Charts Don't Paint a Full Portrait of Funds

Brenda challenges Gary B. Smith's technical analysis of Fidelity Magellan and Legg Mason Value.
Author:
Publish date:

Yes, a picture can be worth a thousand words.

But sometimes, it doesn't tell even half the story.

And even though this means disagreeing with my esteemed colleague, the wildly popular Chartman (a.k.a.

Gary B. Smith

), I've got to say that his pictures don't say all that much about mutual funds. (See Gary's Oct. 27

column defending the idea of charting funds.)

TA vs. Fund Analysis: Join the discussion on our

message boards.

That's right. I just don't think standard technical analysis applies in the fund world.

Before you start sending angry email, listen for a moment. I'm not going to decry charting as voodoo or accuse chartists of simply scanning squiggly lines for a predetermined pattern. Although I think that a close look at company fundamentals is critical before making investment decisions, I grant you that checking out the charts can offer a helpful snapshot of a stock, especially these days, when investor psychology often moves a price more than profits.

So it's logical to assume that technical analysis could work with funds, too. It makes sense if you view a fund as a collection of stocks, or an index, and track the net asset value as you would a stock's price -- a representation of the emotions and psychology that drive buying and selling.

Trouble is, a mutual fund is not a stock. It is, in fact, a completely different animal -- much more than merely a group of stocks or some sort of semistatic index.

How?

First of all, most mutual funds are actively managed. That is, they're subject to change. So depending on how active a manager is, the set of stocks you track today may be a completely different mix than the one charted just a few months ago. On our recent "TheStreet.com"

TV show on

Fox News Channel

, Gary took his charting tools to

(FMAGX) - Get Report

Fidelity Magellan and

(LMVTX) - Get Report

Legg Mason Value. In the former, he found a pattern in Magellan that suggested that a fall through the NAV of 120 might mean the fund's dropping another 10%.

What the chart fails to recognize is that Magellan manager Bob Stansky, who like most of the folks at

Fidelity

doesn't often offer a peek inside his portfolio, is not afraid to make big strategy shifts. Earlier this year, he made a prescient call to substantially reduce his tech exposure. Chart-topping

Legg Mason's

Bill Miller is another active manager who takes huge stakes in a stock but can change his mind at any time, which he showed this spring when he sold much of his stake in longtime holding

America Online

(AOL)

.

Charts are designed to follow psychology, but they miss out on the psychology of the most important person to the fund: the manager. They have no way of showing what's going on in his or her head.

So what exactly is being charted when analyzing a fund? Not much, as John Rekenthaler of

Morningstar

pointed out in a recent chat we had on this subject. "With a stock, you're charting the same darned company. But a mutual fund is an ever-evolving entity," he says.

Don't forget to add in the cash variable, too. Lots of managers keep a cash cushion. It can change depending on their market outlook. That can throw a curveball to a chartist, too.

Plus, as I understand it, volume is a key factor in technical analysis because it serves to measure the commitment of a given change. When you consider a mutual fund's chart, you have no sense of how many buyers and sellers are moving any of the stocks in the portfolio, so how can you exploit any pattern?

That said, I suppose some funds are more chartable than others. A sector fund, one that focuses, say, solely on tech or financials, where the stocks tend to make broad moves together, might give a clearer view than one that mixes lots of different sizes and styles. And a fund headed by a manager who sticks with his or her stocks over time might be more instructive, too. You can check out a fund's turnover to figure out the frequency of a manager's past trades. Bottom line: The more a manager maintains a particular philosophy -- going only with large growth, for example, or relying on one particular sector -- and the less he or she trades, the better chance you have of getting a readable chart. But the broader or more diversified a fund and the more active the manager, the weaker the technical analysis.

Now, that's the question of "can." But what about "should?" Should you use technical analysis to try to trade funds as you do stocks?

You can guess my answer on this one. Yet when I say "no," I'm not wagging a finger at fund traders because I think there's something inherently wrong with doing so. It's just really hard to do well. You can make pretty significant stock trades for cheap, but jumping in and out of funds can be a lot more expensive. Not only do you have to consider the price tag of the fund -- its expense ratio, which is measured as a percentage of the assets you buy, on average is about 1.4% -- but also loads and other fees, some of them specially designed to penalize short-term shareholders.

Still want to make a quick trade? Say you had followed the chart on Legg Mason Value and jumped out a week and a half ago when the chart suggested it was on a death spiral. You would have missed out on a big move -- Miller's fund is up some 7% since then. And besides, even during the fund's dip, the chart didn't really provide adequate context. Sure, Legg Mason Value was down, but it was still beating the market and the majority of its peers.

So the truth is, even devoted chartists should think twice before throwing their funds up on a graph. TA is no shortcut. Boring and basic as it is, you have to do fundamental work: Figure out your manager's style and factor in risk, turnover and cost.

Defending Morningstar

As I said, a picture isn't always totally telling. Speaking of which, allow me a quick defense of the firm that helps you get a clearer picture of your funds. I've got to disagree with Cramer and his

evaluation of fund-rating company Morningstar last week. He wrote, "Right now, we have that silly Morningstar rating system -- who does that, anyway, Doctors of Mutual Fund-ology? -- which is so outmoded and useless as to make me laugh. I'm not happy with that system. It is not good enough for you."

No way. I, for one, depend almost daily on the raw data that Morningstar provides, everything from rolling returns to portfolio holdings. Of course, you can't just rely on its star system -- anyone who buys a fund just because he or she sees stars is silly. You have to do some of the work and analysis yourself. But the researchers and analysts at Morningstar take their jobs very seriously and provide a category system that is far from useless. I love the reporters on our funds team -- they do a fantastic job, no question -- but there's no need to discount the work the folks at Morningstar do. It's a good job, and we as investors are the better for it.

Never 'Nuff on Neff

Who says you have to be high-tech to have high returns?

John Neff's got a record no other manager can muster: As manager of

(VWNDX) - Get Report

Vanguard Windsor fund, he beat the

S&P 500

index 22 of 31 years, delivering thousands of percentage points more in returns than the market.

But don't ask him for a quick email, to pick up a book through

Amazon.com

(AMZN) - Get Report

or surf the message boards for hot stocks.

You see, Neff still doesn't own a personal computer. "I don't feel any void," says the legendary stock picker, whose reputation is right up there with

Peter Lynch

.

Neither does he want any part of the highflying Internet sector. Too expensive for an investor who prefers price-to-earnings ratios in the single digits. And he thinks

Fortune 500

companies like

Wal-Mart

(WMT) - Get Report

are well-positioned to knock the Nets down. But that doesn't mean he can't appreciate what a good Internet partnership means. One of his top picks is

Delta Air Lines

(DAL) - Get Report

. Neff likes its excess cash flow and its position in the industry. But he especially notes Delta's deal with

priceline.com

(PCLN)

. "This enables Delta to fill empty seats in off-hours," he says. "There's nothing more perishable than an empty seat."

For more on Neff's investment picks and stock strategies, be sure to watch "TheStreet.com" on the

Fox News Channel

this weekend when he does the Stock Drill and joins Cramer, Greenberg, Kansas and myself for Word on the Street.

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.