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DOING THE MUTUAL SHUFFLEIf volatile markets upset your mix, time to rebalanceNovember is when mutual-fund investors search for losers to sell for tax deductions or to offset investment gains. For the past few years, they haven't found much to dump. The average U.S. equity fund doubled in value between 1995 and 1997. But in 1998, things are different. Although the stock market is recovering from its worst tumble in eight years, damage to the funds is widespread. The average equity fund was down 2.7% through Oct. 23, says Morningstar Inc. Selling is no problem compared with deciding what to do with the proceeds from the sale. For most investors, the smartest move is to recycle the money into equity funds. If you have the same investment goals you had before, such as retirement or education, you have little choice. If you're selling to declare a tax loss, you need to find a temporary home for your money. You can't buy back the fund for 30 days, lest the Internal Revenue Service disallow the deduction. If you stash the cash in a money-market fund and the market jumps, you'll only reinvest at higher prices. OUT OF WHACK. Beyond tax-related selling, now is also good time to reassess your portfolio. The manic markets of the past year have thrown many asset-allocation plans out of whack. If your $100,000 investment program was in balance a year ago--say, 50% large-cap, 25% small-cap, and 25% international funds--and you earned an average return, your stake was worth $91,130 on Sept. 30. And by then, large-caps made up 56%, and small-caps and international represented 22% each. ''Rebuild your portfolio to the ratios you previously targeted,'' says Robert Bingham of San Francisco financial advisory firm Bingham Osborn & Scarborough. That means reallocate assets or use new money to make up any deficits. Shifting among funds this time of year is tricky. You don't want to buy in a taxable account before a large taxable distribution. You can always park money in an index fund, which makes little or no capital-gains payouts, until after the distribution. And as long as you're moving money, you might as well upgrade your portfolio. To find candidates, we screened for funds with noteworthy attributes using Morningstar Principia Pro and BUSINESS WEEK's Interactive Mutual Fund Scoreboard (www.businessweek.com). We also talked with pros who use funds to invest clients' money. One of the most difficult jobs over the past several years was running an actively managed large-cap fund that competed with the Standard & Poor's 500-stock index. But a few savvy managers stood out. Morningstar analysts praise the large-cap Ameristock, Clipper, Legg Mason Value Primary Shares, and T. Rowe Price Dividend Growth funds for their ''high alpha.'' That means the funds earned greater-than-expected returns considering the risk they took. That's no small feat during a period when the S&P trounced 96% of domestic equity funds. Take little-known Ameristock, based in Moraga, Calif. Manager Nicholas D. Gerber focuses on the 100 largest U.S. companies, and from those he has assembled a portfolio of 44. Gerber weights his stocks by their degree of undervaluation. Among his largest holdings are Intel and Caterpillar. Toward the bottom are the expensive ones--Microsoft (MSFT), Procter & Gamble (PG), and Pfizer (PFE). The result, says Gerber: a fund whose portfolio resembles the S&P, but with a higher yield and lower price-earnings ratio. The Clipper Fund is a different sort of high alpha fund. Although it has trailed the S&P by 1.7% annually over the past three years, Clipper's managers are very picky--and that attitude is now paying off. Clipper is ahead of the S&P for the year, 13.7% to 11.6%. Clipper concentrates on companies that dominate their markets and sell at no greater than 70% of their ''intrinsic value,'' which manager Michael C. Sandler describes as ''what a rational private investor'' would pay. That keeps the portfolio concentrated in 17 companies, including Philip Morris (MO), Fannie Mae (FRE), and McDonald's (MCD). Moreover, Clipper's managers will build up cash, rather than lower their standards. That's a drag in hot markets--in the first half of 1998, the fund earned 8%, less than half of the S&P. In chillier environments, the strategy clicks. FIVE-STAR WINNER. Even before the market downturn, mid-cap and small-cap funds were lagging. Tom Stevens, chief investment officer of Wilshire Associates Inc., argues that small-caps haven't been this cheap relative to large-caps in 25 years. Since small- and mid-cap funds have underperformed for so long, a fund that we rate A or to which Morningstar awards five stars is scarce. That's what makes Mairs & Power Growth so attractive. The St. Paul (Minn.)-based fund invests primarily in growth companies in the Upper Midwest. First Eagle Fund of America, a mid-cap value fund, and Oak Value, a mid-cap growth, are also considered good choices. Finding good small-cap funds is made tougher by the fact that many of the best are closed to new investors. But in the wake of the market's tailspin, some, such as Third Avenue Value Fund, are reopening. This fund, which is run by vulture investor Martin J. Whitman, finds value in bankruptcies, distressed securities, and out-of-favor companies. Among his newer additions: Montgomery Ward. Some small-cap funds have become too big to invest successfully in little companies. Not the Chicago-based Fasciano Fund, with about $120 million in assets and a sturdy record. Manager Michael F. Fasciano invests in companies with earnings growth rates of 15% to 25% a year, and BUSINESS WEEK's scoreboard gives Fasciano an A in its peer group for risk-adjusted returns CONTINENTAL DRIFT. Just as is the case in the U.S., Europe's equity markets have run into a rough patch. But the coming of the euro, which 11 countries will adopt as currency next year, is seen as a powerful catalyst for Continental stocks. A smart way to play this trend, says Walter Wisniewski of Paragon Capital Management in Syosset, N.Y., is the Scudder Greater Europe Growth Fund. Or you could choose one of the better-performing diversified funds that are invested heavily in Europe. BT Investment International Equity, Fidelity Diversified International, and Scout WorldWide all have more than 60% of their assets in Europe. The difference is that if all of a sudden Asia or Latin America looks promising, these diversified funds can change their course. When it comes time to trade in your losers and shop for new funds, keep in mind that gains in the stock market may be harder to come by in the near future. True, interest rates are falling, but so are profit growth and the global economy. The latter have come together to produce the Correction of '98. That should give you an ideal opportunity to rebalance your portfolio and target those funds that can take advantage of Wall Street's weaker tone.
By Jeffrey M. Laderman in New York RELATED ITEMS
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Updated Oct. 29, 1998 by bwwebmaster
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