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When fund stars topple
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August 13, 1999: 3:43 p.m. ET
Experts offer advice when mighty mutual funds fall off their pedestals
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - Magellan. Janus Twenty. Van Wagoner. The names of winning mutual funds stick in our minds like bright stars in a vast investing universe.
But sometimes a hot fund has a management shakeup -- or it starts skidding down on performance charts. And you're stuck with a toad in your portfolio.
"Turnarounds happen pretty regularly," said Russ Kinnel, editor of mutual funds at fund researcher Morningstar. "A manager is doing something differently, or he's investing in part of the market that's not working any more."
Falling from the pedestal
For example, PBGH Growth Fund had annual returns as high as 50 percent between 1991 and 1995, Morningstar said. Three mediocre years followed, and now the fund is on the top 10 list of "lemons" tracked by Fabian Investment Resources.
"Like anything else, if you're that hot, you're going to get that cold," said Ed Foster, chief investment strategist at Fabian.
(Efforts to reach someone at Pilgrim Baxter were unsuccessful.)
In another case, Strong Schafer Value Fund was soaring with returns of 23 to 34 percent between 1995 and 1997 before value-oriented funds took a nosedive, Morningstar said. The problem is Strong Schafer Value Fund hasn't taken part in the recovery that has happened in 1999, Kinnel said.
While its peers are up as much as 36 percent as of June 30, Strong Schafer Value is ranked 269 out of 270 funds tracked by Morningstar, with losses of 6.49 percent. July only added to the losses: The fund is down 11.3 year to date as of July 31.
David Schafer, manager of the Strong Schafer Value Fund, argued that other funds in the category have strayed from their value-oriented investing mandate. For example, other funds own drug stocks or high valuation companies like Microsoft (MSFT), America Online (AOL) or Dell (DELL), while Schafer's fund requires a lower price-earnings multiple and higher earnings per share growth than the average for the S&P 500.
But at the same time, he acknowledged it's no fun to go from a peak to a valley.
"It's like you get leprosy," Schafer said. "It's not fun. We have our own money in the fund, so we don't like to lag."
Schafer also said he sold several large offshore drilling stocks in early 1999 on the fear that their earnings would suffer from falling oil prices. But oil prices rebounded and the sector took off. The fund missed most of the upside.
"There hasn't been a five-year period that we haven't been out of favor," Schafer said. But a good run can follow a nasty downturn. For example, the fund lost 10 percent in 1990 but gained nearly 41 percent in 1991, Morningstar said.
What should you do?
Foster, of Fabian, advocates a hard-nosed approach. (In order to make Fabian's "Lemon List," a fund has to underperform its peers for one, three and five years).
"If you are holding a lemon, a once-hot fund, it's time to sell," Foster said. "Funds on the Lemon List are doing D- and F work. … Investors who own these funds have an opportunity lost. You want to get into a better fund and upgrade to an A or B fund."
For example, the Vanguard Windsor fund made the Lemon List. It earned 21.97 percent to 30.15 percent between 1995 and 1997, and just about broke even in the following year, according to Morningstar. Foster said investors should sell their shares in the fund and put their money in another Vanguard fund. (The fund has rebounded in 1999 and is up 14.1 percent year to date as of July 31, Morningstar said).
Kinnel said investors need to look at fallen stars and see if their reason for initially investing in the fund has changed. Look at the returns, and see if you still have faith in the management.
If the fund is suffering from bad stock picks or is investing in sectors that are clearly not within its strategy, it might be time to jump ship, Kinnel said.
"Sometimes you have to pull the trigger," Kinnel said. "Sometimes it's best to sell it and not be trapped by inertia."
Investors also should keep track of how a fund is doing compared with others in its category. If it is lagging, that is a danger sign to get out, Kinnel said.
But sometimes it's not clear-cut, Kinnel said. For example, Merrill Lynch Growth Fund has gone through tough times with some bad stock-picking and a management shakeup. But Kinnel said new manager Stephen Silverman is making positive changes.
"A year ago, it would have been a good time to bail out but now they seem to be making some improvements," Kinnel said. "In cases like this where there is potential for a turnaround it's a tougher call."
Investors should also watch to see if it's just a question of a sector being out of favor, Kinnel said. For example, Gabelli Asset Fund took some heat in 1996 for holding a lot of media and telecom stocks. But the fund earned 38 percent the following year, and is still beating the S&P 500.
What goes up, goes down … and goes up?
Finally, it's important to keep in mind that sometimes mutual funds rise, fall, and rise back up again. Fidelity's flagship Magellan Fund, for example, suffered in the mid-1990s when former manager Jeffrey Vinick made a big play in bonds. But after star manager Robert Stansky took over, the fund has soared and Wall Street still watches his moves carefully.
And Garrett Van Wagoner is tasting the sweet feeling of being on top again. His funds were the talk of Wall Street before returns went into the toilet for two years until the fall of 1998. Now, the funds are up 53 percent to 113 percent year to date as of July 31, Morningstar said.
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