Four Funds That Deserve the Heave Ho
When should you bail out on your fund?
Fund Spy
One thing mutual fund investing has in common with stock investing is that selling is much more difficult than buying. Investors often make the mistake of overreacting and hastily selling on a little bad news. Alternatively, investors can also suffer from a paralysis that prevents them from selling a money-losing investment because of their reluctance to admit they made a mistake--as well as a desire to recover the dollar amount of their original investment.
Nevertheless, making the decision whether to sell an investment is a lot easier if you’ve written down why you bought it in the first place and what role it’s playing in your portfolio. Putting your investment strategy in writing helps you stay committed to a disciplined investment plan and on track for achieving your financial goals.
With mutual funds, I’d suggest starting your decision-making process anywhere but year-to-date performance. You might begin by examining the expense ratio to see if it has changed. If it has gone above 1.25% in a stock fund or 0.80% in a bond fund, then you should hold the fund to an extremely high standard. If it isn’t one of the very best funds in its class, throw it back.
Next, look at the fund’s portfolio to see if it is still accomplishing what you bought it to do. Say you own a fund for its small-cap exposure, and it’s your only small-cap fund. If it moves most of its assets to mid caps, you should consider selling or adding a true small-cap fund so that you won’t lose that exposure.
Finally, go ahead and look at returns. If the fund's relative performance for the trailing three- or five-year period is in the bottom quartile of its category, take a long hard look at why that has happened. If you’re confident the reason is that the fund follows a strategy that is out of favor, then it might be worth holding. For example, Clipper Fund (CFIMX)looked sluggish for the trailing three years at the end of 1999 because it's a deep-value player that focuses on absolute returns. In this instance, it was simply out of favor. However, you should be darn sure that market trends, not more serious investment-specific risks, account for such a low ranking.
With this in mind, I’ll help you along the way with four funds you ought to get rid of now. These are funds we recently added to our pans list.
This is an example of a fund that might not be fulfilling the mission shareholders thought it would when they bought it. Its strategy is to buy merger targets in order to gain a nice return when the target is acquired. Over time, the fund has served as a good diversification pick by delivering returns that aren’t in sync with the markets. When the bear market slowed mergers to a crawl, management shut the fund’s doors because it couldn’t find many opportunities. The fund's cash stake currently stands at about 75% of assets, though; as a result, it looks suspiciously like a money market fund with little upside potential. If the fund had remained closed, I’d cut it slack. After all, it doesn’t control the M&A market. However, the fund is reopening to new investment despite its huge cash hoard and that means current shareholders will see their investments further diluted. The last thing this fund needs is more cash.
Phoenix-Engemann Balanced Return A
This fund’s expenses are on the rise, and it’s tough to justify why investors should stick with it. Shrinking assets led expenses to rise from 1.30% in 2001 to 1.50% in 2003. Considering that roughly half the fund is invested in Treasuries, which require almost no research, that’s a huge price to pay. To be sure, the stock half of the portfolio has a large-growth bias, which has been decidedly out of favor, but even last year returns were unimpressive. I don’t see any reason why large growth should lag over the next five years, but you’d be much better off creating your own mix with a moderately priced large-growth fund and a dirt-cheap Treasury fund.
Here’s a clear example of how poor performance and high expenses can feed off each other. High expenses make it hard to produce good performance, and poor performance leads to shrinking assets--and that keeps expenses steep. No fund is worth this fund’s 2.37% expense ratio. Performance has been consistently weak, though the lowlight was management’s 20% bet on developed-market stocks that backfired when emerging markets rallied.
This fund really fails the performance test. It’s working on its fifth straight year of underperformance. The big worry, however, is the cloud that continues to hang over Strong Funds. Nearly all the big firms that were implicated in the fund scandal have come in from the cold. They’ve instituted reforms and cleared out some or all of the people who crossed the ethical line. But not Strong. They’re still in the bunker. The company is not saying much except that it's up for sale. So you’ve got an added layer of uncertainty. Who needs the grief?
Poll Results
Last week, I asked you which undiscovered value fund held the most appeal and 45% of you chose Vanguard U.S. Value, 25% chose Sound Shore, 15% picked C&B Mid Cap Value, and 14% opted for American Century Capital Value Inv.