A compilation of this week's daily Fund Forum columns.
Is there a tool out there where you plug in the 20 stocks you like and it spits out the mutual funds that most closely resemble your picks? -- Bruce Carton
Your question dovetails with a question in last Thursday's
column, in which a reader was searching for a fund to match her stock holdings.
Unfortunately for both readers, I have not been able to find a screening tool on the Internet that would make it easy to match a fund to a specific set of stocks. For example,
Morningstar's site offers an advanced fund screening tool, for which you have to pay a premium. The tool allows you to search for funds using numerous parameters, including sectors and regional exposure. But you cannot hunt for funds based on their specific stock holdings.
Morningstar's site, like many others on the Internet, delivers the top 10 holdings of mutual funds. But combing through the stocks of each fund to find the ones you want is probably not what you had in mind.
For a much heftier price, Morningstar offers a way to search for funds by their stock holdings, using its Principia Pro CD-ROM. The mutual fund version for this tool costs $495 a year for monthly updates.
If you are set on owning these 20 stocks, you might want to think about buying them yourself or hiring someone to manage your account for you.
Do you know of any better ideas? Send all your questions and comments to
email@example.com, and include your full name.
Not Easy to Manage 20 Stocks
A few professionals wrote in to offer some additional advice to reader
, who was considering investing in a portfolio of 20 selected stocks. Managing such a portfolio is not as easy as it sounds, according to one pro.
"I was surprised you didn't try to ascertain from Kat his or her ability or desire to monitor the 20 stocks closely," writes Jim McCall, portfolio manager of the
PBHG Large Cap 20 fund. "If each stock represents 5% of the portfolio, one needs to be diligent always in this volatile market environment, lest you log onto
MarketWatch.com and discover your portfolio is down 20% from where it was when you checked it last week!" McCall says.
"Obviously, my point is if you have a life and can't spend all day every day watching the market, leave it the those of us who don't have a life," he says. "I must admit, however, I do like the way Kat thinks!"
Others wrote in to suggest investing in a unit investment trust, a fixed portfolio of securities that has a finite life.
These instruments warrant more attention than a single line at the bottom of one of my columns. Look for more on UITs in a Fund Forum later this week.
Do P/Es Matter in Funds?
Most of the stock analysts and commentators (including
) keep talking about stock valuations being too high and point out they will probably fall to lower valuations under certain circumstances. But I haven't seen anyone address this situation regarding mutual funds. So is there any advice for both new and existing mutual fund investors? Harvey Talley
Some people will tell you that certain areas of the market are overvalued. Some won't.
It all depends on who is doing the talking. (On
, for example, we have a lot of different points of view.) For years some financial professionals have been crowing that the market is overvalued and ripe for a fall. But when it comes right down to it, who knows?
Without having to decide which pundit is right, there are a few things you can always remember when looking at your existing funds or picking new ones.
For starters, keep in mind that a mutual fund is just a basket of stocks. If the stocks in the fund are overvalued and begin to decline, then the mutual fund will follow suit. So, to get a handle on valuations and your mutual fund, you need to check out the standard valuation measures as they pertain to the stocks in your fund. Figures are available for the average price-to-earnings ratio and the average price-to-book value ratio for a mutual fund. (
site carries them.) These ratios will let you compare the valuation of a particular mutual fund to an index fund or one or more of its peers.
Some financial professionals care more about these measures than other pros do. Which brings me to my next point: It is important to know and understand the investment approach of your fund manager. A fund might have the word "value" in its name, but that doesn't tell you much about a manager's style. The approach of
Strong Schafer Value, for example, is different from the value style at
. Other funds, so-called "aggressive growth" or "momentum" funds, are generally less concerned with valuation -- or the price they have to pay for a stock -- than whether the price is going up.
If you personally are concerned with valuation, you may want to avoid momentum or aggressive growth managers. You may also want to avoid sector-specific portfolios where you think the sector is overvalued. A simple way to look at it: If something has rocketed, then it has the potential to head downward with the same force.
Small-cap funds certainly have lower valuations than large-cap growth funds. Then again, small-cap stocks have dramatically underperformed the large-caps. We don't really know when or if the world will turn around for small-caps and when large-cap growth names will no longer lead the market.
"I think one thing to do in a market such as this is try to diversify," says Tim Schlindwein of
, a financial adviser in Chicago. "If one buys a more broadly diversified portfolio that isn't just focusing on one area where all the action has been, you mitigate your exposure to that area of the market and still participate in the broad market's movement."
"Where I would be very cautious in the mutual fund arena is the focused funds," Schlindwein adds. A focused fund, with only about 20 or so stocks, or a sector fund is going have heavier weightings in certain areas and may not recover as quickly if that part of the market goes south. Of course, a focused or sector fund could have a place in a broader portfolio. That just goes back to spreading your bets around.
What's a CDA Rating?
