Lots of fund investors want it all: Great performance when the market is going up and protection when the market is tumbling.
Where to find that perfect type of mutual fund? “It’s in the same place as the pot (of gold) at the end of the rainbow,” says Harold Evensky, a Coral Gables, Fla., financial adviser. “It’s just not there.”
Market-matching performance in good times is as easy as buying an index fund, of course. But on the cautious side, market action this year is a reminder of the shortage of sure-fire safe havens for people investing in stocks.
Remember how “value” funds, which invest in cheap, unloved stocks, were supposed to drop less than other funds in a market downturn? That premise sounded reasonable because value stocks were already seemingly low in price.
Well, value funds have certainly disappointed investors lately, as they did in last year’s summer downturn as well. Since the July 16 peak in the Standard & Poor’s 500-stock index, value funds tracked by Lipper Inc. are down substantially more than “growth” funds that invest in the stocks of fast-growing companies.
Among “multicap” funds that buy stocks of various sizes, for instance, the average multicap value fund tumbled about 13 percent from mid-July through the third quarter, while the average multicap growth fund was down about 6 percent. For the year, multicap value funds were down an average of about 2 percent through the third quarter, while multicap growth funds were up about 13 percent.
Some other supposedly low-risk types of stock funds have also disappointed safety-seeking investors this year. Real-estate funds, which seemed cheap and relatively safe after a horrendous 1998, have fallen farther this year. Market-neutral funds, complex vehicles that were supposed to deliver decent returns in good markets and bad, have mostly gone down.
Investors have to accept that “there are no safe harbors” in the stock market, says Tim Medley, a Jackson, Miss., financial adviser. Rather, he says, investors who buy stocks–because their returns have trounced those of other alternatives over time–have to be prepared to “muddle through bad situations” and sit tight until the market turns up once again.
Investors should focus on “safe investing” rather than elusive havens, Evensky says. Like most advisers, he says the key is spreading one’s money among diverse types of securities to get strong long-term results with the least risk possible.
As investors weigh their options in a rocky market, they can find a few stock funds that have used unusual strategies to deliver solid if unspectacular returns with sharply reduced risk. Two such funds are Merger Fund, which invests in companies engaged in already announced corporate combinations with the idea of profiting when the transactions are completed, and Gateway Fund, which buys stocks and sells corresponding call options. Both funds have average annual returns in the past decade of just over 10 percent, compared with nearly 17 percent for the S&P 500 index, according to Morningstar Inc. (Merger Fund is closed to new investors.)
Another option that may appeal to some investors: “bear-market” funds, which do well in down periods such as the past few months. But such funds, essentially a bet that stock prices will decline, aren’t a safe haven–not, that is, unless investors know when a down period is beginning and when it is ending. Over longer periods of time, when the stock market has been rising, funds such as Prudent Bear Fund and Rydex Ursa Fund have been bottom-of-the-charts performers.
Here’s a further look at a few of the stock-fund categories investors have looked to as those elusive safe havens:
– Value funds. Martin Whitman, manager of Third Avenue Value Fund, attributes the weak performance of value funds to two factors. Those are investors’ love affair with Nifty Fifty-type big growth stocks and “the really unprecedented flight to garbage,” such as Internet stocks with no earnings and questionable prospects. “I can’t attempt to outperform garbage,” he says.
Third Avenue Value’s performance is flat this year after a 4 percent advance in 1998. Investors have pulled out in droves, leaving the fund with $1.3 billion in assets, down from $2 billion at the beginning of the year.
While value funds haven’t proven a safe haven in this growth-focused market, supporters say they may outperform growth funds going forward, as they have over some other periods of time. Whitman, for instance, is enthusiastic about “a tremendous amount of bargains” in industries including insurance, real estate and pharmaceuticals.
– Real-estate funds. These funds invest in property-related stocks, including real-estate investment trusts, securities whose appeal for conservative investors includes hefty dividend yields averaging around 8 percent. Despite generally positive conditions in the real-estate business, though, real-estate securities have been in a slump. The average real-estate fund is down 6.7 percent this year, after a negative 15.52 percent return last year, according to Lipper.
As with value funds, the managers of real-estate funds say the dismal results will give way to strong performance somewhere down the road. “These stocks are cheap, and they can’t keep growing their earnings and seeing their stock prices drop,” says Andrew Davis, manager of the $350 million-in-assets Davis Real Estate Fund.
Another reason to buy real-estate securities and funds is the hope that they will perform like actual real estate, rather than like other stocks, over time–thereby diversifying a portfolio. But some financial advisers don’t buy that argument. While tangible property may be a distinct asset class, real-estate securities don’t merit a special spot in people’s portfolios, Medley says.
– Market-neutral funds. These funds split their assets between purchases of promising stocks and “short sales” of other stocks expected to be lagging performers. (In a short sale, an investor sells borrowed shares of a stock with the hope of replacing those shares later with ones bought at a lower price.) In theory, balancing long and short positions will “neutralize” the effect of the market’s overall direction and deliver decent, low-risk returns.
The reality, though, hasn’t been impressive. Since the first fund, Barr Rosenberg Market Neutral Fund, appeared in late 1997, for instance, it has delivered a negative 12.33 percent return, according to Lipper. One problem: A number of market-neutral funds tend to buy value stocks and sell short growth stocks, a costly strategy in the recent growth-happy market. While this has been a tough period, market-neutral investing “has a proven track record” in the past decade, says David Katzen, manager of Phoenix-Euclid Market Neutral Fund.
Assets of the funds have declined, as some early buyers have lost faith. Evensky says he gave up on market-neutral funds in February, selling positions that approached 5 percent of clients’ portfolios.
