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WALL STREET, CALIFORNIA | QUARTERLY MUTUAL FUNDS REVIEW
AND OUTLOOK

Before Cashing Out, Put Your Underperformer to the Test

October 06, 1998|PAUL J. LIM | TIMES STAFF WRITER

Once upon a time, Neuberger & Berman Focus and PBHG Growth were at the top of their games. Focus was the second-best performing mutual fund in its category in 1992. And PBHG Growth was No. 1 among its peers in 1993.

But lately, both have stumbled--badly. Year-to-date, Focus is down 15.8% while PBHG Growth is down 21.1%. Over the last 12 months, Focus has lost 20.9% and PBHG Growth 27.9%.

Those are big numbers, and they might well provoke a knee-jerk reaction among the funds' shareholders: that is, to sell. But would that be the right decision? Is it time to unload either of these funds? In general, how do you know when it's time to give up on a mutual fund that has lost its luster?

"The most difficult decision in investing is selling," said Doug Fabian, editor of the Huntington Beach-based Fabian Investment Resources newsletter, which publishes a "Lemon List" of funds to sell.

"There's so much out there recommending what you should buy and how you should buy," he added. "But there's not a whole lot written about selling funds."

Investors may choose to sell funds for many reasons--such as to rebalance their portfolio, follow a favorite fund manager or just because they need the cash.

But the third quarter of 1998, one of the worst periods for stocks in decades, has highlighted the reason most investors look to sell: poor performance. Yet what appears to be the simplest approach--sell 'em if they lose your money--can often lead investors astray.

Better to pause and approach the sell decision analytically. Start by understanding a few basic lessons about fund evaluation:

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Lesson No. 1: Don't judge a fund in a vacuum.

Stock markets worldwide have lost value this year, so expecting your fund to make money in this environment is probably unreasonable. The average U.S. diversified stock fund is losing money on a year-to-date and 12-month basis, according to Morningstar Inc.

"Fine," an investor who owns Focus and PBHG Growth might then decide. "Focus has lost less than PBHG Growth year-to-date and over 12 months. I'll keep Focus and dump Growth."

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Lesson No. 2: When judging fund performance, compare apples with apples.

While it's true that Focus and PBHG Growth both invest in U.S. stocks, Focus is classified by Morningstar as a "large-cap value" fund. That means it invests in big U.S. companies whose shares tend to sell for lower price-to-earnings and price-to-book-value ratios.

PBHG Growth, on the other hand, is a "mid-cap growth" portfolio, meaning it aims to invest in faster-growing, small to medium-sized companies whose stocks sell for higher P/E and P/B ratios.

"A large-cap value fund is designed to perform differently from a mid-cap growth fund," noted Peggy Ruhlin, a financial planner in Columbus, Ohio.

Assuming you invest in these distinct funds to fulfill different roles within a diversified portfolio, "If you compare the two against each other, you'll be deluding yourself," Ruhlin said.

Just as PBHG Growth has lost more than Focus this year, the average mid-cap growth fund has lost more than the typical large-value fund.

Point taken. But then the investor who owns both of these funds might say, "OK, I know that the average large value fund is down 3.1% year-to-date. And Focus is down five times as much. I should dump Focus."

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Lesson No. 3: Don't rely on short-term performance.

An investor who makes decisions based solely on year-to-date returns may think that Steadman Investment--a real dog of a large-value fund that happens to be up 11.2% this year--is a screaming buy. But if that investor looked harder, he or she would have noticed that Steadman Investment has lost money on an annualized basis over the past one, three, five, 10 and 15 years. (Fortunately, the fund is closed to new investors.)

And that same investor would have overlooked the fact that while Neuberger & Berman Focus is trailing its peers badly in the short term, it's holding its own on a five-year annualized basis and actually has beaten its average peer over the past decade.

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Now that you know how not to sell a fund, what should prompt the sell decision?

To start, divide your various mutual funds into two groups. In the first, list the funds that are held in a tax-deferred account, such as a company-sponsored 401(k) retirement plan, individual retirement account (IRA), or Roth IRA. In the other, list funds held in regular taxable accounts.

Then proceed with these steps:

Tax-Deferred Fund Accounts

Step 1: Determine the investment category for each fund.

For instance, if you own Janus Twenty, you should list that as a large-cap growth fund. If you own Scudder International, list it as an international fund. And if you own Northeast Investors, classify it as a high-yield bond fund.

The Times' A-to-Z quarterly fund listings on pages C16 through C18 today include each fund's category, according to Morningstar. The category abbreviations are spelled out in the charts on pages C12 through C15.

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