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Why Some Funds Decline as Steeply as They Rise

Managers say their portfolios have suffered disproportionately because they are concentrated on certain market sectors.

September 15, 1998|PAUL J. LIM

At first blush, the worst-performing diversified stock funds during the recent market slide would seem to have little in common.

Neuberger & Berman Guardian, for instance, which is off 30.4% since the market peaked on July 17, is a large-cap value fund. Rydex Nova, which is down 26.6%, is an aggressive growth portfolio. And American Heritage, which has lost a stunning 47.4% during this two-month stretch, invests in small companies.

But talk to the managers of these portfolios--and the others that made the list of the 25 worst performing large-cap and small-cap funds from July 17 to Sept. 10--and certain themes surface.

"The commonality is real simple," said Sheldon Jacobs, editor of the No-Load Fund Investor newsletter. "It's what they're invested in."

Some fund managers are quick to note that their poor showings are to be expected.

Their message to investors: You can't criticize us for doing what we said we would.

Rydex Nova, for instance, is not only supposed to perform in sync with the benchmark Standard & Poor's 500 index of blue chip stocks, the $805-million fund is designed to magnify that performance by 50%. Hence, when the S&P 500 fell 17.2% from July 17 to Sept. 10, Nova fell 26.6%.

Similar arguments can be made for Potomac U.S. Plus and ProFunds UltraBull. ProFunds UltraOTC was hurt by recent sell-offs in large Nasdaq stocks like Dell Computer, but for the year to date, the $55-million fund has feasted on such large growth stocks, delivering returns of 39.8%.

Financial planners note that since investors use the above funds not as core holdings but to boost returns, short-term losses may not be so troubling.

Indeed, investors may want to buy or sell these funds not solely on short-term performance, but based on their own sense of how the market or a particular sector is likely to do going forward.

Bad Bets

Among the most common explanations given for poor performance--especially among value managers, who seek stocks considered undervalued compared with the company's earnings, assets, or intrinsic value--is a bad bet made on a particular industry or sector.

Prior to the market correction, many sectors were considered so pricey that many managers scavenged energy and financial stocks, two sectors with low price-to-earnings ratios. But these sectors have been battered further.

"A couple of our areas got hit harder than the market in general," said Jim Oelschlager, manager of the $672-million White Oak Growth Stock fund, which had been white-hot coming into 1998, posting total returns of 52.7%, 32.3% and 24.3% in the previous three calendar years.

"One of the areas, financials, saw stocks like Citicorp get cut almost in half," Oelschlager said. "Clearly, this is overdone and unjustified."

Vanguard/Windsor, once a well-regarded fund delivering 20%-plus returns, also recently fell off its pedestal thanks to its quarter-stake in financials. Since the market top, Windsor has lost 24.9%.

Investors in such funds must weigh a fund's short-term stumble against its long-term performance, financial planners say. Indeed, T. Rowe Price Associates financial planner Christine Fahlund says investors must still consider a fund's three-year, if not its five-year track record--provided it the same fund manager has been in charge.

For instance, both White Oak Growth and Steadman American Industry are off about 30% since the market peak of July 17. Yet, White Oak Growth has still managed to deliver 22.3% a year for the last five years. Steadman, by contrast, has lost about 14.8% a year during that time.

Too Much Focus

Many managers say their funds were not only hurt because of their position in financial stocks, but because the portfolios are "concentrated."

Focused funds have become all the rage in the fund industry, which is constantly seeking ways to make portfolios stand out in an increasingly crowded field. A focused portfolio invests not in 100 or more stocks, as in common in the industry, but in 20 or 30 of the manager's so-called "top picks."

In theory, this makes sense. If the picks are on the money, these actively managed portfolios should greatly outperform in down markets. However, if even a handful of a focused fund manager's holdings trip, the fund could easily find itself trailing the market.

Consider what's become of the popular Torray fund.

This $1.5-billion fund, which has advanced 20.8% a year for the past three years, has lost 25.3% in the recent market slide.

"It goes with the territory," said Bob Torray, who co-manages the fund, whose top 15 holdings constitute roughly 75% of the fund's assets. "When you run a concentrated fund and you run into a situation like this, it's always possible that a third or even a half of your stocks will be hit all at one time."

In addition to his large stake in financials, Torray notes that many of his satellite-related firms, such as Hughes Electronics and Loral, have also plummeted.

Yet Torray, whose fund boasts a low annual turnover rate of just 12%, isn't selling.

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