Market is giving fund investors a chance to upgrade portfolios

Mar.22, 2008 in Market Outlook

No time like the present

By Chuck Jaffe, MarketWatch

Last Update: 3:37 PM ET Mar 22, 2008

BOSTON (MarketWatch) — When the stock market goes through a crisis in confidence
so do ordinary investors. It’s hard to have much faith in a financial plan when
all of the news is bad. The standard advice is “Hang on, for dear life,” which is
the hardest advice to follow at a time when your investment mettle is being
tested.

While trading in and out of funds is frequently a recipe for disaster, there are
moves that investors can make to improve their confidence and portfolio without
blowing up the long-term returns that they supposedly surrender by giving up on a
fund.

To see why that is, consider that the standard advice warns against riding trends
or timing the market, because it’s hard to use those strategies to improve
returns consistently over the long haul. The evidence supporting the idea that
investors are supposed to stay put in funds during downturns is a long-running
study from Dalbar Financial Services, which shows that the Standard & Poor’s 500
had an annualized average gain of 11.8% over the last two decades, but the
typical equity fund investor was able to capture just 4.3% annually.

But if you talk to the guys who study behavioral finance — the way investors act
– they are not opposed to small moves to boost confidence. They’ll warn of the
dangers of portfolio overhauls, where an investor claims to make faith-inspiring
moves, but is really just tilting a portfolio in the direction of what has been
hot lately.

The changes to consider in times like these are more about upgrading a portfolio
than overhauling it.

Dr. Richard Geist, president of the Institute on the Psychology of Investing,
said in a radio interview this week that investors should use nervous times as an
opportunity to build their ideal portfolio, to make the list of stocks or funds
they would want to buy if they could get a reasonable price. They then want to
compare that dream portfolio to what they have today, consider dumping any
investments they would not buy again today and see if they can improve their
holdings on the cheap.

That’s great for stock investors, who can look at companies they would want to
hold for a lifetime, see if a beating in stock price reflects any substantial
change in the intrinsic value of the business and decide if they are getting a
bargain. It’s a lot tougher in mutual funds, where each security represents an
entire portfolio of stocks, and a price beat-down holds no real clue as to
whether you are buying assets on the cheap.

One thing the recent bearish conditions have brought out, however, is a lot of
funds with great long-term track records reopening to new investors. Dodge & Cox
Stock (DODGX), Dodge & Cox Balanced (DODBX), Royce Opportunity (RYPNX), Longleaf
Partners (LLPFX), First Eagle Global (SGENX), Third Avenue International Value
(TAVIX), Tweedy Browne Global Value (TBGVX), Wasatch Core Growth (WGROX) and
Small Cap Growth (WAAEX) are some of the best names on a long list of funds that
have started taking new cash from investors.

Those are the kinds of names that might have come up during an investor’s
research, the kind of names that have delivered solid and consistent long-term
performance, but that were not available during better times. Today, they are
available for an upgrade.

“If you can build a better portfolio today — if you’re not happy with a fund you
own and can now buy something you believe is better — you’d be foolish not to
try,” says Leonard Goodall, editor of the No-Load Fund Portfolios newsletter.
“You need to worry about taxes, and about sticking with your asset-allocation
plan, but if you could look at your portfolio tomorrow and say ‘This is better
than what I have today,’ that’s certainly good for you.”

Even Lou Harvey, president of Dalbar, acknowledges that investors may be able to
make a change without becoming the statistic, the guy who gets that lousy return
because they made a jump.

What the Dalbar study — and the latest annual results are due out in a few weeks
– fails to account for is where investors put their money next. An investor may
bail out of a fund at the “wrong time” — defined as just before the fund takes
off — but that makes it the “right time” to buy the better fund in the same
asset class, capturing the rising tide that lifts the entire category.

“It’s OK to switch from a fund that you think has lower prospects of return to
one with higher prospects of return,” says Harvey. “But what you are really
betting on is the rate of recovery. You are saying ‘Here are funds in the same
category, which one do I think will recover the best and fastest from this
downturn.’ You’re keeping your asset allocation — which is the key to getting
the long-term performance you expect — but in funds that give you more
confidence than the ones you own today.”

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