If you want a mutual fund to hold for 10 or 20 years, the place to look is among the small-cap growth funds. Such is the suggestion of Lauren Young, personal-finance editor of BusinessWeek, who notes that small-cap growth has been leading the market as the economy moves into recovery. Young cautions, however, that if such funds get really big, they could morph into the midcap category, so investors should be alert to such changes. More broadly, she recommends looking for funds with low fees, low turnover, an experienced manager, and a defined style -- growth, value, or whatever.
As scandals over mutual-fund trading practices explode, Young says she hears anecdotally that some investors are shying away from funds. In her view, the financial impact on fund shareholders will be minimal. "The real cost is one of trust," she adds.
These were among the points Young made in an investing chat presented Oct. 28 by BusinessWeek Online and Standard & Poor's on America Online. She was responding to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Lauren, the market did well today on news from the Fed and the economy. How do you see the market broadly now?
A:I think we're much healthier than we were six months ago. One thing that really helped the market today is the merger announcement from British American Tobacco (BTI ) and R.J. Reynolds (RJR ). We had another merger announcement this week with FleetBoston (FBF ) and Bank of America (BAC ). Mergers don't happen in unhealthy times -- and that's really good. But they're happening now, and that's a good sign.
Q: Has the mutual-fund world been rallying along with the market?
A:Yes, for sure. But anecdotally I'm hearing from some investors and advisers that they're actually not investing in funds right now or putting new money into funds because of the scandals that are going on in the industry relating to trading issues.
Q: Let's talk about those scandals -- how much do you think they will spread and hurt the industry?
A:I think this is the tip of the iceberg. I think that it's very clear that there has not been good monitoring of some of the agreements in the industry with respect to trading. So I think unfortunately we're going to see many more worms.
I think that overall, mutual funds are actually a great investment. And the truth of the matter is, from a financial standpoint, the actual impact on people who will be affected by any kind of trading improprieties will actually be quite minimal. So the real cost is one of trust.
Q: How about real estate funds? Do you think REITs are still a good play for a portfolio?
A:It's a great investment in terms of income. Also, I think REITs are a good long-term investment because they're a great way to reduce risk in your portfolio. Now in terms of the "now" aspect of it, current yields are under 6%, and they've actually been historically higher. But on a relative basis to U.S. corporate bonds or U.S. Treasuries, they're still attractive.
Malls and factory outlets and health-care facilities are leading the market, but apartments and office and industrial properties have lagged behind.... There are still some good values. This is a great place where a mutual fund can do the picking and find those good values for you.
Q: What's the best-performing mutual fund for the long haul?
A:What's the long haul? Seriously, to me the long haul is 30 to 40 years. I think there are a lot of funds that fit the bill. If you're really in it for the long haul, then most likely you're going to be looking at an equity fund. We have a lot of really good funds that have performed well -- it's the usual suspects (Dodge & Cox [DODGX] is just one example). It depends on what kind of investor you are, though, too. For some people, for the long haul an S&P 500 index fund might be the best investment.
So overall, I would say that the best one for the long haul is one that has low fees, so they're not eating away into your return; low turnover, so you don't have to worry about taxes; a fund manager or team with a lot of experience; and clear goals -- if it's growth it's growth, if it's value it's value.
You just want someone, I think, who's really consistent. If you go on our Web site and check out the funds with the best 10-year pretax returns, it ranks the best performers (see BW Online's Interactive Mutual Fund Scoreboard). These are all really good funds.
Q: What type of funds do you think will lead the bull market -- large-cap, small-cap, growth, value?
A:Well, I think small-cap growth has been leading so far coming out of the slowdown. If we have a bull market as long as the last one, hopefully everyone is going to get their turn.
I do believe actually if you're looking for something to buy and hold for a very long time -- 10 years, 20 years -- that the most opportunities can be found in small-cap growth. The problem is finding good funds, because when they get big and get lots of money, they become midcap growth funds, and that's not what you necessarily signed up for.
