Five Trades to Upgrade Your Fund Portfolio

In the investing world, there's a huge difference between patience and inaction. A smart, patient investor chooses his investments wisely and then holds on for the long haul as long as the investment still has the key fundamentals that led him to buy it in the first place. Ideally he'll hold on until he reaches his investment goal.

An investor suffering by inaction might buy without a very good reason in the first place. Once he's bought it, he either pays scant attention to it or is unsure of what to do with new information. A better way, though, is to be open to chances to find something better.

If you own a lousy fund, it's a good idea to see if you can upgrade to something better provided you can do so without incurring a sizable tax bill or paying a big commission. You shouldn't react to every up and down in performance, but don't lose sight of long-term performance. If a fund's five- and 10-year numbers go in the tank, it might be time to bail.

I actually wrote a column like this in October 2001, and I was four for four. I suggested swapping  Grand Prix  for  T. Rowe Price Mid-Cap Growth (RPMGX). Grand Prix lost an annualized 16% over the trailing three years while the T. Rowe fund returned an annualized 10.14%. I also suggested swapping  AXP Mutual  for  American Funds American Balanced (ABALX). The AXP fund returned 2.76% annualized versus 7.86%. In the tech arena, I suggested swapping the gimmicky Amerindo Internet B2B for  PIMCO RCM Global Technology . Things got so bad for the Amerindo fund that it was merged away while the PIMCO fund returned 6.22% annualized—a figure that beat 95% of tech funds. Finally, I recommended dumping Invesco Blue Chip Growth in favor of  Harbor Capital Appreciation (HACAX). The Invesco fund is history, and the Harbor fund is off 0.68%, which is actually a touch above average for a large growth fund.

Here then are five upgrades featuring prominent funds.

Trade  Dreyfus A Bonds Plus  for  Harbor Bond (HABDX).
Dreyfus A Bonds Plus is typical of a lot of the mediocre bond funds out there. It won't blow up on you or do anything crazy, but over time a lot of small defeats leave it well behind the category's best. And starting the year with a 35 basis point (0.35%) expense handicap to Harbor manager Bill Gross can't make it any easier. Dreyfus made its name with money market and bond funds aimed at the retail investor. However, advanced analytical tools and a more enlightened approach favored by institutional managers such as Gross have swept across the bond-fund world over the past 10 or 15 years. Thus, just standing still leaves funds like Dreyfus A Bonds Plus further behind. If you think bond funds are a commodity, consider that a $10,000 investment 10 years ago in each of these funds would have produced more than $3,000 more in Harbor Bond than Dreyfus A Bonds Plus, and you could have done much worse than the Dreyfus Fund.

Trade  Putnam OTC Emerging Growth A for  Heritage Mid Cap Stock A .
I've been really pleased by the changes at Putnam, but Rome wasn't built in a day. In general, it takes years to fix an investment shop. So, consider Heritage Mid Cap Stock instead. Manager Todd McCallister has built a great record since taking the helm in 1997. He favors companies that dominate their market niche. The fund's not as aggressive as Putnam OTC, and it won't do as well in powerful growth stock rallies, but overall it has shown much more prowess at picking stocks. On top of that, it has a smaller asset base and a smaller expense ratio.

Trade  Federated High-Income Bond A (FHIIX)for  Eaton Vance Income Fund of Boston A (EVIBX).
Anytime you can cut 20 basis points off what you are paying for bonds, you've got to be happy. However, the main reason I chose this trade is that Eaton Vance has demonstrated a greater ability to handle whatever the market throws at it. The junk-bond market has some big peaks and valleys, and Eaton Vance has proved a nimble trader throughout. The fund rarely falls into the category's bottom half. It's been more hit or miss for the Federated fund.

Trade  Fidelity OTC (FOCPX)for  Fidelity Capital Appreciation (FDCAX).
Why the heck does Fidelity OTC have $7.5 billion in assets? It's not an awful fund, but I can't really find any strengths either. It has an odd mandate of sort of tracking the Nasdaq composite but making active bets against it, too. Fidelity uses this fund as a way station for promising managers who usually ship out to something bigger and better in a couple of years. Each manager change brings a strategy change with it. Some track the Nasdaq closely while others are willing to differ dramatically from it. So, this fund is really betwixt and between. If you want a good actively managed growth fund, try Fidelity Capital Appreciation, which is smaller and cheaper and boasts a much more experienced manager. Harry Lange has built a great record here and at other funds, and he's one of Fidelity's best. If you're looking for a pure bet on the Nasdaq, go with an ETF such as NASDAQ 100 Trust Shares (QQQ) and you'll save a ton on expenses. Fidelity estimates that Cap App will make a distribution of $1.61 on Dec. 6, so don't buy it for a taxable account until after that date.

Trade  Olstein Financial Alert C (OFALX)for  Selected American Shares D (SLADX).
Robert Olstein does a nice job of digging into companies' financials to find those with strong balance sheets generating strong cash flow. However, he doesn't have a monopoly on the idea, so why pay the fund's 2.21% expense ratio? You can find other funds that do similarly rigorous work for much less. The large cap Selected American charges less than one third of that with its 0.69% expense ratio. Or if you want mid-cap, go with Selected Special Shares  (SLSDX) for 0.96%. Either way, you're hiring some excellent researchers who love to dig into a company's financial statements to find companies that are truly undervalued. If you're investing through a broker, consider  American Funds Fundamental Investors A (ANCFX) as an alternative. Its managers and analysts do a bang up job for an expense ratio of just 0.66%. American and Selected are not expecting to make capital gains distributions for these funds this year.

Poll Results
Last week I asked which was your biggest mistake, and most of you said holding on too long.

14.9% - Buying a fund based on one-year performance.
18.7% - Letting a broker talk me into buying a bad fund.
7.5% - Not seeking the help of an advisor.
54.1% - Waiting to recover my original investment before selling.
4.8% - Beanie Babies: I thought their prices would always go up!