Most investors in mutual funds took a loss in the first quarter, but funds using the value strategy lost much less than growth funds. So the best advice for a new investor would be to opt for so-called core funds, blending growth and value.
That's the recommendation of Philip Edwards, managing director of Standard & Poor's Select Funds Group, which culls the universe of more than 10,000 funds to come up with its Select list of 300. For example, he cites the Vanguard Growth & Income Fund as a broadly diversified fund with good returns and low expenses.
Edwards also names, among others, large-cap value funds Selected American Shares and Vanguard Windsor II and, on the small-cap side of the value equation, the Royce Total Return fund, the Ariel Fund, and the Third Avenue Value fund. Above all, Edwards stresses the importance of a diversified portfolio to help investors weather storms -- and the risks of attempting to time the market.
He spoke in an investment chat presented Apr. 3 by BusinessWeek Online and S&P on America Online. Following are edited excerpts from his answers to questions from the audience and from Jack Dierdorff of BW Online. A complete transcript of the chat is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Well, the first quarter of 2001 is behind us. How did mutual funds do vis-à-vis the overall market?
A: Well, that depends on the type of mutual fund that you're talking about. The growth-oriented funds were a disaster, while the value-oriented funds fared not as badly. For example, the large-cap growth sector was off more than 20%, while the large-cap value sector was off less than 10%.
Q: How many funds do you watch in S&P Select Funds?
A: Just about 300. These are chosen from a universe of over 10,000 as the best of the best.
Q: Any thoughts on the type of fund a new mutual-fund investor should consider? Is this a time for money-market funds?
A: Yeah, money-market funds at least have a positive return. But actually, this may be a great buying opportunity. If it's a new investor, I would suggest a core fund -- a fund that has both growth and value aspects to it. For example, the Vanguard Growth & Income Fund (VQNPX) is a broadly diversified fund with good returns and low expenses.
Q: Also, should bruised growth-fund investors be thinking of switching now? Or just hang on and hope?
A: I think that people need to take a broad look at their portfolio and ensure that it is diversified. I think, if we've learned anything over the last 18 months, it's that diversity counts. And if investors are well diversified, then I would hold tight.
Q: Have you seen any late numbers on redemptions? Money flowing out of funds, net?
A: I don't have this at my fingertips. I think, though, redemptions are to be expected, given the huge amount of money that flowed into mutual funds in '98 and '99. But underlying that, more importantly, I think, is a long-term attitude of investors toward equities. As a result, I think we'll see most people stay put.
Q: What kind of strategy has been followed by mutual-fund managers in this trying time?
A: We've seen the more aggressive managers move into significant cash positions -- some up to 30% -- as a defensive measure. However, most have decided to stay fully invested and are willing to ride out the downturn.
Q: Thoughts on JAAGX
(Janus Aspen Aggressive Growth)?
A: Well, a broad statement about Janus is that you only need one Janus fund. We have several Janus funds on our Select list, and we think very highly of the group. They do, as advertised, have very in-depth research and have a very collegial process. And, in any one of their funds, you're getting the benefit of several managers' insights.
Q: Are balanced funds a good bet now? I'm thinking of buying DODBX
(Dodge & Cox Balanced fund).
A: Balanced funds are a good way to achieve diversification in one fund. And the Dodge & Cox Balanced fund has long been a good fund. It is a large fund, with $5 billion in assets (that's before today!). But I don't think that should be a deterrent in a balanced fund. So that is a good place to go in this environment.
Q: How about bond funds now? And should a 34-year-old have bonds in a retirement account?
A: I would think that an appropriate asset allocation would include a small allocation of bonds. But I would think that, given the age, it would be a greater weighting toward more aggressive and equity funds. A good bond fund is the Alleghany/Chicago Trust Bond fund (CHTBX).
Q: The mutual-fund report in the Apr. 9 BusinessWeek points to bear funds that sell short as standouts for performance in this market (see BW, 4/9/01, "There's Hardly Anywhere to Hide"). Any in your universe?
