Getting To Know A Fund By Its Close KinPam Black
What do mutual funds and baseball have in common? Statistics, for one. In fact, when the twice-monthly publication Morningstar Mutual Funds recently introduced a novel way to categorize and evaluate the funds it tracks, the inspiration came from sports historian Bill James, who likes to compare the stats on current baseball players with those of similar past players.
Morningstar decided to do the same thing with each fund it profiles by listing the three funds that have traits most like it. The information, which is available to the public through the Morningstar Mutual Funds booklets on file at many libraries, has several uses. It offers alternatives to funds closed to new investors. It can give a no-load substitute for a load fund. It can help you swap funds for tax purposes and provide insight into a fund's composition. Morningstar is the first fund-tracking company to offer this service, but Value Line plans to introduce a similar tool soon.
A fund's reaction to market forces, risk level, and returns are compared to those of 1,300 others, all at least three years old. The correlation between two funds is rated "strong," "fair," or "weak."
HOLD THE FORT. There are many ways to use the Most Similar Funds designation, which appears at the bottom right of Morningstar's full-page reports. Some successful funds, such as CGM Capital Development, with a three-year average annual return of 29.78%, are closed to new entrants. But by consulting the most-similar list, investors can see that AIM Constellation, with a 21.78% return, or Twentieth Century Giftrust Investors, with a 28.48% return, are fair fits for CGM. Likewise, if you favor Fidelity Magellan but think it has gotten too big, you might consider Fidelity Growth & Income, Neuberger & Berman Selected Sectors, and MFS Research A, all strong fits. If you're enamored of a fund that requires a high minimum investment or steep load, the similar-funds ranking can steer you toward alternatives.
The new ranking can also help you maintain your market position when realizing capital gains or losses. If you sell off part of a portfolio to claim gains or losses, you can immediately pick up a similar fund. This way, you get the tax advantage without violating the so-called wash-sale rule that requires investors to wait 30 days before buying back the same securities.
To diversify a portfolio, look for funds that have a low correlation with most others. A fund that has only weak fits is likely to behave differently from the other funds in your portfolio. For example, Merger Fund, which invests only in companies about to be bought or sold, may be a good choice "if you want to bring in an element that marches to a different drummer," says Don Phillips, publisher of Morningstar Mutual Funds. ASM, which invests in the 30 companies of the Dow Jones industrial average, is also unique. Most equity funds try to capture growth by holding stocks with smaller average market capitalizations than the big blue chips in the Standard & Poor's 500-stock index. ASM, however, holds even larger companies than those in the S&P.
Insight is also offered into a fund's makeup. Fidelity Capital Appreciation's similarity to Mackenzie American, GT Worldwide Growth, and Ivy International suggests it is heavily invested in cyclicals, as is Mackenzie, and in global holdings, as are the other two. The fact that growth funds Colonial Shares and Common Sense Growth are Evergreen's look-alikes implies that the latter has grown from a small-cap into a mid-cap fund.
Some experts think the new ranking can help investors weed through the overgrown fields of funds out there. "We applaud anyone providing the individual investor with more decision-making tools," says Paul Greenwood, an analyst at investment consultant Frank Russell Co. "But it shouldn't be used in isolation. You have to look at all the information for that fund and find out why it's showing up as a strong fit."
STILL YOUNG. When financial planner Bill Young of First Financial Group tested out the rankings against a software program that shows how much overlap there is between the individual securities in different funds, he found a very low correlation between funds Morningstar listed as strong fits. "I would rely more on stocks being a greater indicator of similarity, rather than correlating statistics," he says.
Mark Riepe, vice-president at consultant Ibbotson Associates, says Morningstar has yet to determine how stable the correlations between funds are over time. Phillips doesn't argue: "Funds are managed by individual personalities with strategies that can change, so there is a danger is believing too much in numbers." Therefore use the most-similar choices only as a starting point, and they might help you improve your batting average.
TABLE: THE NEXT-BEST FUND? FUNDS CLOSED LIKE-FUND TO INVESTORS ALTERNATIVES JOHN HANCOCK SPECIAL EQUITIES A 28.06%* AIM AGGRESSIVE GROWTH 27.56%* High risk, small-cap growth PUTNAM NEW OPPORTUNITIES A 28.49 BABSON ENTERPRISE 18.45 QUEST FOR VALUE SMALL CAP A 18.10 Moderate risk, small-cap value SHADOW STOCK 14.65 HARBOR INTERNATIONAL 14.69 IVY INTERNATIONAL A 15.75 Low risk, large-cap value T. ROWE PRICE INT. STOCK 12.77 STRONG COMMON STOCK 23.87 VISTA CAPITAL GROWTH A 23.78 Medium risk, mid-cap blend FUNDS WITH NO-LOAD SALES CHARGES ALTERNATIVES AIM CONSTELLATION 21.78%* BERGER 100 21.92%* High risk, mid-cap growth AIM WEINGARTEN 6.97 VANGUARD U.S. GROWTH 7.22 Low risk, large-cap blend FIDELITY DESTINY I 19.20 NEUBERGER & BERMAN GUARDIAN 15.64 Low risk, large-cap blend *3-YR.AVERAGE ANNUAL RETURN THROUGH APR. 30, 1994 DATA: MORNINGSTAR INC.