Lower turnover will cut fund's cost

A broad index fund, managers with patience can reduce trading fees

March 17, 2002|By Russel Kinnel | Russel Kinnel,MORNINGSTAR.COM

In the investing world, patience is definitely a virtue. The less a fund trades, the lower its trading costs. In addition, high turnover can weaken after-tax returns.

One good way to capitalize on the benefits of low turnover is to invest in an index fund that tracks a broad index like the S&P 500 or Wilshire 5000. Narrow index funds tend to have higher turnover.

Patience can also pay off big for active managers. Those with the skill and work ethic to take advantage of the stability of their portfolio by getting to know their companies better than the competition can produce great results. Many of the best managers run funds with low turnover. Today I'll highlight five that have turnover below 25 percent and a Morningstar Category Rating of 4 or 5.

Dreyfus Appreciation: Fayez Sarofim buys giant companies with big brand names and then he holds on a long time. The fund is running with turnover of a mere 4 percent a year with a portfolio loaded with well-known companies like Pfizer, Coca-Cola and Microsoft.

Though they'll tolerate an increase in a company's valuations, management doesn't generally buy when a stock gets frothy - that's helped the fund to consistently beat most of its peers.

Investors in taxable accounts have a tricky call. They can choose this fund with an expense ratio of 0.88 percent, or they can pay more for its close relative Dreyfus Tax Smart Growth, which charges 1.35 percent.

The Tax Smart Growth fund officially takes taxes into account in its strategy, and its tax-adjusted returns have been a tad better than Appreciation's over the past three years.

Excelsior Value & Restructuring: I'm amazed this isn't a bigger fund. David Williams has been smoking the competition since the fund was launched in 1992. He has beaten his peer group and the S&P 500 in all but one calendar year.

Williams invests in restructuring plays and other companies that have disappointed investors. He has lots of hated stocks like Tyco, Stillwell Financial and IBM. It's a tricky game, but the fund's returns since inception are an annualized 20 percent.

Even so, assets are at just $2.2 billion. Maybe it's the odd name that scares people away.

Ariel: John Rogers Jr. is clearly a patient guy. He's been running this fund since 1986 and he runs turnover of just 24 percent. This isn't a flashy fund, so its returns are best viewed from a distance.

By putting up modest gains in rallies and losing less in down markets, Rogers has nearly doubled the returns of the Russell 2000 since the fund's 1986 launch. Rogers looks for companies trading at more than 35 percent below his estimate of their intrinsic value, and he makes his picks count by limiting the portfolio to 35 names.

With just a handful of new stocks coming into the portfolio each year, you have to figure he gets to know them quite well.

T. Rowe Price Equity-Income: This fund is much less concentrated than the others I've mentioned. The fund's income requirement probably limits the pool of potential investments a fair amount, so it doesn't make sense to shuffle a small group.

Manager Brian Rogers puts that increased diversification to good use, though; this is a remarkably stable fund. Rogers has only suffered one year in the red since the fund was launched in 1985, thanks to the fund's mix of diversification with an emphasis on dividends.

Vanguard Health Care: You have to like the way manager Ed Owen defies the conventional wisdom about sector funds. Usually, they trade like crazy as they chase after the companies with the hottest new products.

Owen tries to maintain exposure to all the big industries in health care while gradually shifting into the cheapest stocks in each area. This is a much more sober approach than you typically see in a sector fund, and returns are way better than those you typically see at a health-care fund.

You might look at the fund's huge asset base and assume that the fund's low turnover is simply the result of its size, but it was actually low long before this became America's favorite sector fund.

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