Wall Street Week with Louis Rukeyser; 2105; Mutual Fund Mania?

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produce to Friday August 2 to light special guests are Edward and Toyin portfolio manager. The Delaware group John C. Bogle chairman and chief executive officer the Vanguard Group of investment companies and a Michael Livre president Lipper analytical Securities Corp.. Good evening. I'm Louis Rukeyser. This is Wall Street Week. Welcome back. Twenty seven years ago when I needed to get to some remote spot in the kingdom of Wattles I was advised to catch a flight on Air America which turned out to be an airline run by the CIA. With all that history behind us I find it unaccountable that my powers at the CIA failed to clue me in on what they apparently knew five years ago about a wondrously friendly back. I don't know about you but there were lots of times when I could have

made excellent use of a bank that would hand over a few million bucks at the drop of an innuendo and then not bother me with petty details like paying the money back. Can't tell you how many times when the pile of monthly bills grew irritatingly large that I would have been simply delighted to have a friend at the Bank of Credit and Commerce International. They wouldn't even have had to spell it all out. Mayor wink and a nudge would have done it. After all a bank that allegedly catered to about three thousand high net worth criminal clients bought Bert Lantz's bank and threw eight million bucks to Jimmy Carter's foundation. Could hardly have Cavel that helping me and the little woman out with the occasional grocery bill and heck guys I can keep a secret if Porro Clark Clifford can claim he didn't know who loaned the bank he was supposed to be running. I wouldn't have asked too many questions about precisely which Pakistani was leaving an envelope at my gate.

Where are these international gangsters when you need them. But if the indictment of the Pakistani founded Arab owned and Luxembourg based the s.c.i for what New York district attorney Robert Morgenthau called the largest bank fraud in world history was the week's most spectacular financial event. It was by no means the only case of Now You See It Now you don't. That was for example the economic recovery which was the illusion the recovery or the continuing recession. On the positive side machine tool orders moved up after three months skid good personal spending and income both showed gains. New home sales recorded a brisk increase the purchasing managers were practically smiling and the government's index of leading economic indicators advanced for the fifth month in a row. But factory orders suffered a relapse. New construction contracts faltered and while unemployment actually went down more significant was back to back monthly

declines in pain jobs the bottom line seemed to be that the economy was beginning to move forward. But with many a lagging part and overall at a pace that would embarrass a tortoise. All that perversely encouraged investors thought the evidence of continuing sluggishness might hasten the day when the Federal Reserve will next cut short term interest rates which I suppose will be the next best thing to a loan from the CCI. We tonight will take a special in-depth look at the legitimate form of investing that has had an unprecedented boom in the past decade. Mutual funds. But first let's see if the feeling was mutual. In Wall Street in the week just past the Dow Jones industrial average climbed back over 3000 this week but couldn't quite beat its all time high of three thousand thirty five reached two months ago. For the week. The Dow gained about 34 points to three thousand six point to six. While the Dow faltered on Friday

all the broader indexes kept on rising with the counter composite. Now on a seven day winning streak the only streak elves are showing as a streak of lethargy as the 10 technicians predicting the next six months net out once again to absolute zero which may be their grade for the week. The big winner this week as the dollar and the precious metals last round was the bond market which soared to its highest levels since May amid optimism that the off predicted decline in long term interest rates may finally be at hand which would be nice for all of us unlucky folks who still have to repay our loans. Now before we meet tonight's special guest let's take a look at the industry whose explosive growth has been one of the most dramatic stories of modern investing. As we seek to give you a handle on how to parry mutuals. As recently as 1980 there were fewer than 600 mutual funds in America today there are

more than 3000. The largest number are in a category that did not even exist a generation ago. Money market funds while the top five categories are completed by growth funds growth and income funds long term municipal bond funds and the Go For Broke group whose objective is described as aggressive growth in terms of where the money is about 39 percent is in taxable money market funds 30 percent in bonds and income funds 23 percent in stock funds and just under 8 percent in short term municipals last year for the first time. Mutual fund assets topped a trillion dollars representing more than 60 million accounts five times the number a decade earlier. Ten percent of all trading in stocks and 21 percent of the equity holdings of individual investors. But the success in selling the funds has not always been matched by their performance over the past 10 years when the Dow with dividends reinvested would have returned a

three hundred ninety two percent profit. The average equity fund lagged badly up less than 252 percent. Nor does the funds vaunted professional management look much more professional. When you look only at the past five years for that period according to Lipper analytical services the Dow gained about 105 percent. The average stock mutual fund only 67. If you take just the past 12 months the result is finally more respectable for the funds with the Dow up just under 8 percent while the typical stock mutual fund rose by 8.6. Incidentally Lipper reports that the best performing mutual fund over the past 10 years was Fidelity Select health which more than double the Dow's performance by delivering an eight hundred fifteen percent return. I hope you had it all the way. On the other hand let's hope that only your worst enemy is stuck with the forty four Wall Street fund which is now worth less than $20 for every

