Don’t Sell Fund Because Of Slow Quarter

The mutual fund industry’s third-quarter results are in, and you’ve had time to compare your stock funds’ performance to other funds.

Now what do you do if you own a fund that is clearly a laggard this year?

Especially in this kind of roaring bull market - with such a strong media focus on funds that are racking up gains of 40 percent, 50 percent or more - it’s common for fund owners who are doing relatively less well to feel slighted, and perhaps itchy to sell their laggard and buy something “better.”

Which strikes John Markese, executive director of the 170,000-member American Association of Individual Investors in Chicago, as bordering on dangerous gluttony.

“I’ve heard people say, ‘My portfolio is doing lousy - I’m only up 20 percent or 30 percent this year.’ I’ve never heard that before in my life,” Markese says. For those kinds of returns, “people should be kissing the ground,” he says.

There is definitely a time to divorce a laggard fund, Markese and other pros say, but you don’t do so simply because the fund isn’t the year’s biggest gainer, or because it fails to beat a well-known industry proxy like the giant Fidelity Magellan fund, which was up 38.9 percent through the third quarter ended Sept. 30.

How do you decide if your fund is truly a laggard - and whether you should dump it?

Start with these questions:

What, exactly, is your fund lagging against? Be sure you’re making an apples-to-apples comparison of your fund and market or fund-industry indexes. If your fund invests in smaller stocks, for example, it isn’t fair to compare it to market indexes such as the Standard & Poor’s 500, which is a big-stock index.

The S&P gained 29.8 percent through Sept. 30. But the Russell 2,000 index, a widely watched small-stock index, was up 25.7 percent.

Is the problem in the fund or in its sector? Some of the weakest funds this year, relatively speaking, have been “small-cap value” funds, which invest in smaller, more conservative stocks rather than go-go growth issues such as technology stocks.

If you specifically bought a fund to invest in small-cap value stocks - because you wanted to have an element of that investment style in your portfolio - it doesn’t make sense to jettison the fund because that sector is lagging. Market sectors come in and out of favor over time, and while small-cap value is lagging now, it is most likely to shine once investors begin tiring of chasing hot growth stocks.

Did you buy the fund for consistent high performance - or as a hedge against trouble? Gold- and real estate-oriented stock funds have been lousy performers this year. But if you own such funds as a hedge - meaning that you expect them to perform better if the stock market overall takes a spill - there may be no reason to kick them out of your portfolio.

Now, let’s say you get past those basic questions and you’re still faced with the cold reality that your fund is lagging in its category. Is your manager simply incompetent? A lousy stock picker in a good market?

Sometimes, management’s long-term record suggests sticking with the horse you’re on.

Other laggard funds, however, may indeed deserve to be sold. Most fund pros concede that if your fund has lagged within its category or sector not just this year, but for the past two years as well, you should consider pulling the plug.

“I think three years is plenty” of time in which to judge a fund, says the AAII’s Markese. Many fund shareholders want to believe that a consistent laggard will come roaring back some day, but that day may never come, Markese notes.

Robert Markman of Markman Capital Management in Minneapolis says the “golden question” for fund investors who are mulling what to do with a laggard is this: “If you didn’t own the fund, what would you do?” Would you buy it fresh today? Or are there other funds in the same sector, or in a different sector, that would attract your dollars first?

By asking that question of every fund in your portfolio, Markman says, you will be focused on the future, which is where investors should always be looking.