BUSINESSWEEK ONLINE : JANUARY 29, 2001 ISSUE
SPECIAL REPORT Caution: Your Fund May Be Top-Heavy Many mutual funds are a lot less diversified than you think James McCall had the wind at his back just over a year ago when Merrill Lynch & Co. (MER) wooed him from a competitor to manage a new ''focused'' mutual fund. The market was on fire, and McCall's reputation helped to attract $1.1 billion in assets to the new fund, which invests in just 20 fast-growing companies. But the Focus Twenty Fund's debut has been far from auspicious: The tech-heavy fund sank 28% in 2000 as the Nasdaq recoiled. ''It's a painful thing,'' McCall says. ''When you go through a lot of uncertainty, these types of portfolios don't do well.'' But don't think you've escaped just because you steered clear of focused funds and bought instead a diversified equity mutual fund. Funds holding 100 or more stocks can be just as potentially risky. The reason: Many mutual fund managers favor their top 10 stock picks and allot a big chunk of their fund's assets to them. In this year's Mutual Fund Scoreboard, we've introduced a feature to help investors figure out whether their fund is top-heavy: the percentage of assets in the 10 largest holdings. These funds can do well when the markets get rough, but it's important to know if your manager has the stuff to pull it off. ''It's the format that tends to amplify a stock manager's abilities or lack of abilities,'' says Russel Kinnel, director of fund research for Chicago's Morningstar Inc., a financial research company. D RATING. The roiling stock market is an especially acute challenge for fund managers who run concentrated growth funds. ''Growth stocks' prospects change more rapidly, making the funds more volatile,'' Kinnel says. Many growth managers of diversified and focused funds alike rode the bull market to soaring returns with an elite group of large-cap stocks such as Microsoft (MSFT), General Electric (GE), Intel (INTC), and MCI WorldCom (WCOM), to name a few. Some of those same stocks, however, turned losers last year and have crippled the returns of diversified funds. For instance, a good long-term performer, the Domini Social Equity fund, lost 15.1% by banking 39% of its assets in a few names. Similarly, the Strong Blue Chip 100 Fund lost 18.6% by following the same strategy as did the Nationwide Growth Fund, down 30.3% last year (table). Some managers who concentrate their investment in a few stocks get low grades from BusinessWeek. Among them are the MFS Emerging Growth Fund, a large-cap fund with an overall D rating. The $7.6 billion fund--with 62% of its assets in its 10 largest holdings such as Oracle (ORCL), Cisco (CSCO), and BMC Software (BMCS)--lost 26% last year. Both the American Century Vista, a $1.9 billion small-cap growth fund, and the $856 million Alliance Fund, a mid-cap blend, are graded D for risk-adjusted returns. Each has about 46% of assets in their top 10 stocks. But that doesn't mean investors should steer clear of concentrated mutual funds. Some do well even in tough markets and have superb records over the long haul. Wells Fargo Large Company Growth Fund earns an overall A rating with 58% of assets in the top 10, as does Firsthand Technology Value, with a 55% concentration. Manager Scott W. Schoelzel of the popular Janus Twenty Fund (which, incidentally, has 34 stocks and two bonds) lost 32.4% last year. Still, the Janus Twenty's annualized five-year return is an impressive 26.2%, and its BusinessWeek risk-adjusted rating is a B+, the second highest. The fund has about 60% of its assets in its top 10 holdings. Schoelzel believes that holding more stocks is far more risky, since he can't know 100 companies as well as he knows 20. And then there are also some diversified gems. Michael Sandler, a 15-year veteran manager of the A-rated Clipper Fund, had the best performance among all large-cap value funds that we rank. Sandler invests in a handful of blue chips and piles 49% of the fund's assets into his top 10 picks. The fund has a low risk rating and 19.7% risk-adjusted return for the past decade. What could sideswipe the fund, says Sandler, who co-manages with Bruce Veaco, is a bear market; ''I can't say we'll be immune.'' John G. Davenport, fund manager for the $550 million Evergreen Capital Growth Fund, also earns an overall A. His fund concentrates 38% to 40% of assets in 10 of the 30 to 35 stocks in which he invests. Davenport argues that the fund is well diversified because his stocks represent most economic sectors. ''There's very little risk reduction that occurs from going from 30 to 100 names,'' he adds. Plus, he's not exposing investors to ''valuation risk'' by holding high p-e stocks and instead pegs his returns to big positions in the likes of Tyco International (TYC), Sysco (SYY), and First Data (FDC). Concentrated funds can be a cost-effective way to invest in a small basket of stocks. But investors should focus on who's running the show. By Mara Der Hovanesian in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Best Mutual Funds TABLE: The A List TABLE: The Best Performers in Their Categories TABLE: The Largest Funds TABLE: The Fund Categories Caution: Your Fund May Be Top-Heavy TABLE: Diversified Funds Lose on Big Bets Funds That Can Dodge Tax Bullets TABLE: Weighing Funds' Tax Baggage Commentary: No Excuse for High Fund Fees SCOREBOARD: Equity Funds: Mutual Fund Scoreboard (.pdf) Interactive Mutual Fund Scoreboard INTERACT E-Mail to Business Week Online

Copyright 2000-2009, by The McGraw-Hill Companies Inc. All rights reserved. Terms of Use   Privacy Notice