Your funds fell with Enron and popped with the tech bubble, so let's see how we can make the pain less excruciating next time.
Let's face it, after the frothy late 1990s, we just didn't expect the losses we've seen since. Stocks have trailed bonds for two straight years and the average U.S. stock fund is under water over the past three years. Most disturbing of all is that many fund managers were no better at staying above the fray than their shareholders. After being scorched by outsize and ill-timed bets on tech stocks, many sought shelter in the shares of now bankrupt energy trader Enron.
To help us sift through this mess, we huddled with Russ Kinnel, director of fund research at Chicago research house Morningstar. Which fund companies stood tall and which let us down? How can we pick a solid core fund to help us weather lousy markets? Who are the savviest stock pickers out there, and why didn't fund managers see the Enron disaster coming? Read on.
1. What have we learned from our losses?
People now have a very real example of what equity risk means. I think any fund investor asked in 1998 or 1989 would say, "Yeah, I know these funds can have a down period." But I'm not sure they knew it was possible to buy a fund in 1998, see it go up 150% and then lose so much that they're actually in the red by a wide margin now. That's the case today.
Russ Kinnel, Director of Fund Research, Morningstar
I looked at the (ATCHX)
Amerindo Technology fund earlier today. It gained 250% in 1999 but is in the red over five years. Now we have a true sense of the unpredictability of the markets and the economy. That is healthy, and certainly one way or the other we were bound to have reduced expectations. Even if we'd hadn't had a bear market, we couldn't keep going up 25% a year.
The main lesson is that people who were diversified are still in pretty good shape. Yes, they still lost some money but not a lot. People who piled into tech and tossed out anything that wasn't beating the Nasdaq
losses. Unfortunately, a lot of those people were thinking they were close to retirement. (Check out this story
to see a blueprint for a diversified portfolio.)
2. During the tech mania we saw a gush of ill-conceived growth, tech and subsector tech funds. It's tough to generalize, but how did the fund industry comport itself?
You raise a good point. There are a number of fund companies whose business models are designed for speculation, not savings and capital appreciation. If you're charging 2% annual expenses, then you really have to be speculative and take big risks to make a fund pay off after fees. If you're a smaller firm, you might try to get attention by making crazy niche funds. That's a business model built on speculation, and that's a hard away to make a living. It's a real problem for investors.
3. What companies stand out to you as acting prudently, and what are some others that stand out as sales chasers?
|Stocks? No Thanks
Stocks are looking winded compared with humdrum bonds
|Source: Morningstar. Returns through Feb. 28.
There were a number of fund companies with sober messages. Most could afford to because they were so big, but most were pretty sensible like Vanguard
. Fidelity launched a couple of funds that were really risky ( (FWRLX)
Fidelity Select Wireless/ (FNINX)
Fidelity Select Networking and Infrastructure) and their (FDEGX)
Aggressive Growth fund was hit hard. But by and large their funds were diversified and held up better than most
was amazingly well insulated
from the fury. We can also credit shops like T. Rowe Price
for not making Net funds, but American Funds didn't even have a tech fund. Their more conservative approach looked outdated in 1999, but now they've been proven right.
On the other hand, a lot of big fund companies did come out with some silly funds. Merrill Lynch
launched its Internet fund right at the market top, and Strong
launched a bunch of tech funds. Then you had Amerindo
with a (BTBAX)
B2B [business-to-business] Internet fund, and Munder
had a slew of gimmicky funds.
4. There are two big fund companies that really suffered more than most during the downturn, Janus and Putnam. What are your thoughts on each?
Neither launched particularly speculative funds, but both had problems.
Putnam's problems were kind of a surprise because they're very style-conscious and have risk controls. But they may have confused the two. They had a fund like (POEGX)
OTC & Emerging Growth out there that's supper speculative and heavily into tech stocks [the fund is averaging an 18% annual loss over the past three years]. The OTC fund managed to do far worse than other aggressive funds. They staked OTC and other growth funds to an aggressive space and then didn't pick good stocks in that space. Maybe too much of their focus was on making sure the funds stayed in their style box, not what was actually in the portfolio.
At Janus they did some really good research on Net and tech stocks, but they clearly projected out those companies' growth too far. They got too focused on growth potential, not the value of those businesses. They also had too much overlap among their funds. They speculated and it got them big returns, but they paid for them later on. They still had great research, but some of their funds just took on too much risk. Look at (JAVLX)
Janus Twenty: Schoelzel is a great manager, but he probably should have been more cautious in terms of industry exposure and price risk.
