Investors May Regret Ditching Mutual Funds

Investors who fled stock mutual funds last year have full reason to regret it: Final results for 1988 show that equity funds posted an above-average year, beating their more conservative bond and income fund counterparts.

General equity funds posted an average 14.47% return in 1988, beating their compound average annual growth rate of 13.48% over the past 15 years, according to Lipper Analytical Services, a Summit, N.J., firm that tracks fund performance.

That gain came in a year when investors pulled out about $5 billion more from equity funds than they put in, according to statistics through November. Last year is expected to be the first since 1979 that equity funds suffered a net sales outflow.

“In ‘88, investors were fighting ‘87’s battles,” said A. Michael Lipper, contending that investors were overly conservative last year, a result of lingering nightmares of the stock market crash and fears that the market would tumble further in 1988.

However, not all the news for stock funds was good. Both for the full year and fourth quarter, equity funds on average were unable to beat the major stock indexes such as the Standard & Poor’s 500, which gained 16.55% for the year with dividends reinvested.

Such under-performance occurred partly because many funds had high proportions of their portfolios in cash--the result of their own somewhat conservative market outlooks, Lipper said. Also, the year’s record takeover activity was concentrated in blue chip stocks, boosting disproportionately such blue chip-laden indexes as the S&P; 500 and the Dow Jones industrial average, he said.

The top-performing group for the year included funds investing in small-company growth stocks, posting an 18.99% gain. That was a significant recovery from the year before, when they were the worst-performing group among general equity funds.

All but five stock and bond fund groups posted double-digit gains, and only one, gold funds, posted a loss. These funds, which invest in stocks of gold mining firms and in the metal itself, plummeted 14.54% for the year after posting the best returns among all groups in 1987 with a 35.66% average gain.

Bond and income funds--the type that invest predominantly in bonds and other fixed-income securities--posted a respectable year. The largest group, fixed-income funds, gained 7.91% for the year and 0.90% for the fourth quarter.

For the fourth quarter, however, stock funds posted more modest gains. General equity funds posted a 1.42% advance. International funds, which invest in foreign stocks, were the top performers in the October-December period. Aided by the falling dollar, which increased the value of overseas securities, international funds rose 9.37%. They dominated the list of top-performing funds for the quarter, taking all of the top 10 spots.

Japanese Funds Ahead

Funds investing in the rip-roaring Japanese stock market--which posted record highs during the quarter, gaining about 8%--were among the biggest winners in the quarter. Among those Japanese-oriented funds was Merrill Lynch Pacific, the period’s top performer with a 18.22% gain. Its portfolio was more than 80% invested in Japanese equities, including four property-casualty insurance companies that posted above-market returns, said Norman Harvey, senior vice president for Merrill Lynch Asset Management, which oversees the fund. The fund also wasn’t hurt by a 7% gain in the yen versus the dollar, he noted.

But analysts said investors should be cautious about jumping headlong into international funds for short-term gains, because the dollar’s fall could reverse. Also, the biggest winners in one year or quarter--because they tend to take the biggest risks--often end up being the losers in the next quarter or year.

“You’re probably better off looking for funds with good long-term records which haven’t been at the top recently but are under-performing a bit,” said Joe Mansueto, president of Morningstar Inc., a Chicago firm that tracks fund performance. Among such attractive funds, he suggested Evergreen Total Return, GIT Equity-Special Growth, Nicholas II, SoGen International and Strong Total Return.

The volatility of top-performing funds was illustrated by the Kaufmann Fund, a small-company growth fund that was the year’s top performer with a 58.57% return. But in the fourth quarter, it was the third-worst-performing fund, with a 8.26% loss. (It was among the worst performers in 1987 as well.)

Kaufmann portfolio manager Lawrence Auriana attributed the poor quarter to a correction in a number of stocks that had done well earlier in the year. But the fact that the fund only invests in about 26 stocks also adds to its risk and volatility, analysts said.

Good Year for Ethics

Significant inclusions among the year’s top 10 performers were two growth-stock funds that use ethical criteria for their investments. One, Parnassus Fund, which was up 42.44%, invests only in firms with “enlightened and progressive management,” measured by such factors as sensitivity to communities they operate in and treatment of employees.

The other, Calvert Ariel Growth, up 39.97% for the year, avoids firms involved in defense and nuclear power, and those with plants or people in South Africa, according to portfolio manager John W. Rogers Jr.

None of the 10 largest stock funds, as measured by asset size, made the year’s top 10 performance list. But seven of the 10 beat the S&P; 500. They included Fidelity Magellan (up 22.76%), Windsor (28.70%), Fidelity Puritan (18.89%), Fidelity Equity Income (22.49%), Templeton World (19.69%), Pioneer II (21.63%) and Washington Mutual Investors (17.66%).

The top-performing bond or income fund was Convertible Securities and Income, with a gain of 36.24%. Convertible securities generally performed well during the year because their prices moved up with rises in common stocks and they paid generous dividends.

