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WALL STREET, CALIFORNIA: Third-Quarter Fund Review
and Outlook

Seeking Strength in Good Times and Bad

Here are seven stock funds that have regularly performed better than their peers in times of troubled markets.

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

By now, most investors are only too aware that the average stock mutual fund tanked in the third quarter.

What many would like to know is which funds held up best--and perhaps more important, which funds could be expected to fare better than the average fund if Wall Street's bad times are going to hang around for a while.

The obvious answer, on both counts, is so-called bear market funds, which specifically bet on, or are "hedged" for, a down market, usually by "shorting" the market with stock index futures or with individual stocks.

Those specialized funds include Rydex Ursa, Prudent Bear and ProFunds UltraBear. Just as you'd expect, when the Standard & Poor's 500 index lost 10% in the third quarter, these funds gained--10.9%, 21.9%, and 16.4%, respectively.

Because these funds are designed to do pretty much the opposite of what the overall stock market does, though, most investors probably wouldn't want to rely on them as core holdings.

So, we set out to find stock funds that both invest for gains--and thus are suitable as core holdings--and that have historically held up better than their category peers when the market has slumped.

We started with Morningstar's universe of 6,023 mutual funds that invest in stocks.

First, we eliminated all funds whose total returns didn't beat at least two-thirds of their peers (as defined by Morningstar's various mutual fund categories) in the month of August--the period in which stocks pulled back most violently during this year's market dive.

Notice we said "peers." Not only is it unfair to judge, say, a small-cap fund's performance against that of a large-cap fund, it does a disservice to investors.

Moreover, if you were to measure funds' performance only against that of the S&P 500 in recent months or years, no fund that invests in small-cap or emerging markets equities would make the list. You'd be left with an undiversified group of large-cap growth funds.

The initial screening left us with 1,987 mutual funds. Of those, we eliminated all funds that did not beat the average fund performance in their categories in the years 1994 and 1990--the last two weak or down market years.

Next, we considered fund manager tenure, to make sure credit for 1994 or 1990 performance would not be going to folks who weren't in charge then. Thus any fund that had changed managers since 1990 was eliminated.

This winnowed the list to 23 funds.

Then, considering the possibility that the bull market might come back to life in the next several months, we wanted to be reasonably sure we were looking at funds that had also done well when the market did.

So we tossed out those funds that didn't finish in the top two-thirds of their respective categories, in terms of total returns, during the last 12 months, three years and five years.

Once we eliminated funds closed to new investors, we were left with a list of seven funds: three large-cap funds, one mid-cap, one small-cap, one world (global) stock fund and one sector fund.

Note: All of these funds did lose money in the third quarter. The thing to keep in mind is that they lost less than their peers.

Here's a look at the seven:

* Vanguard U.S. Growth (no load; minimum initial investment: $3,000; [800] 662-7447). Some of the best-known stocks in this $11-billion large-cap growth fund got shelled during the third quarter--names such as Coca-Cola, Procter & Gamble and Disney. Yet during that period, U.S. Growth fell 16% less than its large-cap growth fund peers.

U.S. Growth did well in the other recent down markets: It delivered a total return of nearly 4% in 1994, when its peers fell, on average 2%; U.S. Growth advanced 4.6% in 1990, when the average large-cap growth fund fell 2.1%.

One reason is that this is a fund that settles for singles and doubles when other growth funds swing for the fences.

For instance, the fund will invest in companies whose earnings are growing 13% to 15% a year. "That's not mind-bogglingly fast, but we do think there's a greater probability that these growth rates can be achieved," said co-manager David Fowler.

Indeed, well more than 90% of the 70 stocks in the fund's portfolio sport an "A" grade or better based on Standard & Poor's equity ranking system, which considers the stability of a company's earnings and dividend growth during the last decade.

The fund also pays attention to valuations. In recent months, for instance, the fund trimmed its holdings in Dell Computer as the stock price--and therefore price-to-earnings ratio--soared.

Thanks to the cautious approach, U.S. Growth has beaten at least 80% of its peers during the last one, three, five, 10 and 15 years.

* Dreyfus Appreciation (no load; minimum initial investment: $2,500; [800] 373-9387). When stocks are treading water or being pulled under, and every fund manager is struggling, those whose funds have low expenses have an automatic performance edge.

This $2.7-billion large-cap growth fund boasts an annual expense ratio of just 0.87%, compared with the category average of 1.43%.

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