5. With so many funds owning Enron shares when the company collapsed, are we right to question how much value a fund manager really adds?
Every good investor makes mistakes. I would say, though, that if we didn't have so many funds with such a focus on short-term performance, Enron wouldn't have been such a big mess. At the end of 2000, Enron was so tempting for growth managers because their tech favorites were falling apart and here was Enron just chugging along. It was in a completely different area and had solid growth.
There were clearly too many fund managers who felt like they had to own a stock like Enron because it was going up. Few were willing to say, "Well, I can't really value this because the books aren't clear, so I'll look for something else."
6. Given the potential for new legislation after Enron, will fund investors finally see rule changes where they get more frequent portfolio reports or only pay capital gains taxes when they sell fund shares?
I hope so.
I would dearly love to see two things fixed. First, as funds realize gains on their trades, shareholders are taxed along the way, even if they don't make a profit on their fund shares. That's clearly unjust. Second, I think we need a Reg FD for fund shareholders in terms of portfolio disclosure. Fund companies show consultants their portfolios once a week, but they only show the same information to shareholders twice a year. There's no reason fund companies can't post their portfolios more frequently on their Web sites for shareholders.
7. A lot of investors would've seen smaller losses if they'd owned a solid, cheap core stock and bond fund. How should investors pick their core funds?
Your core funds should make the vast majority of your portfolio, and they are going to drive performance and keep you on track -- simply buying a good, stable large-cap fund and core taxable or muni bond
fund really helps you. Indexing is a great way to do it. Also, funds from companies like American Funds ( (AIVSX)
Investment Company of America) or Dodge & Cox Funds
Dodge & Cox Stock) can make sense. These are incredibly stable shops. T. Rowe Price funds ( (TRBCX)
T. Rowe Price Blue Chip Growth) can make sense, too.
As for bond funds, indexing can be a good idea, so you want to look at Vanguard's funds ( (VBMFX)
Vanguard Total Bond Market Index). But there are a lot of good active bond fund managers, too. A lot of Bill Gross' funds ( (FBDFX)
Fremont Bond/ (PTTAX)
Pimco Total Return) are pretty small, as well as the folks at Metropolitan West
Metropolitan West Total Return Bond) , Dan Fuss ( (LSBRX)
Loomis Sayles Bond) and Robert Rodriguez ( (FPNIX)
FPA New Income). Fidelity has some solid bond funds, too. (Check out this recent screen
of core bond funds.)
8. What are we missing?
I think because foreign markets got sucked into the same bear market that the U.S. did, investors might not fully appreciate the value of foreign exposure. Many of us may have forgotten why those funds make sense in a long-term investor's portfolio. They haven't done well recently, but that shouldn't continue. I think people shouldn't ignore foreign funds because you don't want to miss out on exposure to some of the great companies out there.
If Nokia (NOK)
is a better company than Motorola (MOT)
, do you want to, only want to, own the U.S. company? Also, there will be times when foreign markets will beat the U.S. market. (Check out this recent column
on how and why foreign funds can be a good fit in your portfolio.)
9. Should just about every fund investor have at least some bond exposure?
Just about anyone can use bond funds in their portfolio. Too many assumptions are built on the market's post-World War II record where stocks have beaten bonds over any 10-year period. That's true, but you can have different results. At some point there will be a 10-year period where bonds beat stocks.
Also, just imagine if you had just built your portfolio at the end of 1999 and your kid was going to college in 2009 -- it would've been good if you'd bought some bonds, right? If you're 25, maybe only start off at 5%, but it's a good habit to get into. Even if you're far from retirement, you'll need money for other, more near-term goals like a house or college education. Bonds can help you there.
10. Who are two or three stock-fund managers who consistently seem to go their own way and catch trends early, rather than follow the herd?
I'd look at the team behind (VPMCX)
Vanguard Primecap. Their portfolio is unlike anyone else's. They do a contrarian growth strategy and have had a rough year, but they're growth investors who dig into financials and don't overpay. That won't go out of style anytime soon.
The team behind (LLPFX)
Longleaf Partners is another example. They had a lot riding on Waste Management (WMI)
and got killed for a while, but ended up doing very well. That happens often with them, and I give them big points for it.
David Williams at (UMBIX)
Excelsior Value & Restructuring is another example. He's a growth manager who clearly buys what no one wants, like Stilwell Financial (SV)
. He's quietly been doing well for a long time, and his fund is still small.
I also have to mention [2001 Morningstar stock-fund manager of the year] Bill Nygren, who runs the (OAKMX)
Oakmark fund. But he's an obvious one.