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February's Mutual Fund Red Flags

These funds are gambling on casino stocks.

Paul Herbert, 03/11/2008

Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.

This article originally appeared in Morningstar FundInvestor, an award-winning newsletter that presents investment strategies and tracks 500 funds.

Betting on the house can be a good strategy, but it isn't foolproof. Stocks falling into Morningstar's "Gambling/Hotel Casinos" industry have been big losers lately. On a market-cap-weighted basis, the group has fallen 14% in the three months through Feb. 1, 2008. Some of the industry's biggest players, such as Las Vegas Sands LVS and MGM Mirage MGM, recently reported earnings weakness, owing to poor performance in some of their big properties, such as Sands and the Venetian, a Las Vegas Sands property, and the Bellagio, an MGM casino. Las Vegas Sands blamed something called "poor table win" for its disappointing results. (Basically, that means that gamblers weren't losing enough.)

These may be temporary concerns, but there are also other longer-term worries. A big part of the successes of these firms, particularly the big guys mentioned above and Wynn Resorts WYNN, has been expansion into Macau. The Chinese government-issued monopoly on gambling ended there in 2002, and global firms rushed in and built casinos. Competition has heated up, though, and profits may be harder to come by. Plus, weakening U.S. consumer spending may eat into these firms' U.S. businesses.

With these ideas in mind, we took a look at mutual funds in the 500 that have put a lot of chips down on these names.

Baron Partners BPTRX
This fund was having a really strong year in 2007, right up until early November when its gaming holdings started reporting sour results. The fund owns both Las Vegas Sands and Wynn and also counts Boyd Gaming BYD in its top holdings. Add in its stake in Penn National Gaming PENN, which will be taken private in 2008, and the fund has nearly 20% of its assets in companies in this industry. Manager Ron Baron likes to focus his bets on his best ideas, after spending a lot of time evaluating their managements and brands. He also holds on for the long term, so we don't expect him to dump the shares soon. (Baron Capital Management is one of the bigger institutional owners of gaming stocks, too, and it peppers the portfolios of funds such as Asset BARAX, Fifth Avenue Growth BFTHX, and Growth BGRFX). Still, the fund's 10% drop in the past three months shows it's quite dependent on the fortunes of these stocks now.

Marsico Focus MFOCX
Only 29 stocks made the cut for this concentrated mutual fund's portfolio, but Las Vegas Sands, MGM Mirage, and Wynn are three of them. Together, they account for 11.5% of the $5 billion fund's assets. Like Baron, Marsico Capital Management owns these stocks in several of its mutual funds (including 21st Century MXXIX and Growth MGRIX, as well as USAA Aggressive Growth USAUX and Harbor International Growth HAIGX, two funds that it subadvises), and the firm still seems to be very bullish on them. Cory Gilchrist, manager of 21st Century, says that the firm likes their business models and the opportunities in Asia. These mutual funds don't depend on the gamers as much as the Baron offerings do, but they are still rather significant holdings.

Thornburg Value TVAFX, Van Kampen Pace ACPAX, and Chesapeake Core Growth CHCGX
Baron and Marsico have the largest positions in these stocks in the 500 by far, but a few other funds have stakes in them. Each of the fund's listed above has taken a stake of at least 3% of assets in Las Vegas Sands or Wynn. One stock's performance probably won't make or break any of these funds. It's worth keeping in mind that they have benefited from rises in these stocks in recent years and could get nicked if they were to continue to slump.

Paul Herbert, CFA, is a senior fund analyst with Morningstar.

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