With more than 2,200 mutual funds on the market, how can an investor pick the right ones? Not, according to at least one industry analyst, by looking at their performance ratings.
Instead, Charles Trzcinka, an associate professor of finance at the University of Buffalo, recommends that investors start by comparing prices.Trzcinka recently completed a study of mutual fund fees for the Securities and Exchange Commission and found that in many cases the factoring in of mutual fund fees - particularly the seemingly small marketing fees known as 12b-1 fees - can change an above-average fund into one that is performing below average for others of its category.
The complete study will be released this summer. But Trzcinka's preliminary and general conclusion is this: "It's a real danger to look at returns first."
That's a somewhat shocking statement to investors who have been primed by the multitude of mutual fund rankings to look for those funds with the best returns. In fact, there's reason to believe that the rankings mania may have gone too far: One recently published survey of the best and worst performers in each mutual fund group for the first quarter of 1990 showed scant spreads between the two.
In small utility funds, for example, the worst-performing fund lost 4.8 percent in the first three months of the year; the best performer was down only 2 percent. Of what use are comparisons like these to investors?
Instead, Trzcinka says the mutual fund investor ought first to analyze his or her own investment needs and risk tolerances. Decide first, for example, whether you have the time frame and peace of mind to put a portion of your portfolio in a small-stock mutual fund, where the risks - and rewards - are high.
Once you've decided what type of funds you want to be in, look at the cost of those funds. Immediately discard the "load" funds - those with front-loaded or back-loaded sales charges.
Once you have a universe of "no-load" funds, find the ones that don't have 12b-1 charges, Trzcinka says. In the long run, the cheapest funds will give you the highest net return.
Finally, when you've narrowed your group by type and weeded it by price, then - and only then - should you check the rankings. Look for funds that are steady performers, not the tippy-top or the very bottom of the ratings lists.
Trzcinka's advice on finding funds comes as the fund industry begins to shift its own marketing gears. At the industry's annual convention in Washington this week, speaker after speaker talked of the difficulties they expect in attracting investors in the '90s.
The mutual fund business is coming out of a period when new and increasingly specialized funds were announced almost daily. Now it is turning to service and packaging to bring in new investment dollars. Investment companies are reaching the point where their new funds are simply pulling dollars away from their old funds, and their cost of attracting investment dollars is rising.
"Almost every conceivable need has already been met, and the law of diminished return will take over," said John Bogle, chairman and chief executive officer of the Vanguard Group. Instead of new products, mutual funds will respond with more programs, he said.
These programs already are in evidence, particularly in areas of retirement management and college savings. Instead of selling the extra percentage point or two in returns, funds will go further to provide shareholder services, Bogle said.
Those services include lower fees, higher liquidity and more information - reliable information about the funds themselves, clearer shareholder statements, and more information in the form of retirement and education planning kits.
If Bogle's predictions come true, and mutual fund companies react to increased competitive pressures by laying off gimmicks and laying on consumer value, according to Trzcinka, it will make fund selection all the easier.