With underperforming fund, 'holding onto a mistake doesn't make it better'

August 21, 1994|By New York Times News Service

Q: I own an Individual Retirement Account that is partly invested in the Colonial Trust IV Utilities Fund, Class B shares. The fund has lost a lot of money, but my broker told me to hold on for now. Please advise.

A: The fund has been a significant underperformer, losing 12.7 percent this year compared with a 9.1 percent loss for all utilities funds. For the 12 months ended June, it fell 13.7 percent, compared with a 5.8 percent drop for its group, and lagged by nearly two percentage points for the three years ended then (8.1 percent, compared with 9.8 percent), according to Morningstar Inc., fund researchers in Chicago.

The poor record is not surprising, said Harold R. Evensky, an investment adviser in Coral Gables, Fla. The fund's expenses are high, nearly 2 percent a year; it has changed investment styles several times, probably because the tack it took each time did not work, and, for those looking for a utility play, it does not seem to move in tandem with the utility index, Mr. Evensky said.

The bottom line: "Holding onto a mistake doesn't make it better," Mr. Evensky said. "If for no other reason, I'd get out on account of the expenses -- 2 percent on an income fund is too much to swallow."

If you want to stay with a utility fund, he suggested Vanguard Specialized Utility or Fidelity Select Utility, both lower-cost, no-load funds.

Q: How do you calculate a 10-year average annual return? Adding the returns for each of the 10 years and dividing by 10 gives an incorrect result.

A: What you have computed is called the "arithmetic" return. The returns published by fund data providers use "geometric" returns, which more accurately reflect the money investors actually receive.

To calculate an average annual three-year return, for example, -- let's say that in year one a fund returned 5 percent; in year two, 10 percent, and in year three, 15 percent. Had you started with $1,000, you would have $1,050 in year one; $1,155 in year two (that's $1,050, plus 10 percent), and $1,318.25 in year three. Your profit is $318.25, for a cumulative return of 31.825 percent. Dividing that by three gives an average (arithmetic) return of 10.6 percent. But for the geometric return, you must take the cube root of 1.31825 (a financial calculator is helpful). This gives you 1.0965, or 9.65 percent.

Q: Your recent column on short-term world income funds -- calling them a disappointment because of poor total returns -- was somewhat misleading. As holders of the Scudder Short-Term Global Income Fund, my wife and I enjoyed yields of 9 percent in 1992; 7.8 percent in 1993, and 7 percent (annualized) in 1994. The fund's total return is unimportant unless we decide to sell our shares.

A: It can be appropriate to buy funds for income, ignoring interim price swings, said J. Julie Jason, managing director of Jackson, Grant & Co., investment advisers in Stamford, Conn.

The main danger in such a strategy is that you will need the money sooner than you expected. If "the equation changes and you are forced to liquidate the shares into a down market, you're in trouble," Ms. Jason said.

And you cannot panic in the face of plunging share prices, as many investors did during the crash of the junk bond market in 1990.

Even so, the Scudder fund is not well-suited for such a strategy because of its hedging and currency risks. As a rule, you should be ready to accept losses when you reach for higher yields than a high-quality bond market can provide, she said.

In a rising interest-rate environment, better choices would be short- to intermediate-term United States bond funds that do not hedge or use options or derivatives.

For intermediate-term investors, she recommends Vanguard's Bond Market Index Funds or its Intermediate-Term Portfolio; or the Fidelity Intermediate Term Bond Fund.

Investors who want more income and can handle greater volatility might try the Vanguard High-Yield Corporate Portfolio, she said.

Q: Why doesn't mutual fund management have to report all tax information to investors, and in a timely way? I own shares in three Massachusetts tax-free bond funds, run by Fidelity Investments; Scudder, Stevens & Clark Inc. and the Dreyfus Corp. Part of the capital gains distributions paid by the funds is excluded from Massachusetts income tax -- in my case, ranging from 12.38 percent to 74.82 percent, not insignificant amounts. Fidelity and Scudder notified me, though well past Jan. 31. But Dreyfus did not, and I obtained the information only through persistence (29.15 percent was excluded). Perhaps some regulatory agency should mandate reporting, rather than leave it to the pleasure of a particular fund company.

A: Dreyfus will begin reporting the percentage of capital gains distributions exempt from state taxes for Massachusetts residents starting this year, and is studying doing so in other states in which it offers single-state funds to see if comparable rules apply, a spokesman for Dreyfus said.

According to the Securities and Exchange Commission, exemptions are a matter of state law. But the SEC is taking a

look at the question of disclosure. "It's an issue worthy of consideration," said Michael Jones, a commission spokesman.

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