Closed-end funds--those whose shares are fixed in number and trade on stock exchanges--enjoyed a sales boom in 1988. Share prices of the 20 largest diversified equity closed-end funds rose 16% in 1988, according to Thomas J. Herzfeld, a closed-end fund expert in Miami.

The biggest loser for the year was American Asset Yield, a fund investing in both stocks and bonds with a 54.55% decline, which management has attributed to its small size and high expenses. Lipper Analytical listed the fund as the top performer for the quarter, but that was largely because the fund included in its return monies reimbursed to shareholders that had been previously taken in as expenses. Since that should be considered a return of investors’ own money--not gains from investing--The Times removed the fund from the top 10 list for the quarter. (And without that reimbursement of expenses, the fund’s 1988 performance would be worse than that reported.)

What is the outlook for 1989? Experts disagree on the direction of stocks for this year. But long term, investors should continue to keep some portion of their portfolio in stock funds, most experts agree.

“On a longer-term basis, equities will produce a better result than fixed-income securities,” Lipper said.

MUTUAL FUND PERFORMANCE (Appreciation plus reinvested income and capital gains) QUARTER ENDED Dec. 31, 1988 Top Performers Merrill Lynch Pacific+18.22% GAM International+15.44 Harbor International+15.43 DFA Group: Continental Small Co+14.84 DFA Group: Japan Small Co+14.11 Colonial Intl Equity Index+14.00 Alliance Canadian Fund+13.67 Alliance International+13.58 US Boston: Bstn Fgn Gro & Inc+13.24 Keystone International+13.09 S&P; 500 (dividends reinvested)+3.06 All funds average+1.73 Worst Performers Schield Port: Aggressive Growth-9.83% Wasatch Aggressive Equity-8.29 Kaufmann Fund-8.26 FPA Capital-6.88 Steadman Oceanographic-6.46 Strategic Silver-6.31 Fidelity Select Electronics-6.29 Steadman Investment-6.15 Rochester Covertible Income-5.61 Fidelity Select Financial-5.58 YEAR ENDED Dec. 31, 1988 Top Performers Kaufmann Fund+58.57% Integrated Equity: Aggr Gro+48.45 Parnassus Fund+42.44 Columbia Special+41.20 Calvert Ariel Growth+39.97 Gabelli Growth+39.10 Fidelity Select Retail+38.71 Fidelity Select Transportation+38.45 Harbor International+37.71 Fidelity Capital Appreciation+37.62 S&P; 500 (dividends reinvested)+16.55 All funds average+11.66 Worst Performers American Asset Yield-54.55% Strategic Investments-43.00 United Services Gold Shares-35.74 Steadman Oceanographic-25.85 Fidelity Select Precious Metals-23.86 International Investors-22.11 Van Eck Gold/Resources-21.33 Shearson Lehman Precious Metals-21.32 Financial Portfolio: Gold-20.00 Midas Gold Shares & Bullion-18.99 FIVE YEARS ENDED Dec. 31, 1988 Top Performers New England Zenith Cap Gro+354.29% Merrill Lynch Pacific+279.23 Japan Fund+266.54 Trustees’ Commingled Intl+208.84 Vanguard World--Intl Growth+205.48 BB&K; International+202.18 Alliance International+183.59 T. Rowe Price International+180.93 Prudential-Bache Utility+174.36 Putnam International Equities+170.66 S&P; 500 (dividends reinvested)+103.92 All funds average+68.66 Worst Performers 44 Wall Street-78.93% American Heritage Fund-60.25 Strategic Investments-58.06 Steadman Oceanographic-54.01 Dividend/Growth: Laser & Tech-52.06 Steadman American Industry-40.40 United Services Gold Shares-39.91 Strategic Gold/Minerals-39.53 First Investors Discovery-37.49 Nautilus Fund-32.84 GROUP PERFORMANCE (periods ended Dec. 31, 1988)

Quarter Year Five Year International Funds +9.37% +16.57% +175.61% Global Funds +6.15 +13.44 +108.26 World Income Funds +4.89 +4.90 +124.57 Natural Resources Funds +2.87 +12.10 +52.39 Utility Funds +2.22 +15.44 +118.41 Equity Income Funds +2.18 +13.13 +84.13 Growth & Income Funds +1.88 +15.07 +82.91 Balanced Funds +1.74 +11.22 +84.67 Option Income Funds +1.72 +14.74 +58.75 Income Funds +1.70 +12.17 +69.40 Growth Funds +1.36 +14.03 +63.11 Convertible Securities Funds +1.33 +13.27 +61.73 Capital Appreciation Funds +1.29 +12.97 +51.67 Fixed Income Funds +0.90 +7.91 +66.90 Specialty Funds +0.87 +16.68 +84.90 Science & Technology Funds +0.86% +9.23% +30.52% Gold Oriented Funds +0.78 -14.54 +1.20 Option Growth Funds +0.63 +1.08 +65.17 Small Company Growth Funds +0.00 +18.99 +47.06 Health/Biotechnology Funds -0.85 +11.05 +79.27 S&P; 500 (dividends reinvested) +3.06 +16.55 +103.92 All funds average +1.73 +11.66 +68.66

Source: Lipper Analytical Services