One tough year ends - and another begins

`Uncertain': Unforeseen events could lead to a third straight year of declines, but with strong fundamentals, solid gains aren't out of the question.

Mutual funds

January 20, 2002|By William Patalon III | William Patalon III,SUN STAFF

After a year in which most of the key mutual fund categories performed pitifully, investors are no doubt hoping for better results in 2002.

Unfortunately, this year might be no less challenging for mutual fund investors.

The three major stock market indexes have lost ground for two straight years, and analysts warn that an unforeseen event could shock the markets enough to stretch that string to three. Without such a shock, however, stocks should notch respectable gains this year, and mutual funds along with them, many experts say.

"We are in such an uncertain time right now," said David L. Berman, head of Berman Financial Group LLC in Timonium. "The fundamentals are such that stocks should have a very strong year. There are caveats - [if, for instance,] there's a significant escalation in the war on terrorism ... there's always something that can come up."

How stocks, bonds and mutual funds fare is becoming more and more important to the country's economic health because households increase their holdings of these financial assets every year. Fifty-two percent of households own mutual funds, according to Brian Reid, senior economist for the Investment Company Institute, a mutual fund trade association based in Washington.

But most funds did little to reward those households last year. Technology funds dropped an average of 34.7 percent, and most of the other key categories did poorly, too. Growth funds lost an average of 25.2 percent.

The only mutual funds that distinguished themselves were gold and real estate funds, and funds invested in small-capitalization stocks. Investors who weren't properly diversified should have learned a lesson for this year.

"The important lesson we learned last year is that you can't forget, for instance, small caps, and just put money in the large-cap segment of the market," said Michael P. Byrum, chief investment officer for Rydex Global Advisors, a Rockville mutual fund company. "Investors miss certain segments of the market" and miss out on gains when they aren't properly diversified.

Picking the right funds isn't easy: There are about 8,300 to choose from, and they vary by market capitalization, market indexes and industrial sectors. The Sun asked several investment professionals for tips on where to look as individual investors position their mutual fund portfolios for 2002.

If the economy recovers, as many analysts think it will, small- and mid-cap funds should continue to do well, said Phil Dyer, a senior manager with Wealth Management Services in Towson. Dyer said investors should consider such funds as the Wasatch Core Growth Fund, which invests in growth and value small-cap stocks, and the Artisan Mid Cap Value Fund.

"Small- and midsized companies are more nimble," Dyer said. "Some companies are so large that [rebounding from the recession] is like turning a battleship around in a bathtub. It's fairly difficult and takes time."

For investors who believe in the long-term prospects of the technology sector, Dyer recommends staying with funds that buy tech shares that are beaten down or are fairly valued. One such fund is the Firsthand Technology Value Fund.

Berman said investors should avoid most of the mutual funds that manage tens of billions of dollars, reasoning that such a large size reduces the chance for large gains.

To further put the odds in your favor, Berman said, pick a mutual fund from a well-regarded fund family or one that has a manager with a long-term record of success.

The Davis family of funds, including funds such as Davis New York Venture, is a proven winner. As for managers, Berman points to Bill Miller of the Legg Mason Value Trust fund and Charles Albers of the Oppenheimer Main Street Growth and Income fund, as long-tenured managers with excellent records of rewarding investors.

Many analysts expect this year to be a stock-picker's market in which successful fund managers will eschew straight index investing and focus on picking winning stocks from many industries. If that happens, Berman said, investors should include in their portfolios a capital-appreciation fund, a fund that doesn't stick to one style of investing. Such funds buy stocks of all capitalizations, growth and value, and across all industries.

Some worth a peek include the Oppenheimer Capital Appreciation Fund, the Growth Fund of America and the Janus Capital Appreciation Fund, Berman said.

Although health care and financial services shares have posted good gains since the stock market's bottom in September, those areas figure to remain important, said Rydex's Byrum.

As Americans age, they will need more health care services, which bodes well for companies in such industries as assisted-living centers, medical instruments and pharmaceuticals. And as aging Americans' savings grow, so will the demand for brokerage services, insurance and other financial services, experts say.

Most experts say it's important to have part of almost any portfolio invested abroad. A well-diversified international fund is typically recommended, but for investors with a long-term view - and who can stomach substantially more risk - funds investing in China or South Korea could pack a big payoff, said Brian Bruce, director of global investments for PanAgora Asset Management Inc., a Boston money-management company.

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