PBHG Funds Ride Momentum to Big Numbers -- but for How Long?

How many times can you die and come back to life? With cats, odds get long around nine times. For Pilgrim Baxter's PBHG Funds, the number's hard to pin down, but it just went up by one.

The mutual fund family was performing so dismally last year that an attempt by parent United Asset Management (UAM Quote) to sell Pilgrim Baxter fell through, largely due to its funds' poor performance.

Today, the firm's flagship (PBHGX Quote) Growth fund is approaching five-0 territory, returning 49.3% through Wednesday's close. And other PBHG funds are posting Raghib Ismail-like numbers as well:

PBHG Funds On Fire
Fund	YTD return
(PBTCX Quote) Technology & Communications	132%
(PBHEX Quote) Select Equity	72.6
(PBCRX Quote) Core Growth	56.3
(PLCPX Quote) Large Cap 20	53.1
(PBLDX Quote) Limited	41.1
(PBHLX Quote) Large Cap Growth	30.1
Source: Morningstar

PBHG funds' resurrection comes as momentum investing -- long a religion at PBHG -- is back in favor. The strategy involves buying explosive small- and mid-size company stock before other investors pile in, then getting out of them before those same investors bail.

It's a hit-or-miss strategy that's risky and difficult to time, as demonstrated by the up-and-down results of the Growth and (PBEGX Quote) Emerging Growth funds:

The Rise and Fall and Rise of PBHG Funds
Fund	1995 return	1997 return	1999 return*
(PBCRX Quote) Growth	50.3%	-3.4%	47.8%
(PBEGX Quote) Emerging Growth	48.4	-3.7	20.7
S&P 500	37.5	33.3	14.2
*Through Nov. 30. Source: Morningstar.

That kind of variance in performance should give potential new investors pause. After PBHG Growth had its big run-up in 1995, the firm's assets under management skyrocketed from $3 billion to $9.6 billion in 1996, according to Financial Research, a Boston fund consultant.

But in 1996 PBHG Growth, along with the firm's other funds, started hitting the skids. In 1997, Growth underperformed the S&P 500 index by 36.7%.

As a result, a half-billion dollars left the firm in 1997, followed by $2.2 billion in 1998. This year, despite the performance turnaround, the bleeding has only gotten worse. Through October, net redemptions total $2.4 billion.

"If you look at when the money flowed in, [investors] missed the upswing, and they got nailed by the downswing," says Steve Janachowski, a financial planner with Brouwer & Janachowski in Tiburon, Calif. "A lot of these people probably made no money."

Perhaps because of that legacy, Gary Pilgrim, the firm's chief investment officer and co-founder, now seems to be distancing himself from the "momentum" moniker. He says his shop's style is simply misunderstood.

"We're not momentum investors, at least as I define it," says Pilgrim. "Momentum investing is chasing rising stocks, and obviously, we don't do that."

Rather, PBHG simply concentrates on finding emerging small and mid-size firms with rapidly growing earnings. "Sometimes those companies are popular, and sometimes they're not," he says.

As for his funds' volatility, he says, "Our performance has fairly wide variations because we don't move around and try to develop strategies to do other things when growth stocks are out of favor."

But frequent trading can be an indication of momentum investing, and on that score, PBHG funds employ a rapid-fire approach. Though PBHG Growth, which Pilgrim runs, has managed to trim its annual turnover rate -- the measure of how fast a fund is buying and selling stocks -- to a mere 81%, according to Morningstar, the annual turnover rate for the (PBTCX Quote) Technology & Communications fund is 276%.

It's even worse for PBHG's value funds: Annual turnover for (PLCVX Quote)Large Cap Value, (PBMCX Quote)Mid Cap Value and (PBSVX Quote)Small Cap Value is 568%, 733% and 274%, respectively.

"So that's active management," says Pilgrim. And it's based upon a rigid buy-and-sell discipline, he says.

"In the world I live in, you focus on earnings surprises, and every time a company beats earnings, you buy the stock," Pilgrim says. "Every time it doesn't, you sell the stock."

Some financial planners are uncomfortable with PBHG's turnover rates, mostly because it's hard to keep up with what kinds of stocks their portfolios hold.

"We're not using any of those funds at this point," says Janachowski. He says he's not comfortable with momentum investing, though he credits PBHG funds as being among the best at employing it.

"When a momentum fund stops working, then you have the problem of, 'Geez, now what do I do? Am I comfortable with this portfolio?' " says Janachowski.

As PBHG swings for -- and clears -- the fences, even Pilgrim acknowledges that there's no way to tell when the cycle that favors his funds' style will come to an end.

"I think the investor has to assume some responsibility for himself," Pilgrim says. "Investing in high-growth-rate, exciting, emerging companies is volatile. As an investor, you have to say, 'OK, it's hard to time the sector, but it's proven over the long term.' "

Indeed, over 10 years, PBHG Growth is in the top 7% of its mid-cap growth peers, according to Morningstar. But therein lies the rub: Investors attracted to PBHG's funds' style are rarely willing to stick around for the long haul when things head south.

That means investors will surely pile back into PBHG's funds starting next month when 1999 performance results are published. And they'll be in for a rude awakening if the funds hit the skids again. In fact, they probably won't even know what hit them.