Brand-new mutual funds have been posting stratospheric returns lately. Should you hitch a ride on one of these rockets? Only as long as you understand the enormous risk you would be taking, says Money magazine.
Many of these dazzling debutants concentrate on two narrow overlapping market niches, says Money: small companies and aggressive growth."That's no accident. Those two sectors are hot right now, and success draws a crowd. Meanwhile, Wall Street has produced record volumes of initial public offerings, the favorite fuel of small-cap and aggressive-growth funds. The result has been a money launching-pad: The new funds buy hot little stocks, making them hotter, driving up the funds' returns, attracting more money to the funds, heating up their favorite stocks further - and drawing more IPOs to market."
If you want to take a flier on a hot new stock fund, follow these six rules, advises Money.
1. Stick with names you know. Some big fund families with strong track records, notably Fidelity, Janus and T. Rowe Price, seem to have particularly good luck with new funds. Their latest offerings often beat the averages by 10 percentage points or more in their first year. But the fund industry overall is full of fizzles. According to the fund raters at Morningstar, of the diversified U.S. stock funds introduced since the end of 1990, just 48 percent have beaten their older peers in their first year.
2. Stick with your overall strategy. You should never buy any fund just because it's new, says Money.
"You should first decide which category of fund you may need to add to your portfolio. Then weigh the alternatives."
3. Keep an eye on expenses. New funds tend to have higher expenses because of their smaller asset bases - but they shouldn't be too far out of line. If a new fund's expenses are 0.5 percentage points higher than those of its older competitors, advises Money, think twice; if it's one point or more higher, skip it entirely.
4. Keep your expectations realistic. If you think all new funds will skyrocket, "you shouldn't be in investing," says Money, "you should be in psychoanalysis."
5. Buy for the long run. Don't try to "flip" funds for a quick profit; it's a loser's game that only the Internal Revenue Service could love, says Money.
"What you gain in return you will give away in taxes. If you can't commit to owning a fund for five years or more, don't buy it."
6. Make sure you can take the heat. Research by professors Erik Sirri of Babson College and Peter Tufano of Harvard shows that the managers of fast-growing funds know that many new customers sign on if big risks pay off, while few sell if the risks end up losing money. Thus they can be tempted to go for broke. And if the market stumbles, new funds in high-flying categories like aggressive growth are likely to come crashing down.
(Money Magazine, Time/Life Building, Rockefeller Center, New York, NY 10020; 13 issues, $39.95.)