A BUNCH OF FUNDS ROLLED INTO ONEInvestors get convenience, but at a price
The fund of funds, a hot investment idea of the go-go '60s, is finding new life in the '90s. These funds invest neither in stocks nor bonds, but in other mutual funds. Since the end of 1995, their number has more than tripled to 80, with $20 billion in assets, and more are on the way. On Sept. 16, Charles Schwab & Co. launched a small-cap fund that's the fourth in a series that invests in funds sold by the Schwab OneSource mutual-fund supermarket.
Investors like funds of funds because they offer a diversified portfolio with one-stop shopping. Certainly, that's why they're becoming popular in 401(k) programs; the funds save neophytes from the burden of trying to pick a good mix. But more seasoned investors are jumping on board, too. ''When we started the Concert Allocation funds [Smith Barney Inc. funds of funds that invest in other Smith Barney funds], I thought they would attract investors with $2,000 or less,'' says Jay Gerken, a managing director at Smith Barney Asset Management. ''But we're getting $100,000 tickets, too. People want to simplify their lives, and this helps them do it.'' Fund newsletter publisher Eric Kobren says that last year he started three Kobren Insight Funds of funds because readers told him inertia kept them from acting on his mutual-fund recommendations. ''People have a hard time pulling the trigger, so we do it for them,'' says Kobren, whose funds now have more than $100 million in assets.
The knock on funds of funds: Shareholders end up paying two levels of expenses. They pay an average expense ratio of 1.09% for the fund of funds, plus the expenses of the individual funds that the managers buy. ''Some people are skilled at picking funds,'' says veteran fund-watcher A. Michael Lipper of Lipper Analytical Securities Inc. ''But it's very tough to overcome the additional expenses.''
There are exceptions to the ''double taxation'' of fund-of-funds investors. The Vanguard and T. Rowe Price Spectrum funds of funds, which invest in funds that belong to their own families, don't charge expenses. Shareholders bear the same costs as if they invested in the funds directly. These funds are the giants of the field (table).
WORTH THE COST? Fund-of-funds managers say investors are getting value for that extra cost: asset allocation, fund selection, and fund monitoring--all services that investors otherwise must do themselves or pay someone to do for them. And fund-of-funds managers do have some options not available to individuals. Often they can buy load funds without paying a load, or invest in institutional funds.
How do these funds stack up? Only six boast at least a 10-year record; 16 have records of at least five years. None beat the Standard & Poor's 500-stock index, or have come close. ''You can't compare a fund of funds to the S&P or to individual funds,'' says Robert J. Markman, whose Markman Capital Management runs three such funds with over $200 million in assets. ''You have to compare them to portfolios of funds.''
Markman, who is president of the new Funds of Funds Assn., says Lipper and Morningstar Inc. shortchange funds of funds by comparing them to other funds, not to each other. He says funds of funds are qualitatively different and harder to analyze than any single fund. ''Morningstar would be on firmer intellectual grounds by dropping funds of funds rather than misanalyze and miscategorize them,'' he says.
Morningstar President Don Phillips disagrees. He says a fund of funds is a way to reach an investment goal, and should be compared to funds with similar aims. If these managers add value, he says, it will show up in Morningstar's ratings. Of 20 rated funds, only T. Rowe Price Spectrum Income has the top five-star rating. Seven have four stars.
Michael D. Hirsch, who runs five FundManager funds of funds, says the category's risk-averse approach never looks good in a raging bull market. ''We try to capture 80% of the upside and limit ourselves to 50% of the downside,'' he says. On Aug. 15, when the stock market dropped 3.1%, his equity funds were down between 1.4% and 2%. ''That's the behavior you'll see in an extended bear market,'' adds Hirsch. Indeed, the question of whether funds of funds are valuable may not be settled until the bears come out of hibernation. Right now, they can't beat the bulls.
By Jeffrey M. Laderman in New York
Updated Sept. 18, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.