‘Niche’ Companies Spreading Into New--and Unknown--Investments

Imagine Subaru coming out with a luxury car or Jaguar unveiling a minivan. That’s akin to what’s been happening in the mutual fund business lately as “niche” companies introduce portfolios outside their traditional areas of expertise.

It’s all part of an effort by fund families to broaden their product lines and hold onto market share. “We were tired of sending people to Vanguard or T. Rowe Price for the equity portion of their portfolios,” says James Benham of Benham Capital Management in Palo Alto, explaining why his company recently added two stock funds to its lineup of bond and precious-metals products.

Investors, however, must grapple with the question of whether it is wise to purchase a brand-new fund, especially in a realm where the firm has had little experience. This predicament is similar to buying a car in its first year of production and hoping the manufacturer has gotten all the bugs out.

There are no simple answers although fund watchers suggest that you look for some overlap in expertise. “In Benham’s case, it seems like a big jump going from bonds to stocks,” says Don Phillips, editor of Mutual Fund Values in Chicago. “But there’s a natural link in quantitative analysis.”

The company’s two new stock funds, dubbed the Equity Growth and Income & Growth portfolios, make heavy use of computer analysis to find promising investments. From a universe of 2,000 of the largest stocks, the computer selects about 100 securities meeting certain criteria, such as those showing high cash flow, high return on equity and low price-to-book value. “It’s pretty much all numbers-crunching,” says Steve Colton, the portfolio manager who adds that Benham follows a similar method to choose bonds for its fixed-income funds.

Actually, Benham’s case is a bit unusual. Most fund companies of any size have had both stock and bond exposure for years. Instead, the big product gap that many families have been racing to fill is in the foreign area. Five years ago, Lipper Analytical Services counted just 48 global and international stock and bond funds; now there are about 220.

The fund companies and, of course, investors are responding to what experts have been saying for years: Foreign securities not only offer the potential for superior gains but actually cut overall volatility when held in combination with U.S. stocks and bonds. In fact, holding two international funds instead of one can cut your risk by another 34%, figures Jeff Madura, a finance professor at Florida Atlantic University in Boca Raton.

However, running an international fund isn’t a simple extension of managing a U.S. stock or bond portfolio. That’s why Bob Brinker, an investment newsletter writer in Princeton, N.J., is taking a wait-and-see attitude on the first international stock funds unveiled by two of his favorite families, Twentieth Century Investors of Kansas City and the Janus Group in Denver. “This is a totally separate area,” he says. “I’d like to see both companies prove themselves first.”

Brinker plans to monitor results of the two new products for at least a year or two before making a recommendation. In the meantime, he’s content to steer investors toward more established international funds offered by Vanguard and T. Rowe Price.

Phillips also expresses caution about Janus Worldwide and Twentieth Century International; he likes to see a track record on any new fund stretching back at least three years.

However, there is less cause for concern when a fund company with relatively little experience in a particular area hires a seasoned money management firm as sub-adviser. Before Boston-based Pioneer unveiled its first European stock fund earlier this year, it linked up with management teams in Britain, France, Holland, Germany, Italy and Spain to monitor markets and buy securities in those countries. Pioneer hopes the local expertise its partners bring to the table will more than offset the slightly higher management fees involved.

Another way a fund company can cut time off the learning curve is by coming out with an index fund. These are essentially unmanaged portfolios that buy the same stocks or bonds in a popular market indicator, such as the Standard & Poor’s 500. “There’s nothing to it,” says Brinker of the management skill required.

Critics point out that investors in index portfolios can never hope to beat their market--just match it. Besides, the funds, which remain more or less fully invested at all times, will fall as hard as the index during a prolonged bear market.

However, Brinker and other proponents point out that many index products have tended to rank among the best performers in their groups, simply because so many money managers have trouble beating a yardstick like the S&P; 500. Companies specializing in index funds include Vanguard, Boston-based Colonial Mutual Funds and the Rushmore Group of Bethesda, Md.

Although families such as Benham, Janus, Twentieth Century and Pioneer have been busy filling product holes in their lineups, many other companies are still a step or two behind. Expect to see even more funds coming out, as firms scramble to add the choices that will help keep investors happy.

For individuals, one-stop shopping can be convenient, but there is the potential drawback of mediocre results. In Phillips’ view, several groups are feeling pressure to emulate giant Fidelity Investments, which has more than 120 portfolios, rather than duplicate the success of companies that run only one fund, such as the managers of the Sequoia or Acorn funds. “Not too many fund managers want to do only one thing,” he says, “even if they do that one thing very well.”

The ‘Finest’ Annuity For mutual fund investors, there’s another new product worth considering, says Bob Brinker, a money manager and newsletter editor in Princeton, N.J. It’s the Vanguard Variable Annuity Plan, which came out in May. “I believe this is the finest annuity program available in the United States,” says Brinker.

The reason: “rock-bottom” annual costs that total about 1% a year, Brinker says, compared to 2.25% for other annuities. Plus, there are no “surrender” charges on Vanguard’s product; most competitors impose these withdrawal fees, which can total as high as 8% or so before gradually phasing out.

With the Vanguard annuity ($5,000 minimum, 800-662-7447), you can invest in any of four types of mutual funds: money market, bonds, balanced and blue chip stocks. Brinker favors the last category.

The big advantage of annuities is the ability to defer taxes on large sums until you withdraw money, presumably upon retirement. You can typically sock away more cash than in an IRA, 401(k) or other retirement plan. However, your annuity contributions are not tax-deductible. That’s why Brinker suggests you first invest in plans on which you can get a write-off. “Then, if you still want additional tax-deferred growth, go with the Vanguard annuity,” he says.