The search for tools to help the investor make a buck

Mutual funds

December 21, 1997|By Bill Barnhart | Bill Barnhart,CHICAGO TRIBUNE

The amount of detailed information available about individual mutual funds has reached overload proportions, but there is still surprisingly little broad information about what works and what doesn't in fund investing.

The performance of equity mutual funds obviously tracks the performance of equities, which in recent years has been extraordinarily upbeat.

Mutual funds are a convenient vehicle for investors to participate in the bull market in stocks. But the factors that are useful in deciding about stocks bear little relation to factors that are useful in selecting mutual funds, particularly actively managed funds run by professionals with virtual carte blanche to buy and sell stocks.

To explore that critical distinction, brokerage Charles Schwab hired Mark Riepe, a former vice president at Chicago-based Ibbotson Associates, to head its mutual fund research group.

Michelle Swenson, senior vice president for investment products and mutual fund research at Schwab, said, "There's so many lists of funds, we don't need to become another Morningstar," a reference to the Chicago-based advisory service. And Schwab is leery of appearing to compete with its burgeoning client base of professional investment advisers by overtly recommending funds or offering specific investment advice.

"[But] people are looking for rules of thumb," Swenson said. "What should I look at, what's important, how can I make sense of it, what are the things I really need to pay attention to?"

Despite the boom in mutual funds, these questions remain largely unanswered.

For example, what is the value of knowing a mutual fund's track record?

"Historical data aren't particularly interesting," Riepe said. "It's only interesting if it tells something about the future."

Whereas the performance of an individual stock over a long period conveys useful information about the prospects for the stock, it's unclear whether historical data serve that purpose with mutual funds, he said.

Fund track records are relatively easy to obtain and publish, and nearly all mutual fund analysis in the media relies on track records. The proposition that track records are useless has been stated many times by a variety of experts, but historical return data hold sway over the fund investing process.

Riepe's group is completing a study that shows young mutual funds invested in small-company stocks tend to outperform older small-cap mutual funds with the same level of riskiness.

"The preliminary results are that in the large-cap/mid-cap categories, the newer funds seem to do better than the older funds, but after you control for differences in risk, there really isn't much difference in performance. But in the small-cap category, there are larger differences that aren't completely explained away by differences in risk. The newer funds are doing better.

"The question becomes, Is there something else that distinguishes the newer funds from the older funds that could explain this difference in performance?"

Given the conventional wisdom that funds with long track records are preferable, evidence that new funds do better -- at least in the small-cap arena -- raises important questions about a buy-and-hold investment strategy.

"This has massive implications for how the [fund] industry is regulated," he said.

On a related topic, regulators are debating the propriety of allowing new funds to advertise the performance of the portfolio before the fund was sold publicly. But it's unclear whether the so-called preinception track record is worth knowing, Riepe said.

"To what extent are the historical pre-inception data predictive of what the performance is once they launch the fund? That would be a nice little study."

Although he doesn't expect to list "the best mutual funds for 1998" or any other year, "clearly these studies are going to imply that funds that do well have the following characteristics. Hopefully, we're writing reports that don't go out of date, with general meaningful principles of investing in funds that are just as relevant two or three years from now as they are today," he said.

Other issues he hopes to address include how many mutual funds an investor should own and when is a good time to sell. His group is culling about 40 research ideas to focus on a half-dozen of the most compelling topics.

"The marketing people have been continually hearing from the investors that they're looking for more information [for] how to separate out these 9,500 funds, to tell what they should be looking for when they're making decisions. They need some decision tools to help separate the wheat from the chaff."

Q: Why are you penalized by buying mutual fund shares just before the fund distributes capital gains?

A. Everyone gets the same distribution, no matter when they bought fund shares.

But the price you pay for the shares just before the fund makes its annual capital gains distribution includes the value of the distribution. In effect, the fund is handing back to you part of the money you just invested. If you have a taxable investment, rTC you're being taxed on the return of your own money, not an investment gain. People who bought the fund earlier enjoyed the gain. You did not; you paid for it.

Pub Date: 12/21/97

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