Pick Funds For Distance, Not Speed Flashy Sprinters May Have Lagged In Past Years

Now and then, mutual funds have years that are simply breathtaking. Such was the case in 1995, when some diversified United States stock funds produced gains in the high double digits.

Given those astonishing figures, investors might be tempted to throw money at last year’s winners. After all, so many funds failed to keep up with the benchmark of the Standard & Poor’s 500 index that the ones that did sure stand out.

But keeping a clear focus on the long-term nature of investing is important to avoid being blinded by eye-popping short-term returns. As they say on Wall Street, hot stock markets can make many money managers look like geniuses. And one outstanding year may camouflage longer-term records that are less than stellar.

To help sort out the Johnny-come-lately funds from those that have provided steady returns over time, the Chicago research firm Morningstar Inc. ranked all stock funds that had been around at least five years by their 1995 returns.

The specialty funds were weeded out, leaving diversified domestic funds. Of those, eight funds gained more than 40 percent last year, well ahead of the 37.5 percent total return for the S&P 500, but had an average annualized return that lagged behind the 16.6 percent average gain of the S&P over the last five years.

At the top of the list was the Bruce Fund, a growth fund that rose 64.8 percent last year, nearly double the gain of the S&P 500. Investors who do a little digging, though, will find that the fund’s average annual five-year return is just 13.1 percent, trailing the S&P by 3.5 percentage points.

Not surprisingly, the fund remains very small, with less than $3 million under management. “Our record speaks for itself,” said Robert Bruce, who has managed the fund since its 1982 inception. “If we had been successful, our fund would be larger.”

As for last year’s startling return, it can be explained by the impact of falling interest rates on the fund’s holdings of long-term zero-coupon bonds.

Don’t count on a repeat. “We can’t seem to put two years together,” Bruce said candidly.

Unlike Bruce, some fund managers say that their lagging long-term performance is irrelevant because their funds have changed hands recently.

James Grefenstette, for instance, took over Federated Growth Strategies in December 1994 and said he had changed the fund’s focus. The fund tripled its holdings to 90 stocks, limited bets on a specific sector of stocks to no more that twice the sector’s weighting in the S&P 500. It also eliminated the 25 percent allocation to what was the nebulous and volatile group labeled special situations, including companies subject to takeovers, legal settlements or other actions that would add value.

Shifting to bigger stocks, Grefenstette put much of the fund’s money into health care and finance stocks, last year’s winners.

Randall Haase took the opposite tack when he began co-managing Alliance Quasar with Alden Stewart in the spring of 1994. The pair shrank the fund to 70 stocks from 120 as they put in place an “eclectic, contrarian growth approach,” Haase said.

Are these changes sufficient to let investors ignore the funds’ five-year records and concentrate on last year’s barn burner? Probably not. One year is a very short time to judge whether excellent performance is created by skill or by luck.

Investors who are intrigued by a fund’s outstanding performance under a new manager might want to check the earlier record, if there is one.

Investors will do well in these heady times to remember the discipline of deliberate, thoughtful investing. One of its lessons: Never rush headlong into a fund that tops the performance charts in a single year. That may be its only good year for a while.