A: No, they're not, because we're looking for funds that provide consistent, above-average performance over time. Bear funds, by their nature, are extremely volatile and less likely to provide that consistent performance.
Q: Can we hear what some of the other leaders in S&P Select are now, despite the market?
A: There are a lot of value funds that were overlooked in the last few years that are now coming back into the spotlight, such as Selected American Shares (SLASX) or Vanguard Windsor II (VWNFX). Those are large-cap funds. On the small-cap side of the value equation, there's the Royce Total Return fund (RYTRX) and the Ariel Fund (ARGFX), and finally the Third Avenue Value fund (TAVFX).
Q: How about the foreign and global funds in this environment?
A: Nobody is immune from this environment, and the foreign and global funds have gotten their share of punishment, too. International funds are off 13% or 14% this year. But if you're looking for some diversity in the portfolio, there are Julius Baer International Equity fund (BJBIX) and the UMB Scout WorldWide fund (UMBWX), which are very good international funds. And in an emerging sector of the international category are funds that focus on small companies. An example here is the Nicholas-Applegate International Small Cap Growth fund (NAGPX).
Q: Is there any point in being in index funds at this point?
A: There's always an argument between active management and indexing. Two years ago, the indexers were winning, and last year the active managers were winning. Again, I think this goes back to the diversity issue, and I think it's good to have some funds allocated to indexing in the large-cap arena. But I would stick with active managers when you're talking about small- or mid-cap funds.
Q: Can you suggest some good funds for college-education purposes?
A: Yes, I can. I would stick with some core funds, if the time horizon is fairly short to the date that the funds are needed. These would include funds such as the Legg Mason Value Trust (LMVTX) or the Thornburg Value Fund (TVAFX). If you have a longer-term time horizon, I would move into some small-cap funds, such as Wasatch Small-Cap Growth (WAAEX) or the Ariel Fund (ARGFX).
Q: I've heard it argued that sector funds are seldom a good longer-term bet. Do you agree?
A: I think sector funds should ONLY be considered as a long-term bet. If the investor's time horizon is short, then I would stay away from sector funds, given the volatility. And I would only use sector funds at the edges of the portfolio.
Q: High-yield bond funds have a tempting return, but are they too risky with the economy fragile?
A: Not at all! As a matter of fact, we think this may be a strong environment to invest in high-yield funds, given the difference in spreads between Treasuries and these funds. The last time spreads were this wide, high-yield funds did very well. Some high-yield funds on our list include T. Rowe Price High-Yield fund (PRHYX) and Strong High-Yield Bond fund (STHYX), and, finally, Columbia High-Yield fund (CMHYX).
Q: And how about municipal-bond funds?
A: Muni-bond funds are important for tax-management purposes as much as anything. These are good defensive funds as well as funds to avoid some federal taxes. We haven't reviewed that sector yet, so I don't have any specific recommendations.
Q: Where do you stand in the load vs. no-load argument?
A: I think that there are some very well-managed no-load funds. And with the continually evolving distribution channel, there are any number of ways to avoid or reduce the exposure to loads. I also think loads should be considered in concert with the overall expense ratio. For example, the American Funds have loads, but they also have annual expense ratios that rival Vanguard's. American Funds has also recently introduced new share classes that effectively allow you to waive the load with a long-enough holding period.
Q: Phil, do you have any personal ranking of star fund managers? This is a time to test them, for sure.
A: Well, on the aggressive side, I like Tim Miller at Invesco. In the core area, there's Bill Miller from Legg Mason, of course, and on the value side, I like the portfolio counselors at the American Funds, and I'm not listing one there because they typically assign five or six managers on one fund, and I like that diversity.
Q: Can you sum up for us, Phil? I guess some of the watchwords are that the bottom isn't yet here -- and diversity is the key to relative safety.
A: Absolutely! Emphatically! I couldn't agree more. I think in '98 and '99, people ignored risk. And while investing, people need to be cognizant of the risk they're taking and understand that what goes up can come down. The best defense in a time like this is to diversify and not try to time the market.