Millions of mutual fund investors are staring at their account balances and wondering how they went so wrong.
Fact is, if you built a seemingly sensible portfolio of funds in the past five or 10 years, it was quite easy to end up with a tech-stuffed gaggle that's falling through the floor. When tech dusted the rest of the market in 1998 and 1999, pro and amateur investors alike chased the sizzling sector. A record gush of money flowed into tech funds and "diversified" growth-fund managers quietly put 40% and 50% of their money in tech stocks, too. Today
we detailed the steep losses these funds -- and their shareholders -- are still absorbing.
The upshot: Even a portfolio that seemed only moderately aggressive was actually positioned to fall -- and fall hard -- in this tech-led downturn. Let's look at one and then check out some simple alternatives you can use to cut your risk way down, without sacrificing competitive returns. I'm not telling you to buy these funds, I'm just trying to show you how easy it can be to get marketlike returns without a slew of risk.
Over the past few years, it seemed like everybody was buying
S&P 500 index funds, big-cap growth funds, focused growth funds that held only 20 or so stocks and tech funds. If we build a portfolio of the biggest, most popular funds in each style, it would include the
Vanguard 500 fund, the
Fidelity Magellan fund, the
Janus Twenty fund and the
T. Rowe Price Science & Technology fund. Let's call it the Popular Portfolio. Yes, Magellan and Twenty are currently closed to new investors, but given their asset size, there is no shortage of folks with these funds, and funds like them, in their portfolios.
While this probably seemed like a moderately aggressive portfolio, it was actually pretty risky. If we look at the sector weightings of an equally weighted portfolio of these four funds we find that it would have more than half its money in the tech sector, according to
Morningstar. Keep in mind, the telecommunications sector is a big part of the portfolio's "services" bet, so about 60 cents of every dollar in this portfolio is pegged to mercurial and currently sagging tech/telecom stocks.
They're a Techy Bunch
These four funds won their fans by riding the tech wave -- till it crashed |
| Sector | Weighting in Portfolio | Weighting in S&P 500 |
| Technology | 50.9% | 19% |
| Services | 12.6 | 11.9 |
| Financials | 10 | 17.5 |
| Cyclicals | 7.5 | 12 |
| Health Care | 7 | 13.8 |
| Retail | 3.9 | 6.5 |
| Energy | 3.7 | 7.6 |
| Consumer Staples | 2.3 | 6.8 |
| Consumer Durables | 1.3 | 1.9 |
| Utilities | 1 | 2.9 |
| Source: Morninigstar. Weightings as of most recent portfolio reports. |
This Popular Portfolio's tech bet was probably apparent when it sailed high in 1998 and 1999, but it's even more noticeable now. It's down almost 32% over the past 12 months through Feb. 28, according to Morningstar. That's about four times the loss of a portfolio invested just in the Vanguard 500 Index fund, where tech is about 19% of the portfolio.
Even more stark is a look at the Popular Portfolio's volatility. Yes, over the past 10 years its best 12-month return was 67.8%, but its worst 12-month loss topped 30%. That's three times the worst-case scenario for the Vanguard 500 fund. If we look at each portfolio's beta, a measure of its volatility compared with the S&P 500, we find that the Popular Portfolio was a much bumpier road, too. For reference, the S&P 500's beta is 1.0 and a higher beta implies more volatility.
Plain Jane Vs. the Popular Group
A plain old index fund would have had competitive returns
compared with the Popular Portfolio, with a lot less risk |
 |
| Volatility |
 | Popular Portfolio | Vanguard 500 Index |
| Best Year | 67.8% | 52.0% |
| Worst Year | -31.8 | -9.1 |
| Three-Year Beta | 1.34 | 1.0 |
| Source: Morningstar. Returns through Feb. 28. |
But even for tech fans, it didn't have to be that bad. For aggressive investors, most portfolio models prescribe a diversified portfolio that limits its sector-fund bets to 10% or less of your assets. This adds up to a 28.6% tech bet, which might be a happy medium for even those stricken with tech fever. If we compare the returns and risks of a portfolio with 90% of its money in the Vanguard 500 Index fund and 10% in the average tech fund, we find often-higher returns and less risk than the Popular Portfolio.
Over the past 10 years, the Popular Portfolio would've posted a 17.4% average annual gain, compared with 15.9% for the other. But the Popular Portfolio would've fallen short this year, over the past 12 months and over the past five years.
What a Little Tech Can Do
Taking on a smaller dollop of tech funds in your index-weighted portfolio would do wonders against the Popular Portfolio |
 |
| Volatility |
| Popular Portfolio | Vanguard 500 Index |
| Best Year | 67.8% | 51.9% |
| Worst Year | -31.8 | -14.1 |
| Three-Year Beta | 1.34 | 1.08 |
| Source: Morningstar. Returns through Feb. 28. |
Bringing bond and foreign-stock exposure would reduce risk even more. For instance, let's look at a portfolio with 80% of its money in the Vanguard 500 fund, 10% in the Vanguard Total Bond Market Index fund and 10% in the Tweedy, Browne Global Value fund. This fund would trail the Popular Portfolio over the past 10 years, but it would be down only 4.3% over the past year, compared with the Popular Portfolio's 31.8% fall.
This broader portfolio, which has a 21.3% tech weighting, still would've gained more than 45% in its best year, but its worst 12-month return was just 5%, according to Morningstar. Its beta or volatility along the way also was just 0.85%.
Well, there you have it. A few different ideas on how you might participate in up markets, without getting a healthy dose of account-statement shock.
Ian McDonald
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