Investors need "to be patient, to be diversified, and to focus on funds that invest in quality stocks." So advises Philip Edwards, managing director of Standard & Poor's Investor Services, which tracks and rates mutual funds. And he reports that in the second quarter of 2005, the average equity fund gained 2.4%, vs. 1.2% for the S&P 500-stock index.
Over the longer term, Edwards says, S&P has found that investors have an equal chance of winning with a large-cap index or large-cap fund. But the S&P SmallCap 600 and MidCap400 indexes often do better than funds in those sectors, he adds.
However, fund investors currently would do better by diversifying across the capitalization range with equity funds and among bond funds by sticking to short- and intermediate-term durations, Edwards says. Focusing on quality is the key now, in his view, because the market is full of risks, even though S&P sees the possibility of 3% to 4% market gains for the remainder of 2005.
These were among the points Edwards made in an investing chat presented July 5 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Following are edited excerpts (AOL subscribers can find a complete transcript at aol.businessweek.com/chat):
Q: Before we delve into funds, Phil, what's the macro view at S&P on the tone and direction of the market?
A:We remain mildly optimistic. We think the market has the opportunity for 3% to 4% gains for the rest of the year. But we think there are a lot of risks in the market. And as a result, we think investors should remain diversified and focus on quality stocks.
Q: Have equity funds been pretty much tracking the market?
A:Actually, they've been doing slightly better than the market. They performed pretty well in the second quarter of 2005, with the average equity portfolio gaining 2.4%, vs. 1.2% for the S&P 500.
Q: Bond funds vs. stock funds?
A:I would say it's important to be diversified, and I would have some of both in the portfolio. On the fixed-income side, I would look for shorter-duration funds -- in other words, more intermediate- or short-term funds. On the equity side, I would be looking toward those that focus on blue-chip stocks -- that is, stocks with proven earnings and dividends.
Q: Is it wiser to buy mutual funds by sector rather than size of cap?
A:Again, it's important to diversify by cap size as well as by growth and value styles. For equity funds, we believe investors should participate in the large-, mid-, and small-cap funds, as well as growth and value. The amount of participation in each is dependent on an individual's risk tolerance and investment objectives.
Q: I have S&P 500 fund Fidelity Growth & Income (FGRIX ), Vanguard Health Care (VGHAX ), a little in some Janus funds -- I would like to cover mid cap. Do you think Mairs & Power is a good choice?
A:The Mairs & Power Growth Fund (MPGFX ) is one that has a tendency to cover companies in the Midwest because that's where the managers are based. So if you don't mind the geographic concentration, this can be a good choice. It has a strong track record, a low expense ratio, extremely low turnover, and experienced managers.
Q: What's your opinion of the American Funds?
A:Excellent, with the exception of their small-cap funds. They have some of the best portfolio managers that we have run across in our years of research. We utilize those funds whenever we have the opportunity.
Q: Vanguard Energy (VGELX ), I think, requires $25,000 -- is there another good fund that doesn't require so much?
A:AIM has an energy fund (IENAX ) that appears to have a very good track record and only a $1,000 initial investment, but its expenses are high. Excelsior has an energy and natural-resources fund (UMESX ) that has only a $500 minimum and below-average expenses. It also has a strong track record. Fidelity also has an energy fund (FSENX ) that has a decent track record and very competitive expenses.
Q: Please give me your take on Putnam funds.
A:Well, Putnam obviously had a hard time of it. Assets continue to leave the fund family. And we continue to take a cautious approach toward their funds. Meaning if you're already in, there isn't a large reason to get out at this point. But if you're not in, there isn't a compelling reason to get in.
Q: What fund family would you like to get into if switching out of Putnam?
A:Well, I would look at American Funds, Dodge & Cox, T. Rowe Price, and Goldman Sachs. They all offer a wide array of very strong products.
Q: Your thoughts on Vanguard's Health Care fund (VGHAX )?
A:This fund has a very strong track record and a manager who has been in place since 2001. Typical of many Vanguard funds, its expense ratio is extremely low. However, we also show this fund as closed to new investors.
Q: How often should one fine-tune or tune up one's asset allocations?
A:That's a good question. I would say that at least annually you need to take a look at the asset allocation and the weights, and at a minimum rebalance. By rebalance, I mean taking profits and putting them into areas that have more opportunity for growth.
For example, real estate has done very well over the last two years, and I would consider taking some profits from there and putting them into a weaker area, such as large-cap growth. I also wouldn't look at it more than quarterly. I believe there's such a thing as overmanaging an asset allocation, as they're intended to be fairly strategic and long term.
Q: What percent of your mutual-fund portfolio should you have in foreign funds?
A:You should have some exposure to international funds. The amount, again, depends on your investment goal and risk tolerance. But we currently feel that 20% is a maximum that one should be exposed.
Q: T. Rowe Price's Eastern Europe Europe & Mediterranean fund (TREMX )?
