUX) | 12.1 | | Fidelity Equity-Income (FEQIX) | 11.5 | | Vanguard Windsor II (VWNFX) | 14.5 |
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Note: As of 6/10/03.
Sources: Lipper, Morningstar
Rising assets
Top funds earn their way into the Lipper 1,000 through a combination of good securities selection and risk control. The undoing of once high-flying funds like Van Wagoner Technology (VWTKX) was their failure to pay attention to the second of these two key elements of fund management.
American Funds Growth Fund of America (AGTHX) stands at the opposite extreme from the Van Wagoner fund. The latters assets have shriveled to $46.8 million, from $400 million at the end of 1999, as it shed 51% of its value in each of the three years ended May 31.
The former's assets of $33.79 billion have risen 23% in the same period, and not least because its average loss over three years was only 8.9%, ranking it among the top 6% of large-capitalization growth funds.
Growth Fund of America controls risk at every step of the process. It buys growth stocks, but wont pay top dollar, and it sometimes slips out of Morningstars growth category because so many of its holdings have value characteristics.
| Growth Fund of America | | Manager | Team | | Manager tenure | 17 years | | No. of holdings | 214 | | % of assets in Top 10 holdings | 22.7 | | Cash | 13.4% | | U.S. stocks | 70% | | Non-U.S. stocks | 15.4% | | Bonds | 0.4% | | 15-year annualized return | 13.4% | | Load | 5.75% | | Expense ratio | 0.75% | | Top holdings | AOL Time Warner (AOL, news, msgs) | | | American International (AIG, news, msgs) | | | Lowe's (LOW, news, msgs) | | | Forest Labs (FRX, news, msgs) | | | Eli Lilly (LLY, news, msgs) |
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Notes: Data as of 3/31/03.
Source: Morningstar
When it cant find good stocks at affordable prices, it doesnt buy anything. Currently, more than 13% of the funds assets are in cash. Throughout the bear market, cash cushions helped the best equity funds reduce their losses.
Growth Fund also diversifies its portfolio thoroughly, owning more than 200 names, and putting 15% of assets into foreign equities. It isn't a closet index fund, however; it's heavily overweighted in technology and telecommunications stocks and underweighted in manufacturing and financial services.
And although Growth Fund is a buy-and-hold vehicle, with portfolio turnover about 70% below the equity-fund average, it makes important moves when necessary. Between the end of last years first quarter and this years, the fund doubled its exposure to non-U.S. stocks, and boosted energy stocks to 7.8% of assets from 4.7%. It also trimmed cash from 15.8% of assets.
There's no I in team
American Funds is a team-managed shop, meaning six people are responsible for the Growth Fund, each of them backed by scores of research analysts. The current managers have an average tenure of 17 years with the fund.
Mutual funds dont always beat the market. Vanguard 500 Index (VFINX) became the nations largest fund because, during the latter half of the 1990s, the benchmark it tracks outperformed roughly 80% of actively managed equity funds.
But there are periods when they do, and now is one of them. These are times to remind ourselves why we invest in funds rather than in individual stocks. We get the advantages of diversification and professional management.
Of course, even now our Holy Grail isn't average funds, but fund leaders. It doesnt matter to us whether mutual funds as a group do better than benchmarks; what matters to us is whether were able to find any funds that will do better, says Savage at No-Load Fund Analyst newsletter. Even if thats an incredibly small number, thats all we need to be successful.
Such funds are out there, and now is an excellent time to own them.
At the time of publication, Timothy Middleton controlled shares in the following securities mentioned in this article: Vanguard Total Stock Market Index Fund.
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