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A Guide to Selling Your Fund, Part 2

Last week I began offering some guidelines for deciding when to sell a fund. Among the reasons to consider dumping a fund are that it keeps you up at night or that its returns consistently lag those of its peers.

Today, a few more reasons to sell. Consider getting out when:

  • A manager leaves.

    With skittish shareholders trading funds like stocks and fund managers on the lookout for more money (in the portfolio and in their paychecks), you need to know what to do when a manager quits -- or is shoved out.

    Simple, right? Conventional wisdom tells you to take your money and run. The departure of a manager is supposedly one of the clearest sell signs on Wall Street.

    But the rules of the road are changing, so fund investors need to shift direction a bit, too. It's no longer enough to inquire, "What's the new manager going to do?" You also have to ask, "What are the shareholders likely to do?"

    And along with keeping an eye on that maverick manager, you need to understand the shop backing him or her up. The strength of the organization behind your fund is key to knowing whether you should hang on or leave. A big, stable fund family is much more likely to have the resources to train and attract several levels of top talent than a tiny fund from a small upstart company that may not be able to weather rapid redemptions.

    Consider Tom Marsico, one of the most respected managers in the business and long the face of Janus. For more than a decade, Marsico ran Janus' chart-toppers, not only pounding his peers but besting the market, too. Then, in the summer of 1997, the growth-fund guru suddenly left to start his own firm. An occasion for shareholders to bail, right? Not necessarily.

    Those who followed Marsico are surely not disappointed. In both '98 and '99, (MFOCX) Marsico Focus delivered better than 50% a year. But those who stayed behind certainly have no regrets either. Marsico's old fund, (JAVLX) Janus Twenty , was up a whopping 73% in '98 and 64% last year. And that makes sense. Janus is a large, established fund firm with a stock-picking style that can transcend a single manager.

    Other strong fund families? Fidelity and T. Rowe Price have sturdy benches.

    But if your fund is part of a smaller family or in a volatile sector (like the Internet), think twice about sticking around when a manager disappears.

    Besides the risk that the firm won't have a No. 2 person up to the job, you have to factor in the psychology of other investors in the fund. A rash of redemptions can spell big problems for a small fund. If shareholders bolt (and who is more jittery than Internet investors?) and take their money with them, the new manager must deal with a shrinking asset base and may be forced to sell stocks he or she wouldn't have sold otherwise.

    Of course, there's one class of stock funds where you don't need to spend much time on this question. While I have great respect for fine index fund managers who control costs and use trading to their advantage, I wouldn't worry much if even Gus Sauter of (VFINX) Vanguard 500 Index left. A manager's departure is mainly an issue for active funds , not passively managed ones .

    One last note: Complicating your decision are tax implications. If your fund is in a taxable account and you've held it for years, you could be hit with a big taxable gain when selling -- even if it hasn't been a stellar performer recently, Also keep in mind that if you stick with the fund, and a new manager comes in and wants to revamp the portfolio, you could face a sizable capital-gains distribution.

  • When your fund gets growing pains.

    If you bought a fund because you wanted small-cap exposure, you really need to watch its asset size -- especially if it has had a hot year and a lot of cash is flowing in. Compare the fund's median market capitalization today with that of a year ago. Few small-cap funds close when they should. The managers with too much cash to invest may be forced to buy bigger and bigger stocks, or may simply get too huge to dance any longer.

    One Last Thought: Rebalancing

    Rebalance your portfolio every six months.

    This is the "floss twice daily" equivalent for financial planners. But they make it into such a chore, most investors just say they do and really don't. You're supposed to slice the asset allocation pie into the teeniest of tiny pieces. With category classes multiplying and sub-sub-sector funds a growing rage, you can go crazy trying to fill the "micro-cap international hybrid" slot in your portfolio. It makes sense for fund advisers and marketers -- the more slices to a portfolio, the more funds you have to buy -- but doesn't necessarily make sense or money for you.

    There are a lot of stupid rules of thumb that supposedly will tell you how much you need in stocks without considering your goals, tolerance or time horizon. Many a pro will suggest you can subtract your age from 100 to find the portion you should have in stocks. But a 60-year-old with a long life expectancy and some longer-term goals would be a fool to have just 40% in stocks. Sure, in a market that changes personality faster than Sybil, you want to know what you've got. And with tech go-going and everything else either stalling or slipping, it's important to understand exactly how much you have at risk in one group.

    It's not so much stocks vs. bonds anymore. It's what kind of stocks. You need to determine whether your funds are buying similar kinds of holdings. If so, it's just the opposite of diversification.

    How can you make sure your funds don't overlap? You can look into each fund's portfolio and compare the holdings -- a time-consuming job. Or you can compare your funds' R-squared ratings, which measure correlation to an index. See my column, How Many Funds Should You Own? , for more on this.

    So, there you go. Of course, the worst time to bail is when the market's having a tough time. But if your fund is a consistent laggard, with high fees and an asset size that doesn't fit its name, there may be no better time than now to get rid of it.

    Brenda Buttner's column, Under the Hood, appears Thursdays. At time of publication, Buttner held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While she cannot provide investment advice or recommendations, Buttner appreciates your feedback at TSCBrenda@aol.com.

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