When I check my Fidelity funds on Yahoo!, I get a CDA rating, ranging from 1 to 99 (lower is better). What does this number refer to? I phoned Fidelity, and it has never heard of it. -- J. Hilowitz
These mutual fund ratings and rankings are as omnipresent as those grinning photos of
Standard & Poor's
started publishing its own list of "select" funds, a designation awarded on the basis of S&P's analysis of performance and management.
has its risk- and performance-based star ratings. And
, a mutual-fund tracking service and data provider (formerly CDA/Wiesenberger, thus the name of the rating), has its owning ranking system.
Here's a quick but slightly thick description: The CDA rating, a percentile ranking (lower is better), is based on the composite performance of a fund over five time periods with a penalty assessed for inconsistencies. The five time periods are the latest two up-market cycles, the latest two down-market cycles and the most recent 12-month period. If the fund has not been around long enough to have two up- and two down-market cycles, then CDA will use one each. If CDA cannot find one up and one down cycle during the fund's tenure, it will not be rated.
The equation gets a lot more complicated from here. I will let Wiesenberger's definition do the explaining:
"The composite performance number (let's call it X) is the average of the percentile ranks for the five (or three) time periods, plus one-half of the mean absolute deviation of the five (or three) numbers. To illustrate, assume the specific percentile ranks for a particular security over the five time periods are 10, 20, 30, 30 and 10. The average of the five numbers is 20, and the mean absolute deviation is 8. (We get the 8 as follows: Take the sum of the absolute difference between each of the five percentile ranks and the average of 20 -- they are 10, 0, 10, 10, 10, or 40 -- then divide by 5, which equals 8.) For this security, our X is 24 (20 + 0.5*8). Now, let's take another security whose five ranks are 20, 20, 20, 20 and 20. Obviously, the average rank is 20, the same as the first security. However, the mean absolute deviation is 0, so X would remain 20. The second security has a better (i.e., lower) X than the first because its performance is more consistent."
Take a breath.
Once composite performance numbers (or Xs) are computed for all funds, they are ranked and given a percentile rating. With the final CDA rating, you get a measure of performance over market cycles with a penalty for inconsistency.
Like Morningstar's star ratings, Wiesenberger uses the past performance numbers to calculate its rankings. And as the standard, often-seen disclaimer goes: Past performance is no indicator of future performance.
I am not suggesting that there is anything wrong with taking a gander at these ratings when assessing an existing holding or a potential purchase. But any ranking should only be used as a small part of the decision-making process. "There is no single number or ranking that will give a final opinion on whether a security should be purchased," says Daniel Roe, a financial planner with
Budros & Ruhlin
in Columbus, Ohio.
For a lengthier discourse on buying mutual funds, read
Contributing Editor Brenda Buttner's
guide to getting started.
I have started seeing the words "unit investment trust" crop up more and more frequently over the past year. REIT UITs. Internet UITs. You name it.
But trying to find information on unit investment trusts is another matter.
does not offer information on unit investment trusts.
doesn't either. You can't find prices for them in the paper.
Are you curious? I was. And here is what I discovered over the past few days:
Like a mutual fund, a unit investment trust is a portfolio of stocks, bonds or both; however, it is a fixed portfolio of securities with a finite life. Think of a UIT as an index fund that has an expiration date. But UITs don't necessarily track indices.
UITs have been around for decades and were known for investing in long-term, tax-free bonds until the 1990s rolled around. But over the past several years, equity or stock UITs have become all the rage, with some investing in the hottest sectors and styles of the moment. Internet UITs, which
wrote about in December, are a prime example.
UITs have a predetermined expiration date. With municipal bond UITs, the portfolios usually have maturity dates that run from 20 to 30 years. Equity UITs have shorter expiration periods. Many run one year to two years, but some extend out five or seven years. It really depends on what the objective of a portfolio and what it is investing in.
An investor owns a "unit" rather than a "share" of a UIT, and each unit is priced as a proportional fraction of the overall net asset value of the UIT. You can't find these prices reported in the newspaper, but you can get them from your broker.
There is a set offering period to buy into a UIT, but generally you can take your money out before the portfolio reaches its maturity date.
However, UITs are not structured to be actively bought and sold. They are sold through broker-dealers and generally not available directly from a portfolio's "originator," typically a brokerage firm or money manager.
You have to pay a sales charge to buy a UIT. These charges vary, and so does the structure of the payment schedule. The full commission may be paid at the time of purchase or spread over the life of the investment.
For example, the
Van Kampen Focus Portfolio: Internet Series Trust
, which has a two-year maturity, carries a 3.25% charge. There's an up-front payment of 1%, with 2.25% paid over the first eight months of the trust. Then there is a slight small management fee of under 30 basis points.
The charges will depend on the type of product and the expertise needed to build it. The more common Dow 10 UITs, which invest in the 10 highest-yielding stocks in the
Dow Jones Industrial Average
, may cost less than a more unique and unusual portfolio.
When you start talking about charges and fees, comparison shopping is always a good idea -- just to see what the next guy is asking for a similar product. But that is not an easy exercise when it comes to UITs. You have to rely on your broker to get information about UITs, including daily pricing information. (You'll also see UITs referred to as defined portfolios or defined funds, which for me just muddles the matter even further.)