A:Well, it has been managed by the same team since its inception in 2000. It has a relatively low expense ratio for a regional fund and a track record that has recently improved. But this fund has a great deal of volatility to it, meaning that the share price is subject to a lot of fluctuation. I think that if you want to invest in this fund, you need to be ready for the volatility.
Q: What fund would you recommend to take advantage of the boom in China?
A:There is a Matthews China Fund (MCHFX ) that has a strong long-term track record, but its short-term record has been a little bit more spotty. Fidelity has a China Region fund (FHKCX ) that has done better more recently. And Eaton Vance offers a Greater China Growth fund (EVCGX ) that has a strong three-year track record.
Q: Your opinion, please, on Oppenheimer Strategic Income fund (OPSGX )?
A:This fund has an adequate track record, consistently performing in the middle of the pack. The manager has been in place for about 14 years. And its expenses are above average. It appears to be a combination of both investment-grade and high-yield fixed-income. Overall, I would term it as adequate.
Q: Do you think Janus is doing a good job now? I own Janus Fund (JANSX ) and Janus Twenty (JAVLX ).
A:Yeah, I think that Janus is doing a very credible job. They have made a lot of attempts to be very transparent in what they're doing, which we think is good. However, they have been experiencing some turnover in portfolio managers, which we've been taking note of.
Q: What do you think of exchange-traded funds (ETFs) generally, for the average investor?
A:I think that ETFs are an excellent way to invest if you have a lump sum that you want to invest. They are very cost-effective, which is important to investment returns. And they're very simple. However, if you have periodic investments to make, or withdrawals, then you would be better off in an index fund, since with an ETF you'll be paying a commission on every trade.
Q: Your opinion on Fidelity Dividend Growth (FDGFX ) and Fidelity Low Priced Stock (FLPSX )?
A:For Fidelity Dividend Growth, the track record has been pretty poor for the last five years. Fidelity Low Priced Stock has had a very enviable track record, consistently beating most of its peers for the last 10 years. However, this fund is closed to new investors.
Q: Have any sector funds done better than the broad equity funds? Which sectors and funds?
A:Well, year to date, energy has been the biggest winner, up 19%. The next-best sector has been utilities, up 9% year to date. And finally, real estate, up 4.8% year to date. Outside of those three sectors, the news is all bad. I don't think that I would jump on the real estate bandwagon at this point. Again, I would look to a slightly more diversified portfolio. S&P's investment-policy committee is suggesting overweights to consumer staples, health care, and utilities.
Q: Is it good to invest in TIPS [Treasury inflation-protected securities] right now? If so, which fund or ETF would be best for this?
A:TIPS are a good way to protect your fixed-income investment from inflation. So it should be considered part of a diversified portfolio. PIMCO [Real Return TIPS -- PRTNX] and American Century [Inflation-Adjusted Bond Fund -- ACITX] offer good TIPS funds.
Q: A classic question -- is it better to invest in single good stocks in place of mutual funds at this time?
A:Our advice is to focus on a diversified portfolio rather than an individual stock. We feel that the risk with an individual stock doesn't always justify the rewards. A diversified portfolio may better help you to achieve your goals.
Q: How do you see oil prices affecting the market and funds?
A:Oil prices, while high at $60 a barrel, aren't as high as they were back in '73 and '74 during the oil crisis. On an equivalent basis, oil prices would need to be closer to $80 a barrel to be at the '73-'74 level.
We think oil prices have dampened, but not ended, consumer spending at this point. As a result, they have marginally affected the economy. We expect oil prices to settle more in the $50-per-barrel range over the next few years. As a result, we think the prices are largely factored into the market.
Q: Some studies have shown mutual funds not doing as well as the indexes -- what were they doing right to beat the S&P 500, as you reported earlier?
A:Well, S&P's own study shows that investors have an equal chance of winning with a large-cap index or a large-cap fund. However, contrary to popular belief, the S&P MidCap and SmallCap indexes often do better than the funds. This is especially true now that so many of the good small- and mid-cap funds are closed to new investors.
Q: So are there any mid- or small-cap funds you would recommend that are still open?
A:There's a Nicholas Limited Edition Fund (NCLEX ) and a Stratton Small-Cap Value Fund (STSCX ) that we think are very good.
Q: What do you think of T. Rowe Price Growth Stock fund (PRGFX )?
A:It's a great fund. This fund has had a consistently strong track record, is managed by a deep and experienced team, and has extremely competitive expenses. This is a fund we highly recommend.
Q: Phil, tell us where to find S&P's mutual fund rankings online, if you will.
A:They can be found through a subscription to The Outlook, S&P's publication for individual investors. They can also be found on businessweek.com/investing.
Q: Can you sum up your advice for fund investors?
A:Sure. Now is a good time to be patient, to be diversified, and to focus on funds that invest in quality stocks.
Edited by Jack Dierdorff