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Merrill fund gets an Rx
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March 11, 1999: 12:30 p.m. ET
Dismal returns lead to new manager; experts say turnover can be good
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NEW YORK (CNNfn) - If ever there was a need for a mutual fund 911 call, it was at Merrill Lynch Growth Fund.
Manager Arthur Moretti loaded up on energy and financial stocks, and the fund plunged 24.23 percent in 1998 while competitors soared an average of 18 percent, according to Morningstar, a Chicago fund tracker.
The fund fell short of the S&P 500 by a staggering 52 percent -- and Moretti lost his job.
Now, Merrill is hoping one of its star managers, Stephen Silverman, will be the person with the medical bag who can rescue the fund for shareholders.
"The issue is whether or not you want to participate in the fund with the people who are managing it now," said Silverman, 48, a former Marine who spoke about his plans in a straightforward but carefully-worded interview this week.
A top fund takes a nosedive
For most of its lifetime, the fund had a good track record with its strategy of focusing bets in certain sectors.
The fund earned 31.11 percent in 1993; 35.45 percent in 1995; 28.38 percent in 1996, and 17.44 percent in 1997, according to Morningstar. It earned 8.72 percent in 1992 and 0.72 percent in 1994.
"The fund was a stellar performer with a strategy that worked for so long. When you have a successful strategy, you're reluctant to abandon it," said Merrill Lynch spokeswoman Christine Walton.
But then longtime manager Steve Johnes became ill. He died in 1998 after a long illness while still managing the fund. Moretti took the helm in March 1998 and things turned sour.
Moretti lightened up on technology to 3.5 percent and put 47 percent of the portfolio in energy and 25 percent in financial stocks, including real estate investment trusts (REITs), said Kunal Kapoor, an analyst at Morningstar. The bet proved disastrous: Energy stocks, for example, lost 30 to 40 percent in 1998.
"The fund got whipsawed," Kapoor said. "There was some real underperformance here. Part of it was the manager, but Merrill Lynch bears some of the responsibility."
Silverman and Walton declined comment about Johnes or Moretti. Efforts to reach Moretti for comment were unsuccessful.
The fund also earned the dubious distinction of being on the "lemon list" at Fabian Investment Resource, a newsletter that tracks bad performers. In order to get on the list, a fund has to fall short of its peers by 25 percent or more for one year, three years and five years.
"This fund is woefully underperforming," said Doug Fabian, editor of the newsletter. "It was the number one lemon in the top 10 list."
As of Wednesday, the fund had assets of $1.87 billion and was down 8.41 percent year to date, falling short of the S&P 500 by 13.42 percent, Morningstar said.
Merrill brings in a top gun
Six weeks ago Moretti left Merrill (neither Walton nor Silverman would say if he was fired), and Silverman, who manages the well-regarded Merrill Lynch Global Value Fund and the Merrill Lynch Pacific Fund, took over.
He said he will use the same team of eight experts he has at the Global Value fund -- and he plans to hire a ninth person. According to Lipper Analytical Services, a mutual fund tracking company, Silverman's Pacific Fund is the No.1 Pacific Region fund over 10 years.
"Everything is bottom-up (stock picking), everything is fundamental, everything is analyzed intensely," Silverman said. "Everybody (on the team) is smarter than me and everybody has more expertise than me."
The Global Value Fund has almost 60 percent of its assets in the United States, so Silverman disputed assertions that he's largely an international manager.
Kapoor agreed.
"I don't see him as purely an international manager…and regardless of whether he has domestic experience, he is Merrill Lynch's best manager," Kapoor said. "He's done a fabulous job with the other funds, there's no doubt about that."
Silverman declined to say what his top 10 holdings are at the fund now. He said shareholders will find out those details at the end of the April.
"The universe of stocks we'll contemplate buying are growth companies," Silverman explained.
It is not simply a matter of strong earnings, however. He's looking for companies that leap ahead of their peers -- for example, a cellular company with great subscriber growth, or an Internet company with a lot of "eyeballs," or users.
"Growth companies have something that's increasing their economic value," he said.
Silverman said he'll focus on larger companies with a market capitalization of more than $10 billion, a shift from the mid-sized businesses the fund has invested in previously.
Eventually, perhaps by the summer or the end of the year, the fund's top 10 positions will represent 30 to 40 percent of the portfolio; the next 10 will comprise 20 to 30 percent; and the remainder would be in 20 to 30 smaller positions.
Silverman will also focus more on growth companies that he might not necessarily hang on to in the Global Value Fund. For example, Global Value sold MCI WorldCom (WCOM) last year because its valuations were getting too high for a bargain-conscious value fund. A growth fund would keep such a stock in the portfolio, he said.
Should you buy it?
Financial experts say shareholders should not be afraid if a fund gets a change in management. Often, it means that the fund will get an injection of new ideas and start performing better, said Bill Dougherty, a consultant at Kanon Bloch Carre, a Boston company that analyzes mutual funds.
"I view it positively," Dougherty said about manager turnover.
Yet, even though Silverman's reputation is stellar, the outlook is still cloudy.
"Quite honestly, it will take him a while to get the portfolio to his liking," Kapoor said. "People need to sit it out and look at the fund again 9 to 12 months down the road."
Fabian criticized Merrill Lynch for not being more up front with shareholders about the changes.
"Fund investors have become so passive the industry doesn't worry about retaining customers," Fabian said.
Walton countered that by arguing Silverman videotaped a message for financial consultants to deliver to shareholders about his strategy and plans. Most investors buy the fund through a broker. Silverman also plans to send a letter to shareholders in April.
"We feel we've been very responsive in addressing the change in management at the fund," Walton said.
For doubters, only time will tell. 
-- by staff writer Martine Costello
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