Brokers generally have information on all investments in the UIT and defined portfolio world," says Robert Burke, head of defined portfolio marketing at
John Nuveen & Co.
in Chicago. "The sales charges are generally comparable, but the strategies may differ dramatically."
Of course, you will want to analyze the costs of any potential investment. But often the newest and latest UITs are investing in the best-performing areas of the market. You should closely examine the outlook for the sector to determine whether this is a proper place for your assets. Depending on your needs, you may be better off in a more diversified mutual fund.
I have only covered the very basics of UITs. If you have more specific questions and comments, email me at
firstname.lastname@example.org , and please include your full name.
A Bird with Different Feathers
Nasdaq-Amex Market Group
just launched its
Nasdaq 100 Index Tracking Stock
. The securities represent ownership in the
Nasdaq 100 Trust
, a unit investment trust designed to closely track the price and yield performance of the
This UIT, however, is open-ended, a different structure from the ones I describe above, and the securities trade on the
American Stock Exchange
just like stocks.
Betting on Rising Interest Rates
I haven't thought about investing in bonds lately because I can't imagine yields dropping much, and I'm not all that thrilled with current yields. Is there an easy way to bet on rising rates without taking a position in futures? -- Michael Carroll
Sorry I didn't get a chance to answer your letter sooner -- you wrote on Jan. 29 -- but this way, everyone gets to see how awesome your interest-rate forecasting ability is. Since you wrote, Treasury yields have risen by roughly 50 basis points!
Think rates are going to keep rising? First, let me state the general principle that, in the realm of fixed-income investments and derivatives, the only way to make money from rising rates is at the
Chicago Board of Trade
, where you can short or buy put options on Treasury bond and note contracts. If the price of the contract falls, the prices of put options (which give the owner the right to sell at a certain strike price at expiration) will rise.
As long as you know what you're doing, options on Treasury futures aren't beyond the reach of most investors. The futures themselves require a major capital commitment. The Treasury bond contract, for example, closed at 120 30/32 yesterday, with each price point equal to $1,000, for a total of nearly $121,000. But the June 118 puts, a bet that the contract will trade lower than 118 at expiration, closed at 53/64, with each 64th equal to $15.625 for a total of $828 and change.
But assuming you're not interested in that, your goal should be to choose fixed-income investments that best hold their value as rates rise. "Almost everything is going to come down, so you want to pick something that's going to come down the least," says Mariana Bush, closed-end fund analyst at
It helps to understand two basic principles of bond investing.
First, all things being equal, the longer the maturity of a bond, the more its price will change given a change in yield.
Second, all things being equal, the bigger a bond's coupon, the less its price will change given a change in yield.
I found this second concept confusing when I first started learning about bonds because it seemed to contradict the first: The longest-maturity bonds have the biggest coupons, but aren't they also the most sensitive to changes in interest rates?
Yes, but that's not what the theorem is saying. The theorem is saying that if you have two bonds
of the same maturity
and one has an 8% coupon and the other has a 6% coupon, the 8% coupon bond will be less sensitive to changes in interest rates. Its price will rise less if yields fall and fall less if yields rise.
The investment implications are pretty simple: If you want to bet that rates are going to rise, you want bonds with large coupons compared with other bonds of the same maturity. What kind of bonds are those? Bonds of relatively low quality, such as high-yield bonds. They are the ones that pay high interest rates (large coupons) to compensate investors for credit risk.
The strategy makes sense from an economic standpoint. If interest rates are rising, they're probably rising because the economy is going like gangbusters. And if the economy is going like gangbusters, those speculative-grade companies that issued the high-coupon bonds are probably doing OK.
It's not a foolproof strategy by any means. "Very often, when Treasuries sell off, the selloff can be even greater in less-liquid names," says Dan Peirce, head of emerging markets research at
BancBoston Robertson Stephens
Improving credit quality may accompany rising interest rates, but only to a point. "Depending how long it lasts, you have to ask how long will the economy be able to do well if interest rates keep rising, and how will corporations do if they have to pay higher interest rates," he explains. But Peirce also says that, as
discussed in this space two weeks ago, yields on high-yield bonds are high enough by historical standards to compensate you nicely for that risk.
What if you can't stomach the credit risk? Then, according to the first principle, you want to pick investment-grade bonds with relatively short maturities. If you're going to buy a bond fund, that means something short- or intermediate-term. Beware of staying too short, though. You can protect yourself from interest-rate changes by staying in a money-market fund, but often at the cost of a significant amount of income. "People who've stayed too liquid have really been left at the train station," says Marilyn Cohen, president of
Envision Capital Management
, a Los Angeles money-management firm. Remember that a rise in interest rates will cause the value of your principal to drop, but your income will be reinvested at the higher rates.
A couple of other suggestions for bond bears from previous Fund Forums:
floating-rate loan funds, a species of closed-end funds, and
Treasury Inflation-Protected Securities, or TIPS.
Elizabeth Roy answers your bond fund questions every Friday. Dagen McDowell answers general mutual fund questions Monday through Thursday. Send questions on either topic to
email@example.com, and please include your full name.