Personal Business: Investing
FUNDSPEAK: A CRASH COURSE
What's in a mutual fund's name? Does anyone care, as long as it makes money? Are plump profits earned under any name as sweet?
Of course they are. But what if you've bought into a fund with performance expectations based on the fund's name and descriptive material? Then you see those expectations dashed because the information you relied on didn't tell the whole story about the true nature of the fund.
The chance of this is not so farfetched. Even if you dig deeper into a prospectus, the language may be vague enough to justify an investment program that doesn't jibe with your expectations. For instance, Kemper Diversified Income Fund says it invests in fixed-income securities and dividend-paying stocks. But its assets are almost entirely junk bonds--one kind of fixed-income security--and the portfolio looks a lot like that of Kemper High-Yield Fund, a junk-bond fund. Kemper marketing head Bill Chapman says the company might broaden the strategy. But if the fund sticks primarily with junk bonds, "we'll merge it into its sister fund."
One problem facing investors and industry executives is that many of the buzzwords of mutual-fund investing are not well defined. For instance, a number of funds that call themselves "growth and income" or "income and growth" yield less than 1.5%, says John Rekenthaler, editor of Morningstar Mutual Funds. "You can argue about what a growth and income fund should be," he says, "but I would take it to mean it has more emphasis on income."
Remember, a mutual fund is also a consumer product, and choosing the right name is often a marketing decision. "The marketers may use names to suggest funds have certain qualities," says veteran fund watcher A. Michael Lipper of Lipper Analytical Services. "But the people who create the name don't necessarily know or understand how the fund is managed."
NO HELP. The naming and marketing of funds also depends on how funds are sold. Keith Mitchell, president of Delaware Fund Distributors, admits his funds' names could be improved. Last year, Delaware merged two funds labeled "high yield"--a buzzword for junk bonds--into Delchester Bond Fund. He says the merger was done for simplicity, not to hide the junk bonds. "Our funds are sold by brokers, and they know these funds," says Mitchell. "I'd be more concerned about names if we sold direct to the public."
Marketing executive Neal Litvack of Fidelity Investments, which does sell directly to the public, says his company usually chooses descrip- tive names for its funds--except for a handful such as Magellan, Puritan, and New Millenium, which are meant to be brand names.
But getting more descriptive doesn't help unless the fund is accurately described. Last year, for instance, Kemper Financial Services renamed the Kemper Summit Fund the Kemper Small Capitalization Equity Fund. But Morningstar's Rekenthaler says the median market capitalization of the companies in Kemper Small Cap is $1.5 billion, which makes it more a mid-cap portfolio. Chapman acknowledges that but defends the name, saying in the Kemper lineup of offerings, it has the smallest companies.
Much of the confusion stems from the fact that investors and management companies don't use the same terms the same way. For many, "capital appreciation" suggests a high-risk fund that tries to maximize returns by investing in smaller, fast-growing companies with high price-earnings ratios. Lipper uses the term to categorize the biggest risk takers. But both the Fidelity and T. Rowe Price Capital Appreciation funds invest in cheap, beaten-up stocks rather than highfliers. The term "emerging growth," often used in the names of small-company funds, is also subject to interpretation. Last year, Fidelity Emerging Growth Fund had a median market cap of $2 billion and included "emerging" companies such as PepsiCo, though now the market cap and companies are smaller.
CHOCK-FULL. Investors can really get confused sifting through "growth" funds. Historically, this term meant the fund's objective was to make money grow, as opposed to "income" funds, which sought to maximize income. But Wall Streeters also use "growth" to describe an investment style that emphasizes growth stocks, or companies with a faster-than-normal growth rate. "Value" investing has come to be the antithesis of growth, a style which selects stocks that are cheap and out of favor but have traits that may make them shine anew.
But not all the fund companies use the names the same way. AIM Value(C), Dean Witter American Value, Piper Jaffray Value, and Shearson Fundamental Value are chock-full of stocks with high p-e's. Morningstar says the stocks in the Dean Witter fund have a p-e 29% higher than the Standard & Poor's 500-stock index, and its price-to-book ratio is 43% higher. Most Wall Streeters would consider that a growth-stock fund. Also, there are funds with growth in their name that might better be called "value," such as Colonial Growth Shares. The p-e ratio, as calculated by Morningstar, is about 14% below the S&P's, and its p-b ratio, is roughly 37% lower.
Does it matter whether you have a "growth" or "value" fund? And how. From 1989 through 1991, funds following the growth style of investing were the big winners, while in 1992, and so far in 1993, value had the upper hand. To be extra safe, says Peter Lynch, former superstar manager of the Fidelity Magellan Fund, "you should diversify by investment style."
But to understand the style, investors have to read the shareholder reports. Twice a year, the funds have to bare their portfolios. Those reports can be eye-openers.
Consider the T. Rowe Price New Era Fund, which has long been categorized as a natural resources fund. Yet the 1992 annual report shows 9.6% of the $700-million fund invested in Wal-Mart. It was the the No.1 holding, nearly twice the size of No.2, Mobil, the sort of stock you'd expect to find. Price spokesman Steven Norwitz says the fund's mission is to hedge against inflation but has the ability to make other investments in disinflationary periods. The Wal-Mart foray was a winner, contributing about 15 superscript 2 a share to the fund's net asset value in 1992. But that was more than offset by the losses in other nonresource stocks, such as IBM, which cost the fund 21 superscript 2 per share.
The Securities & Exchange Commission, which regulates mutual funds, gives funds a lot of leeway in names. A so-called tax-exempt bond fund need only have at least 80% tax-exempts. A single-country or sector fund can get by with just 65% of its portfolio in securities from that country or industry sector. Rekenthaler once discovered Ben & Jerry's Homemade in a biotechnology fund. "The portfolio manager admitted it had nothing to do with biotechnology," he says. "He just liked the stock." Probably the ice cream, too.
You'd have to study the reports of Delaware Treasury Reserves Intermediate Fund, a top-rated bond fund in the BUSINESS WEEK Mutual Fund Scoreboard, to find it's only 40% invested in U.S. Treasury bonds. The rest is in Ginnie Maes, whose guarantee is as good as a Treasury bond, and Fannie Maes, Freddie Macs, and credit-card receivables. Those are all high-quality issues, but they don't carry the Treasury cachet.
Regulators have ordered funds to change their names. In 1990, the SEC ruled that fund titles could not pair the words "guaranteed" or "insured" with "U.S. government." That's because the government only guarantees the bonds, not the price or appreciation of the fund.
Companies that track fund performance monitor funds to make sure they're properly categorized. Morningstar recently moved the SAFECO Growth Fund to the small-company category, though its prospectus does not restrict the investment to small companies. The reason: the median market cap of the stocks was $150 million, smaller than many small-company funds.
Many funds defy easy classification. "It's an art, not a science," says Lipper, and the process gets steadily more complicated with the introduction of new funds with new investment instruments. Counting single-state muni funds, Lipper has 100 categories. Morningstar, using broader classifications, has 33.
For more analysis, you can subscribe to Morningstar's monthly 5-Star Investor newsletter (800 876-5005; $65 a year) or the quarterly Standard & Poor's/Lipper Mutual Fund Profiles (800 221-5277; $139 a year). Or check the BW Mutual Fund Scoreboard.
If the pros struggle with characterizing funds, where does that leave the individual investors? Certainly, descriptive names and proper classification by analysts and brokers will help. But in the end, the only way investors will know for sure is to delve into portfolios and look for themselves.Edited by Amy Dunkin Jeff Laderman