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WALL STREET, CALIFORNIA: Insight for Investors | FORUM

Shining an Analytical Light on Funds

September 08, 1998|RUSS WILES | Russ Wiles a Phoenix-based mutual fund columnist for The Times

Many mutual fund investors in the 1990s have relied upon analytical tools provided by Morningstar Inc. of Chicago, an independent fund tracking firm. In particular, the company's "star" ratings are frequently quoted in investment articles, cited in advertisements and used by many people as a quick guide for narrowing choices among funds.

John Rekenthaler, one of Morningstar's leading researchers and most visible commentators, spends most of his time thinking about mutual funds and the financial markets. He's a 37-year-old Seattle native who spent part of his childhood in Southern California. Rekenthaler joined the then-fledgling company in 1988 as a mutual fund analyst, after earning a bachelor's degree in English from the University of Pennsylvania.

Three years later, he became editor of Morningstar Mutual Funds, a biweekly research guide that evaluates thousands of funds. In 1995, he was named publisher.

Last summer, Rekenthaler left Morningstar to become an investment strategist for fund company Nuveen, only to return to Morningstar earlier this summer. "Nuveen is a good company, but I felt I gave up some creativity," he said. "I just didn't have the same excitement level going to work."

Rekenthaler now serves as research director for Morningstar, where he heads a five-person staff that focuses on quantitative analysis. The group's goals include the elusive task of trying to compile optimal portfolios of funds for individuals.

Rekenthaler was interviewed by Russ Wiles, a mutual fund columnist for The Times.

Times: For investors with a long-term horizon, is the current stock market downturn a buying opportunity?

Rekenthaler: I think it's a modest buying opportunity. I can't join the crowd that seems to be forming who believe stocks are so cheap that they're buying with both arms. I mean, a stock that went from $60 a share nine months ago to $100 a few months ago but now sells for $80 isn't . . . [necessarily] a bargain.

At the end of August, the typical small-company mutual fund held stocks with an average price-to-earnings ratio of 22 [based on trailing earnings], with a P/E for the S&P 500 of about 26. Both are certainly high by historical standards. With inflation at modest levels and interest rates already pretty low and seemingly headed lower, those valuations aren't terrible. But they're not cheap. The market has become fairly aggressively valued, from absurdly so.

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Times: But small stocks, and the mutual funds that hold them, aren't so pricey?

Rekenthaler: On the small-cap side, valuations are clearly more attractive, and I'm more enthusiastic there. The main point I'd make with small companies is that they have a risk premium attached to them. People are viewing small companies as risky and have been disappointed by them. If they're going to invest in them now, they want to see really attractive prices. That's a risk premium. The markdowns with small stocks already have taken place.

I don't see people perceiving the same risk with blue-chip stocks. People continue to hold high-quality growth stocks like General Electric or Procter & Gamble because they think these companies will always come back. There's very little risk premium attached to those stocks, so I don't see them as particularly attractive buying opportunities.

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Times: Low mutual fund cash positions--they had dipped to around 5% of fund assets recently--have been blamed for part of the market's troubles. The fear is that with cash at such low levels, funds don't have much additional money to keep buying stocks. Do you sense that fund cash levels have changed much since midsummer?

Rekenthaler: It's hard for me to comment on that because we get lagging information on fund cash flows. But based on recent conversations that our analysts have had with various managers, the cash-position question seems to be a wash. Some managers have been raising cash while others have been investing more of it in stocks.

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Times: Do you sense fund investors on balance have been redeeming their shares?

Rekenthaler: Modestly. They're somewhere between a watch-and-see mode and a paralyzed-by-headlights mode. Trading activity [in the funds] has slowed down. Investors aren't pulling out a ton of money, but they're not putting a lot of new money to work. That's a typical reaction.

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Times: Does investor inactivity suggest that fund investors overall have become more patient, disciplined and, perhaps, knowledgeable?

Rekenthaler: Yes. I certainly think institutional investors were the ones who caused the downdraft. Individual fund investors tend to lag. They act in response to market moves that are caused by people with quick trigger fingers--hedge-fund managers and various institutional managers.

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