Q: A huge family here -- what do you think of Fidelity mutual funds?
A:Just before I got onto this chat I was speaking to Bob Reynolds, who is the COO of Fidelity, about the industry and what's going on. So far, they have stayed above the fray. And I think it's because they really do a great job of representing the interest of shareholders.
I have to say, too, Fidelity is a private company (so is Vanguard), and I think that private companies in this industry are often better off because they are really only serving their clients and don't have to worry about meeting quarterly numbers.
Q: Your outlook for global/world funds?
A:My outlook is that you should always have some money in them. Not a lot, maybe 5% to 10% of your portfolio, but the diversification is really useful. Having said that, the growth is definitely coming from China right now. So I think you want to see if your fund has any exposure there.
And I think just be careful that, if you're investing in a fund with worldwide exposure, you don't have a lot of overlap with your U.S. holdings. People make that mistake all the time and don't truly diversify.
Q: What about American Century funds?
A:They are a good fund company. They do things right -- definitely mindful of costs and all of the things that make a fund company a good one. They also offer a lot of different kinds of products, so they're pretty good for one-stop shopping.
Personally, I think it's good to have some diversification among fund companies, but I think American Century is definitely a very solid company. They make a joke about it, but it's true, that the founder makes his own peanut butter sandwich and brings it to work in a brown paper bag every day. You can say that's cheap, but other people would say it's cost-conscious.
Q: What sector funds are looking best now, Lauren?
A:The sector that I always think of, if you're going to buy one sector, is health care. When I said before to go look at the 10-year performance, health-care funds are the best performers. And as baby boomers age, they're going to need more health care. People are always going to get sick. And there is always going to be some exciting new development. Those are all really profitable trends.
Q: What's a good fund in health care?
A:Vanguard Health Care (VGHCX ) and Eaton Vance Worldwide Health Sciences (ETHSX ). I like both of those funds, even though they're different -- Vanguard is much more pharma-oriented, and Eaton Vance is much more biotech-oriented. But the common thread is that they've had the same managers for a long time. So you're really getting experienced people doing the stock-picking.
Now with the Vanguard fund, there's a huge investment minimum. So that probably isn't going to be great for everybody. The minimum is $25,000, but I honestly think it's worth it.
Q: Why don't sector-fund managers go to cash positions when their particular sector starts dropping dramatically?
A:If you buy a sector fund, you're buying into the notion that you want exposure to that sector. Don't expect the manager to go to cash if their job is to put you in financial services or health care. You should pull money out and put it into a money market account yourself.
Q: How do you feel about the safety of Putnam funds?
A:I'm not thrilled about how Putnam has handled the trading problem. Having said that, I think there are some really smart, talented, honest, and good people -- plenty of them -- who work there. One thing I really like about Putnam is that they've got very diversified products, a lot of it style-specific, but the performance as of late has been disappointing.
So I feel really conflicted. And if you're a Putnam investor, chances are you bought your fund through a financial adviser, and I think you need to have a talk with that person about why or why not you're going to stay with the firm. I think that's really important.
Q: How about Legg Mason Value Trust?
A:Legg Mason Value Trust is the gold standard in some ways -- it's the one to beat, the front-runner. Bill Miller, the manager, has beaten the S&P 500 for more than a decade -- consistently every year, and that's really hard.
The fund does have different share classes, so the one that most people would own is LMVTX. That's kind of the big retail portion of the fund. I think this is a very interesting holding. I don't know if it would be my core holding, but it would definitely be one that had 20% to 30% of my asset allocation.
And Bill has a very interesting way of evaluating companies -- he goes where no value manager goes. One of his top holdings right now, for example, is Amazon (AMZN ). One of his former top holdings was Dell (DELL ). This is not the stuff the average value manager would buy, mainly because they have a tough time valuing the company. Bill has a really unique way -- he doesn't pick stocks out of a hat. He's very thoughtful and very innovative, and frankly, very well respected. So I think he's a great person to invest with.
Edited by Jack Dierdorff