If you're like many investors who want to build capital over time and don't need dividends to supplement income, a well-managed growth fund could be the cornerstone of your portfolio.
There are more than 285 growth funds, as classified by Lipper Analytical Services, far more than in any other equity fund category. So, it's a challenge to find a fund that can provide a satisfactory return without exposing you to excessive risk.
Growth funds invest in companies whose earnings are expected to grow faster than those of stocks in the Standard & Poor's 500 or other major indexes.
On average, growth funds have outperformed the average equity fund over the five-year period that ended June 30. But their total returns have generally lagged that of the S&P 500.
Funds' performances have varied considerably, despite their common objective. Of the 184 in operation for the past five years, only 28 had returns exceeding the S&P 500's 11.9 percent annual rate, according to Lipper. On the other hand, 23 failed to match 4.5 percent inflation -- including eight that had negative returns for the five-year period.
Past performance, whether good or bad, may suggest future results. But it doesn't ensure them, even when the portfolio manager responsible for the record remains in the job. A manager who excels in one market environment, for example, may not do as well in another.
And past results are even less indicative of future results if a fund has changed managers.
While you need to consider past performance when you look at a fund, you also need to familiarize yourself with other factors, such as the volatility of a fund's returns and its investment policy.
When you scan the list of top performers of the last five years, you'll see a variety of strategies that produced superior results.
Thomas F. Marsico, manager of top-ranked IDEX II and third-ranked IDEX (and of the more aggressive Janus Twenty) attributes the returns of 17.4 percent and 16.5 percent, respectively, to his freedom to choose on the basis of earnings or value, and to build up cash when he can't find enough attractive stocks. His current cash level is 10 percent, vs. 50 percent a year ago.
William Danoff, Fidelity Contrafund's pilot for the last year, searches for out-of-favor stocks and those whose earnings growth rates exceed price-earnings ratios. The fund has benefited from the strength of health-care and technology stocks. But he has begun to shift away from them and to add financial stocks and cyclicals -- companies that should benefit from economic recovery.
Robert Stansky, who manages Fidelity's Equity Portfolio: Growth well as Fidelity Growth Co.), tries to keep the portfolio of 100 companies divided into thirds according to capitalization (small, or up to $750 million; large, or over $5 billion, and medium) and earnings growth rate (10 percent to 20 percent, 20 percent to 30 percent and more than 30 percent).
"I've looked purely for growth," he says. "Never played value."
Mario J. Gabelli, on the other hand, is very much a value player. For Gabelli Asset Fund, he seeks asset-rich companies whose stock prices are low in relation to their cash flow per share. And he likes to hold those stocks until the market reflects the values he sees. Underperformance by cable TV, entertainment, auto parts and independent phone stocks hurt the fund's performance over the past year -- but didn't shake his confidence in them.
Berger 100 Fund's powerful surge this year is due, in large measure, to the performance of a number of small-capitalization stocks, including those in health care, computers and retailing. William M. B. Berger, portfolio manager since 1974, and Rodney Linafelter, who joined him as a manager in 1990, look not only for annual earnings growth of more than 20 percent but also for return on shareholders' equity of 20 percent or more. Normally around 5 percent in cash, they recently have become cautious and gone to 20 percent. "We're never at a loss for things to buy," Mr. Linafelter notes.
Maintaining he has "no real format," Jerry Palmieri, who has run Franklin Growth since 1965, has an approach that has served him well over the long term. He buys shares -- as cheaply as possible -- of companies with the strongest competitive positions in industries that he expects to grow significantly.
"Health care, transportation, environmental protection -- companies in such industries have to grow," he asserts.
Harry Hutzler, manager of AIM Weingarten since its inception in 1969, and Jonathan Schoolar, who joined him in 1986, search for stocks in two categories. One is "core" holdings of companies that have recorded average earnings growth of at least 16 percent over 10 years and had no more than one down year. The other is companies whose earnings are accelerating. (Stocks of smaller capitalization companies that meet these criteria go into AIM Constellation Fund, which they also run.)
The fund has always been fully invested, Mr. Schoolar points out. "I cannot overemphasize how important this is over time," he says
Growth fund can be key to long-term capital needs