In picking a fund, don't be fooled by a flash in the pan

Your Funds

Dollars & Sense

April 07, 2002|By CHARLES JAFFE

YOU CAN learn something from looking at the list of top mutual fund performers every quarter, but the knowledge you gain probably won't come in the form of what funds to buy.

Instead, it will be what you learn about yourself.

For proof, look no further than the best- and worst-funds lists from the just completed first quarter of 2002. Better still, expand your view beyond the quarter so that you also analyze the biggest winners and losers over the last one, three, five and 10 years.

What you will find should help you choose funds that are more in keeping with your expectations for the future.

So let's start this tale of the tape by looking at the year-to-date leaders. Through the first quarter, it is safe to say that while the top 10 equity funds have big numbers, they don't invest in anything the average investor would want to own.

Eight of the top 10 performers are gold funds, hot recently but in the middle of a dismal long-term performance run. All gold funds combined have less than $2.6 billion in assets, meaning that average investors gave up on these funds long ago.

The two nongold funds atop the list are among the industry's all-time losers, even if they have risen to the top for the current period. The American Heritage fund (62 percent gain in the first quarter) has an expense ratio of nearly 12 percent and keeps the majority of its undiversified portfolio invested in a private company that is developing an injectable cure for erectile dysfunction.

It looks like a bargain compared with Frontier Equity (41 percent quarterly gain), which has an 8.5 percent sales load, a 32 percent expense ratio and a sizable chunk of its money invested in a firm trying to use human pheromones to develop a cologne aphrodisiac.

The moral of this story: There is nothing that appears atop a quarterly list that you'd want to buy. The question that results: In what time period will funds that might actually interest you show up? It won't be one year. The 12-month winners' list has seven gold funds, two funds specializing in investments in Korea, and one that invests entirely in Russia. Again, nothing for the average investor.

Says Roy Weitz, who runs the www.fundalarm.com Web site: "If you are a long-term investor looking at these lists, you will quickly realize that you can't get to your goals by buying the funds that show up in the quarterly and yearly performance list. That tells you to discount recent performance and look for a fund that has done well over much longer periods, or that you believe has the potential to become a fund you can be married to for 15 or 20 years."

You might start to find those kinds of funds on the three-year winners list, but only if you are a particularly aggressive investor. The three-year champs include some souped-up micro-cap or focused funds that sound ordinary enough to attract average investors but which carry enough volatility and risk to still be right only for the most speculative.

Where that becomes evident is by looking at the bottom 10 funds for the same time frame. There are names there that might once have been appealing. If you think back three years and believe you were as likely to buy Van Wagoner Mid-Cap (down 26.5 percent annually over three years) as Turner Micro-Cap Growth (annualized gain of 52 percent), three years probably isn't enough of a track record for you to base decisions on.

Remember, too, that one-third of any three-year record is the last 12 months; in volatile market times, that may make you want to look longer term.

When you look at the five-year list, you start to see some less turbo-charged issues rising toward the top. Ironically, the bottom of this list is littered with the quarterly leaders, most notably American Heritage, Frontier Equity and several of the gold funds with top year-to-date returns.

The 10- and 15-year winners list shows solid funds - even if they are specialized, focused or sector funds - that most likely have the right traits for most potential buyers.

Moreover, funds tend to show their true colors when measured over time, rather than in the heat of big short-term market swings.

"If it takes you until the five- and 10-year lists to find any big winners that make sense to you - where you could actually see yourself owning those funds - you should take your own message, which is to stop watching things from day-to-day and quarter-to-quarter and to let things work for you," says Don Cassidy, senior research analyst for Lipper Inc., which tracks and analyzes fund performance.

"You'll probably learn from looking at big winners and losers that those are not the lists you want to shoot for, that you'd rather have consistency than the feast-or-famine you get with the funds that make the winners lists."

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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