Portfolio director's method can be used by any investor


October 27, 1991|By WERNER RENBERG | WERNER RENBERG,1991, Werner Renberg

In a way, you and Jeffrey Molitor probably have a lot in common.

When you look for an equity fund, you probably screen a number of investment advisers and their funds' portfolio managers.

Molitor screens advisers and portfolio managers, too. But he does it as part of his job. And he oversees hundreds of millions of dollars -- a bit more than you normally would mail to a fund.

As director of portfolio review for the Vanguard Group, Molitor periodically recommends new investment advisers to directors of equity funds that Vanguard sponsors but that he prefers to have managed externally.

Recently, for example, he had to find two advisory firms to share management of the $3.2 billion Windsor II fund with Dallas' Barrow Hanley, Mewhinney & Strauss and Vanguard's own core dTC management group. The need arose when Vanguard's board and INVESCO Capital Management, which had co-managed the fund with BHM&S since 1987, agreed to terminate INVESCO's role because of potential conflicts of interest arising from its expanded mutual fund activities.

After analyzing the records of more than 25 investment advisers, Molitor recommended two little-known firms: Equinox Capital Management of New York and Tukman Capital Management of Larkspur, Calif. The board agreed, and Windsor II's shareholders approved contracts with them last week.

Although you may lack the opportunity -- or desire -- to evaluate so many candidates, you may find it helpful to apply some of Molitor's criteria:

* Investment policies. To judge whether a manager can attain a stated objective -- such as growth and income -- gather clues from a fund's prospectus.

If the stated policy is too vague, skip it. If you're considering a growth and income fund and the prospectus specifies that it may invest in risky securities, such as "junk bonds," pass it by.

Find a fund with a policy that is clear and compatible with yours. For example, it could be fully invested in dividend-paying stocks with below-average price-earnings ratios and above-average yields.

* Sector diversification. A general equity fund should strike a balance between being diversified among economic sectors and being too diversified, which risks under-performance.

Does a manager make big bets by concentrating in some sectors -- and omit other sectors because he feels they're untimely or incompatible with his investment objective?

* Stock concentration. Note how many stocks a fund holds and what percentage of its net assets is represented by the top 10 holdings. A fund with fewer than 35 stocks is a less-predictable performer, probably being more dependent for growth on those selections than on broad market trends. But if the manager is astute at selecting stocks, such a fund can be a superior performer.

* Stock selection methodology. The prospectus should describe in understandable language. Does a manager use a "top-down" approach, starting with an economic outlook and focusing on sectors and firms most likely to benefit? Is he a "value investor," using a "bottom-up" approach that focuses on relative values of the stocks of companies regardless of what they make or do? In applying stocks' price-earnings ratios, does the manager use actual, recent or estimated future earnings? How much weight does the manager give to dividends?

* Performance. Compare a fund's total returns for the most recent five- and 10-year periods with the average returns of similar funds. Look not only at the averages for the periods but also at the annual figures. If one year's return was indeed much better or much worse than the average, find out why. Also, have yields been in line with the group's average? If not, why?

* Portfolio turnover. Since a rate of 100 percent means all of a fund's securities are replaced in one year, Molitor would find it difficult to go for a fund whose rate is higher. "Trading can be important," he says, "but it takes a lot of work to trade well. When the turnover rate is too high, you spend more time trading than valuing securities."

* Reports to shareholders. Do they clearly describe why the fund has performed as it has? Is the manager willing to admit mistakes? Does the manager take credit for hot stocks when doing well, but blame sectors of the market -- instead of his decisions to choose those sectors -- when under-performing? "Sectors do not drive fund performance," Molitor says. "Managers making decisions do."

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