For investment goals, use analysis, not labels

MUTUAL FUNDS

July 11, 1993|By WERNER RENBERG | WERNER RENBERG,1993 By WERNER RENBERG

If you become disoriented when hiking in a forest, a good map and a compass probably can help you to find a trail that will take you where you want to go. Knowing where the sun should be can also help.

But what if you've become disoriented while trying to reach an investment goal by investing in mutual funds? You may have become confused about whether to invest in equity funds -- and, if so, which ones -- because of signs such as these you've seen:

* "Get out of equity funds -- correction ahead."

L * "Stay with equity funds -- they'll outperform bond funds."

* "Value-oriented equity funds will outperform growth funds."

* "Small-cap funds will outperform large-cap funds."

Even more to the point, what if you've avoided equity funds you were told are risky only to see them go up -- and bought some that seemed to show promise only to see them go nowhere or down?

What aids could help you to orient your portfolio so that it's more in line with your return expectations and risk tolerance?

For starters, there are the fund classification systems -- such as the one used by Lipper Analytical Services -- that divide equity funds into groups according to investment objectives.

Lipper assigns widely diversified, or general, equity funds to five categories: capital appreciation, growth, small company growth, growth and income, and equity income. Funds that are primarily invested in single U.S. economic sectors or foreign stocks are bunched in accordance with their areas of concentration.

Growth and income and equity income funds are less risky than the other groups and may be expected to earn lower returns.

That was, indeed, the case in the five years that ended June 30, when their returns averaged 12 percent to 12.5 percent per year, compared with 13 percent or better for the others. It also was the case in the last year, when their 15.5 percent-to-14.6 percent range lagged the 25.5 percent rate of small company growth funds as well as capital appreciation funds' 19.1 percent and growth funds' 16.1 percent.

But in the latest 10 years they exceeded expectations, earning 12.6 percent (growth and income) and 12.3 percent (equity income), compared with 11.4 percent to 9.8 percent for the other three groups.

If funds in general equity fund categories don't always perform according to form, are there other bases for sensing their prospects?

Yes. Many such funds have been further identified as large or small "cap" funds, if their portfolio managers select stocks on the basis of the capitalization (price per share times number of shares outstanding) of the companies that issued them. They also may be identified as value or growth funds if their managers select stocks on the basis of perceived undervalued share prices or growth.

Small-cap and growth funds are often assumed to offer higher returns, as well as higher risks, than large-cap and value funds. But data for stocks that such funds own, whether calculated by Standard & Poor's/BARRA or Wilshire Associates, show a mixed picture.

For the last 10 years, value stocks included in the S&P 500 Index have outperformed its growth stocks, according to S&P/BARRA. Similarly, Wilshire reckoned that the large and small value stocks among its top 2,500 companies beat the large and small growth stocks.

But for the last five years, both the S&P/BARRA Growth and Wilshire Large Growth Company indexes excelled. In the Small Company universe, however, the Value index was ahead.

Would knowledge of all these characteristics have helped you to identify funds that would do well in 1993? Not necessarily.

A good illustration: Fidelity's Magellan, classified by Lipper and generally regarded as a growth fund and invested in many large companies, should have gone down, if its performance had paralleled that of Wilshire's Large Growth Company Index, which was off 4.7 percent for the first half. Instead, Magellan was up 15.6 percent.

How can it be that funds have fared better, or worse, than their labels would have led you to expect? Often by ignoring the labels.

Magellan is in value stocks as well as growth stocks, explains Neal Litvack, Fidelity executive vice president. Its 1993 record is due, in large measure, to portfolio manager Jeff Vinik's big bets on three sectors: energy, technology and utilities. Except for Growth Company and Value, all other diversified Fidelity equity funds also own both growth and value stocks, Litvack says. And he adds:

"Fundamental analysis has mattered more than portfolio style."

All things considered, how can you judge whether a fund may help you to reach your target? Go beyond the labels and study its policies and performance review in the prospectus and shareholder report.

"You never can predict how a fund will perform," says Jeffrey Molitor, Vanguard's director of portfolio review, "but you should have a good indication of its relative risk. You should know what you're buying."

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