Don't Be Fooled by Window Dressing - TheStreet

Investing in a mutual fund should be easier than building a portfolio of stocks. But researching a fund can be as frustrating and time-consuming as trying to balance your checkbook with an abacus.

You start at the top of the standard checklist and work your way down, examining a fund's performance, fees, turnover, manager tenure, sector allocation and volatility. The next thing you know, you're rearranging the letters in the manager's name, looking for alarming anagrams.

But picking a mutual fund doesn't have to be so labor-intensive. You just have to learn what to ignore when researching a fund. You can start with the name and work your way down.

Name-Dropping

You want to know exactly how a mutual fund manager will invest your money, but you can't rely on the fund's name to tell you. A name could say that a fund invests in telecom or tech stocks. But to find out a fund's investing style, you'll have to look much deeper.

The

Securities and Exchange Commission

does require that fund's name accurately reflect the specific type of securities it buys. According to an SEC rule that was approved early last year, a fund with a name that implies a focus on particular investments must invest at least 80% of its assets in those securities. For example, a financial fund has to have 80% of its money in financial stocks.

But the SEC doesn't impose any naming restrictions when it comes to identifying a fund's style or strategy. A fund can use the word "growth" or "value" rather liberally. Take, for example, the

(TVFQX)

Firsthand Technology Value fund -- a bit of misnomer, because a fund that invests almost exclusively in tech stocks is not exactly hunting for bargains. And you'd never know that the

(OAKMX) - Get Report

Oakmark is a great value fund by glancing at its name.

Instead, you'll have to look at the fund's prospectus and regular shareholder reports as well as

Morningstar's style box to figure out exactly how and where a fund is investing its assets. You want to know which broad benchmark and which peer group a fund should be measured against.

Of course, a name will tell you the company behind any fund. These days Oakmark and Fidelity are certainly a lot more impressive than, say, Janus. But that's about all you should divine from the name.

A Price Tag That Doesn't Matter

You don't need to bother looking at the fund's price either. Its net asset value per share, or NAV, is the value of all the fund's holdings divided by the number of shares outstanding. But that number won't tell you if a fund is cheap or expensive, and it won't really tell you how it has performed.

For example, you're going to get nearly the same holdings and performance from almost any

S&P 500

index fund. But their NAVs are all over the place -- from $104.56 for the

(VFINX) - Get Report

Vanguard 500 Index fund to $77.91 for the

(FSMKX)

Fidelity Spartan 500 Index.

Does that disparity matter? Absolutely not. The number of shares that you buy in a fund is irrelevant. You make mutual fund investments in dollar amounts. A $1,000 investment is a $1,000 investment.

Remember, mutual funds have to pay out their net realized capital gains to shareholders every year. These distributions will reduce a fund's NAV. And if you reinvest those distributions and buy more shares at the new price, the NAV won't tell you how much you've actually made or lost in the fund.

Plus, some fund companies will split the shares on a fund to reduce its NAV and make the share price look more attractive. But you can ignore this gimmick.

Big Winners That Are Big Holdings

If you're glancing over a fund's top 10 holdings, you might be impressed if the list is loaded with big winners. Don't be. For one, this list might be dated. It could be a few weeks or a few months old, depending on the fund company.

More importantly, plenty of managers load up on stocks that have done well -- and trim any losers -- to dress up their portfolios at the end of each quarter.

To discover whether a manager is savvy, you'll have to dig into the fund's shareholder reports to find out how long a stellar stock has been in the portfolio. A manager deserves praise for owning

eBay

last year. He does not if he started buying it in late December.

Pops in Performance

When you're thinking about buying a fund, you can almost always disregard its short-term returns. A fund's performance over a few weeks can be misleading if not intoxicating.

In such a short stretch of time, a fund can easily experience a big move in one direction or another. "But that tells you almost nothing about a manager's skill," says Russ Kinnel, director of fund analysis at Morningstar.

Heiko Thieme's

(AHERX)

American Heritage fund has become a classic example of this lesson. The fund is notorious for having most of its assets crammed into just one biotech stock called

Senetek

, which develops anti-aging and erectile dysfunction treatments.

The stock price is so low that a 15-cent move can translate into a 15% gain. So any small jump in this one stock can result in a giant percentage gain for the fund, which has most of its money in the stock. The result: The American Heritage's returns can look awesome over a short period of time. For example, the fund has soared 100% since the end of the year. But the fund can just as quickly head in the other direction, and keep going. Its five-year annualized return is a

negative

24.2%.

Indeed, a fund's sudden drop in performance might tell you the risk level of a fund. Just don't let a sudden jump sucker you in.

Gives Great TV

Thieme is also the perfect example of how fund manager can be a great TV guest but a bad stock picker.

"Appearing on TV regularly isn't an indication of brilliance," says Morningstar's Kinnel.

Indeed, in the early 1990s, the American Heritage manager was a regular guest on

CNBC

, but these appearances were no indication of the fund's future performance.

In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to

Dagen McDowell.