Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN Tuesday - A four-year Look Back

Tuesday, August 3, 2005

A. I guess another way of looking at that is to say that the market (ifmeasured by the S&P) has gone nowhere net in that time.

Q. Right. But of course, there are many other measures, so some parts ofthe market have done much better or worse.

A. Exactly. NASDAQ for example is still down 55% from its March 2000 top.We took a look at the Lipper Indices over these last four years, from theend of July 2001 to the end of last week, and the spread of the numbers isvery large.

Type of Fund	Total Return in %
BEST 6 EQUITY FUND TYPES
Gold	+151.2%
Emerging Markets	+120.5
Real Estate	+119.0
Natural Resources	+ 97.6
Internat. Small-Cap	+ 87.2
Small-Cap Value	+ 74.0
WORST 6 EQUITY FUND TYPES
Science & Technology	-15.5%
Large-Cap Growth	- 3.5
Multi-Cap Growth	+ 1.9
Large-Cap Core	+ 4.7
Mid-Cap Growth	+10.1
Japan Funds	+15.2

Q. So you are saying that only two types of funds, on average, actuallylost money in those four years?

A. Right -- after expenses, technology and large-cap growth -- which ofcourse were the darlings in 1999 and early 2000.

Q. Averages are one thing, but how about individual funds, Don?

A. Well, again, the results might seem pretty surprising, on the favorableside. In those four years, out of more than 3,200 equity funds 2,714 or 84%show positive returns, while only 509 funds (11%) show overall losses. Andremember, funds' returns are after expenses, and the popular marketaverages do not have any expenses dragging them. The funds, of course, mayhave some dividend income, which is ignored when people quote how a marketindex or average has done.

Q. So you're saying that close to 90% of equity funds are up in the pastfour years, while the market level as measured by the S&P is basicallyabout even?

A. Right.

Q. How can that be? What is the key ingredient in the formula that makesthis seem so surprising?

A. I think it's a question of where the money has been, and therefore howpeople perceive how they are doing.

Q. Right -- people judge things based on their own experience! So thatwould explain why probably not 90% of people feel great about 2001-2005?

A. Exactly. Unfortunately, a great deal of money was, and still is, ingrowth-style funds in general and large-cap in particular. And of courseS&P 500 Index funds, which so many people own at work or due to educationabout low costs, have a lot of money too (about 8% of equity fund assets)and they have gone almost nowhere in 4 years.

Q. How did people get into this rut?

A. Several things conspired, I think. First, they shoveled a lot of moneyat what was working very nicely back in the late 1990s and early 2000,which was growth and large cap and technology. So they chased what was hot.Then, people just have a lot of inertia about selling, particularly if theyhave a loss. Studies show they lock in small gains but let their losses getlarge and keep holding. So, trouble with their egos. Finally, and I thinkthis is not to be underestimated as a source of mistakes, people have beenover-educated to "buy and hold." So they hang on and just hope things willcome back (funds or stocks.)

Q. So it sounds like investors are somewhat trapped in a time warp -- theyown the last cycles good stuff!

A. Exactly. Growth style worked from 1982 to 2000, so they learned andpracticed that for 18 years. Habits are tough to break. Value is workingnow.

Q. Are you saying that growth style is no longer valid?

A. Well, what works goes in long cycles. There is a pattern where U.S.stocks go up about 16-18 years and then sideways for the same length. If weare five years into a long sideways/choppy environment, then people have tolearn to be more nimble and stop believing buy & hold. And history showsthat value beats growth over the very long term.

Q. So, how do people figure out when to make a switch in their investments?

A. That is one of the questions that, having no perfect answer, drivespeople to do nothing at all. We will never catch the top or bottomperfectly. But the economy does change and therefore leading themes willbecome trailers, perhaps for a long time.

Q. OK, so again, how should people approach that problem, then?

A. Two things might help. First, asset allocation discipline: if you havehad a great run and now too much of your money is in one type of funds, youneed to pay your taxes and reduce your exposure. Things do not remain hotforever. A second way of approaching it is the cash test.

Q. What's that?

A. Imagine that all the money you have invested today were instead 100% incash. What would you buy today? All of the same things you now have? No. Soyou should use this little mental game to see what needs to be sold off infavor of a better balance of things that need to be included.

Q. Does that mean to sell all your large-cap or growth funds?

A. Probably not, unless they all have useful tax losses! You can replacesome of them with others and move the money to what is working. In fact, wethink that large-cap may be in for some revival (but we are not asoptimistic about growth as value.)

Q. Why do people get so hung up about selling what they have?

A. Part of it is ego protection, and tax aversion, and part is whatpsychologists call the endowment effect -- whatever you own looks nicer toyou than it does to someone else who has no connection with it!

Q. And what people own is an accident of when they started, or when theyput a chunk of money in?

A. Right. And that is random and different for different people. So theaccident of what we own does not make it become the best stuff to have! And"buy & hold" assumes it does.

Q. Thanks, Don.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).