If you're among the investors who review their mutual fund portfolios every January, you should find the checkup more enjoyable than usual -- as well as more challenging -- this year.
Because 1991 was an exceptional year for equity and bond funds generally, it should be a pleasure to contemplate your funds' total returns (price changes plus reinvested dividends).
The challenge will come when you consider whether your money should remain allocated among your equity, bond and money-market funds -- or whether you should make changes to enhance your portfolio's performance or to reduce its risk level.
While the U.S. economy failed to grow in 1991, total returns of the five types of general U.S. equity funds averaged from about 52 percent for small-company growth funds to around 27 percent for equity income funds, according to Lipper Analytical Services. (Diversified international funds grew by about 12 percent.)
Bond fund returns varied with maturities and credit quality. But, on the average, they exceeded 17 percent, reflecting both appreciation resulting from the drop in interest rates and income. That was almost triple what you could earn in a money-market fund.
As you compare the broad groups' returns of the last five years (see table), the strength of 1991 fund performances becomes clear. Although the overall U.S. stock market, as represented by the Standard & Poor's 500 Composite Stock Price Index, fell short of its 31.7 percent return of 1989, the five general U.S. fund groups exceeded their 1989 results. The showing by small-company growth funds, which had been off the most in 1990, was especially notable.
Given the rotation in stock market leadership from year to year, you get a longer-run perspective of fund performance by looking at total returns over five years. As you'll see in the second table, average annual returns and the spreads among the groups have been much lower than 1991 results would have led you to assume. (These figures also fluctuate as years are replaced, such as 1986 by 1991.)
For the past five years, the three more risky general equity fund groups -- capital appreciation, growth and small-company growth funds -- had average annual returns of about 13 percent. Those of growth-and-income and equity income funds were slightly lower.
To consider whether and how you might redeploy your fund assets, you first need to calculate how your money is currently allocated among bond, equity and money-market fund groups -- and within bond and equity fund groups. Then you can decide if shifts are called for.
Also see whether your funds have been performing at least as well as the averages of their respective investment objective categories. If not, you may want to switch to funds with better prospects.
Given today's low money-market yields, you'll probably want no more in a money-market fund than your potential cash needs may call for. How the rest of your portfolio should be divided between bond and equity funds, and what types of bond and equity funds you should be in, depends on factors such as your age, investment time horizon, income requirements and capital appreciation goals.
Considering that revived inflation fears eventually could reverse
the slide in interest rates, you may prefer to be invested in bond funds whose weighted average maturities are not more than 10 to 12 years. Their yields won't be far below longer-term funds, and their prices should be less volatile.
Deciding how you should be invested in equity fund groups may not be as easy, especially if you're in a winner and are worried that your gains may evaporate. While looking at 1991's performance data and today's share prices, make certain that
your funds are suitable for you -- in terms of both their objectives and the risks they entail.
If you're in a good, small-company growth fund, you may be well advised to stay with it or even gradually to add to it -- if you can tolerate its potential riskiness -- despite 1991's returns. If you're not, it may not be too late to establish a position -- gradually.
John H. Laporte, portfolio manager of T. Rowe Price's New Horizons Fund, the oldest fund in the group, believes that small-company growth funds can continue to outperform funds invested in larger companies, which make up the S&P 500, for a couple of years.
While warning that they won't rise "in a straight line," Mr. Laporte cites two factors: First, small companies' stocks tend to outperform large companies' during an economic recovery. Second, the price-earnings ratio of the stocks in New Horizons' portfolio remains no higher than about 1.2 times the P/E ratio of the S&P 500 (using estimates for 1992 earnings in both cases). That's at the low end of its historic 1.0-to-2.0 range.
George U. Sauter, who manages the Vanguard index funds that track the S&P 500 and the Russell 2000 Small Stock Index (among others), agrees on both points. In comparison with the S&P 500, he says, "the Russell 2000 doesn't look expensive."