1Q FUND FOCUS: Risk A Murky Issue With Gangbuster Returns
This report was originally published Tuesday.
By Mara Der Hovanesian
NEW YORK (Dow Jones)--The better mutual fund investors do, the worse off they may be.
Mutual fund managers and other investment pundits worry that triple-digit returns are too much of a good thing. Investors may be loosing sight of risk-reward trade-offs.
"How can you convince someone who just made 200% on Amazon.com that they took a big risk?" asks Bryan Olson, director at Charles Schwab & Co. Inc.'s Center for Investment Research in San Francisco. With "theory and history out the window," Olson wonders, will investors consider that "it's worked over the last three years, will it work over the next three weeks?"
A lot of investing has turned into a lottery where you can "become a millionaire overnight, but you can just as likely loose it all," echoes Edward Von Der Linde, manager of the Lord Abbett & Co. Mid-Cap Value Fund. "Amassing wealth is about time and patience; we've lost that. We have no time and no patience."
Janus Twenty Portfolio Manager Scott Schoelzel says investors have traded prudent investing habits for a "myopic concern with short-term performance."
"You never know you have enough house insurance until your house burns down," Schoelzel says. "Risk for the normal investor is a hard concept for them to get their arms around. It's hard to understand until it happens to you."
Markets are irrational, says Gus Sauter, manager of the $82 billion Vanguard Index 500 Fund. "I feel a little bit like Chicken Little," he says. "(But) the market can get overdone. It does appear that some investors have kind of stepped back from a rational investing approach."
It's no wonder that an investor's risk-tolerance gauge is out of whack.
Consider the following vastly different results for a handful of Morningstar rated five-star funds. These large-cap growth funds, to differing degrees, have significant positions in the elite stocks running the market: Cisco Systems Inc. (CSCO), Microsoft Inc. (MSFT), Intel Corp. (INTC), Pfizer Inc. (PFE), MCI WorldCom Inc. (WCOM), Wal-Mart Stores Inc. (WMT), Philip Morris (MO), and Dell Computer Corp. (DELL).
An investor in the Clipper Fund - a five-star growth fund whose conservative managers tend to carry a lot of cash - has to be wondering, "was worth it?" Consider they lost 3.34% for the quarter in the fund, and gained only 7.56% for the trailing one-year period ending March 31, according to Lipper Inc.
The average growth fund gained 4.36% for the quarter and 13.58% for the trailing one-year period.
Another low-risk, five-star growth fund - the T. Rowe Price Blue Chip Growth Fund - gained only 3.86% in the first quarter and 17.39% in the last year.
Now, what if an investor decided to up the ante a bit and go for one of Morningstar's "higher-risk" five-star large-cap growth funds? They might have chosen the White Oak Growth Stock Fund, which turned in a 13.90% gain for the quarter, and 35.46% for the year. (The fund also lost 19% in third quarter of 1998, while the average fund in the category dropped 11%). Likewise, the higher-risk Alliance Premier Growth Fund, B Shares, gained 9.19% first quarter and 34.72% for the year. (The fund's sector and concentrated stock positions can work against it.)
Taking on a little bit more risk - among funds that invest in blue-chips, which was once considered a conservative strategy - seems to make big differences.
"In the past few years, investors have made a lot of money picking stocks that are ordinarily thought of as fairly conservative," says Gregg Wolper, international funds editor at Morningstar.
But investors who are feeling a bit bold by seven consecutive years of double-digit growth in these "conservative" large cap funds might now be tempted to get into something high-octane, say a sector or Internet fund, Wolper says.
And "a higher risk stock fund doesn't guarantee that you'll make a lot more money," he says.
Olson at Schwab's Center for Investment Research suggests that investors get back into the habit of calculating how much return is gained or sacrificed for a quantifiable amount of risk.
The most commonly used risk-adjusted return formula is the Sharpe Ratio, which uses standard deviation and U.S. Treasury Bill returns as an indicator of risk. Standard deviation formulas look at fund's monthly returns over time and calculate the variability from a norm or average return. Higher numbers mean higher volatility, which is associated with risk.
Beta measures volatility relative to a benchmark index, such as Standard & Poor's 500 Index. A Beta of 1 mirrors the index; a Beta of 1.5 means larger swings in either direction, for instance.
These measures have some drawbacks in that they look at past performance, which does not necessarily dictate what happens to the investment in the future.
"Any risk measure that's backward looking will tend to make some funds look more could safer than they might be," Wolper says.
Investors would be well-served to also consider a portfolio manager's tenure, the fund company's history and their investment time horizon when calculating risk.
"The point is not to avoid risk entirely, but to choose risk," Wolper says. "The right strategy is to identify which risks you can tolerate." |
