A "Theory" on Selling

03/25/2005 12:00 am EST

Focus:

Richard Moroney

Editor, Dow Theory Forecasts

Dow Theory Forecasts is one of the most respected newsletters around, with a reputation gained over an amazing 57 years of publication. Here, editor Richard Moroney offers a checklist of reasons to consider selling a fund, and also features six long-term favorites.

"While holding on to a good fund through lean years is often the best strategy, you should not stick with a perennial laggard simply because it is in your portfolio. Poor-performing and high-cost funds tend to remain losers, so you should always be looking for ways to upgrade your portfolio. Still, you don’t want to chase performance by piling into hot funds, and you should not dump a fund simply because its sector or style is out of favor. As you consider whether to sell a fund, keep in mind the five red flags noted below:

  • If a fund consistently underperforms its peers, sell. A fund may be lagging simply because it invests in an out-of-favor sector. To avoid selling a good fund in an untimely segment, compare performance to peer-group averages and an appropriate index. If your fund consistently underperforms its category and benchmark index, you should upgrade to a better fund.
  • If a fund stumbles after a longtime portfolio manager has left the helm, consider selling. Even if a fund is managed by a team, the departure of the lead manager can greatly impact its risk profile and strategy.
  • Be wary if your fund changes investment strategy or style. It makes sense to hold a lagging fund if the manager’s approach is temporarily out of favor. But if your fund underperforms and abruptly switches strategies, it could indicate a manager is chasing performance.
  • Ungainly size and lagging performance make a bad combination. Large funds can be difficult to manage, which may limit rebound potential.
  • High expenses add insult to injury. If your fund repeatedly trails its peers—yet charges more than the category average—you are being ripped off. Dump the fund and upgrade to a cheaper alternative. Selling or exchanging funds may have costly tax consequences. Still, that is no reason to hold onto a dud; do not let taxes drive your investment decisions.

"Meanwhile, we have isolated six top funds for the year ahead. The funds are standouts in their groups. All six boast above-average performance in recent years, moderate relative risk, and expense ratios below their peer-group average.

"Excelsior Value & Restructuring (UMBIX ) is a long-time favorite among value funds. It invests primarily in companies that should benefit from restructurings or industry consolidations. Excelsior ranks among the top 1% of its peer group for ten-year total return. The fund's results have benefited from positions in energy and cyclical stocks.

"Neuberger Berman Fasciano (NBFSX) pursues a disciplined strategy, investing in high-quality small-company stocks with established franchises that can generate sustainable cash flow and healthy profit margins. While Neuberger tends to underperform when speculative stocks are in favor, the fund ranks among the top 18% of its peer group for three-year returns.

"T. Rowe Price International Discovery (PRIDX) has achieved solid results investing in small and midsize foreign companies. Major weightings include Europe (47%), Japan (20% of assets), the United Kingdom (14%), and Australia (8%). The fund’s five-year annualized return of 2.3% ranks among the top 25% of its peer group. So far in 2004, the fund is up 17.5%.

"Vanguard Short-Term Investment-Grade (VFSIX) seeks to provide current income with limited volatility. The fund has had only one losing year over the last two decades. The fund, which yields 3.5%, invests mostly in short- and intermediate-term investment-grade corporate bonds, with most bonds maturing in less than three years. The ten-year annualized return is 6.2%.

"Vanguard Strategic Equity (VSEQX) is a top pick among mid-cap funds. Longtime portfolio manager George Sauter invests in both growth and value stocks, using a proprietary stock-rating system. Leading industry exposures include financial services, consumer discretionary, and health care. The fund ranks among the top 10% of its category for five-year returns.

"Vanguard Wellington (VWELX) is a good all-weather fund. Roughly 60% to 70% of the fund is invested in stocks of established midsize and large companies, most of which pay dividends. The remaining assets are mainly in investment-grade corporate bonds, with some exposure to US government bonds. The fund ranks among the top 10% of its peers for three-, five-, and ten-year performance."

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