hundred dollars invested in it 10 years ago. Clearly then the question is not just whether you should be investing in mutual funds but if so which one. For some guidance on both those questions let's talk with my three special guests John C. Bogle is a true industry titan and a symbol of its explosive growth as chairman and chief executive officer of the Vanguard Group of investment companies. He is in charge of 62 mutual funds with assets of sixty six billion dollars Edward and Toyin has one of the hottest hands and current mutual fund performance is Del cap fund led all other diversified stock funds for the five year period ending June 30th a Michael Lipper is the industry's leading scorekeeper is Lipper analytical Securities Corp. tracks more than seven thousand funds worldwide. Gentlemen let me start by asking each of you how can an investor decide whether to be in mutual funds and if so which ones to buy.

Jack. Well given the state of the industry today I think it's very easy for an investor decide he should be in mutual funds because he can have savings and money market funds high yield and bond or tax exempt bond funds and growth potential in stock funds. So I'd say unequivocally yes. How to decide the funds this is a little bit difficult to say. Taking the most important part perhaps the equity fund selection I think a beginning investor in particular should go for sort of middle of the road funds like fairly conservative growth in income funds or growth funds. And even as suggested by your remarks at the outset maybe a little seasoning of index funds wouldn't be so bad. Stay with me a minute Jack. When you were last with us seven years ago Vanguard had 26 funds and about seven billion in assets. Now as I noted you have 60 266 billion in assets in addition to being a tribute to the power of this program. This suggests the growth of the industry but how can you have sixty two funds out. People know even within Vanguard with one tidbit.

Well obviously that's not easy. I think though that first the 60 to number is somewhat overdone by the fact for example that if you have a long term municipal bond fund and ensure long term municipal bond fund and municipal bond funds that are exempt from state taxes and five or six different states that's a lot of funds but it's pretty easy to select among them. I think an investor has to be very careful beyond that and making sure he balances out the risks and rewards and each the risks he is taking and the rewards he's expecting. And that's not so easy to do but that certainly work against me. Ed you're riding high. People just go with whoever is riding high. No not at all. It's just very important that they do two things. And one is match their risk tolerance with the risk orientation of the fun. And you can balance your portfolio and you know very well by doing that and you have to look at a longer term result. But not just the number but is the fun doing what you expected it to do operate conservatively or operate aggressively and perform accordingly. You know to those you know By-Laws if you will during

those types of markets. So it's important to balance those two. Let's suppose somebody wants to take your advice but as baffled as to how to do it. They assess their own risk tolerance how do they find a fund that matches it. Well really if you read the prospectus or even if you know you talk to good investment advisors that know the products you know they can steer you in the right direction. You read the financial magazine. They can steer you in the right direction. The risk level and there are many ways to report now many periodicals and many investment professionals. You know that really monitor the risk of different fun and can match that with their expectations. My question Lou I think there's a question before the question about selection and that question is how much time and effort do you want to put in. If you want to put an up to five hours a month I think you can follow as Ed suggests reading periodicals going to libraries reading documents. Most people don't and therefore most people need to go to an

advisor who may very well be a broker or a financial planner. You haven't really any of the three of you answered the basic question which is why funds why not stocks. Let me try that. I think a lot of studies will show that individuals typically have. A small number of stocks in their portfolio and therefore they have a great deal of specific risk. They're not diversified enough. Also most of the stocks in the portfolio have similar characteristics. And when the market moves into a different phase they don't have anything to cushion that particular approach. Jack I describe you as an industry states where you certainly are you also an industry critic. What do you think wrong with the mutual fund industry. Well I think we have a lot of work to do to have the directors of the funds take more responsibility and making fun shareholders get the best possible

break that they can and I think some of the problems are a wave of the increases that's going on this year in which one can only say where were the independent directors of these funds. I think the quality of mutual fund reporting to shareholders is very limited not very detailed not very informational at all and I happen to have an objection to mutual fund advertising which if you don't read the small print you shouldn't even bother to read those would be some of the main things do any of your funds charge a load or sales charge no load. We are strictly pure no load but I'm going to bring in a minute because I know here's one that does. But what's your philosophy there. Well our philosophy is very simple often expressed as if you're going to be in a 100 yard race. Why not start at the hundred yard line and let everybody else start at the 108 with an 8 percent sales commission. I think there is a useful information content in having an investment broker help you to pick a fund. But once you get beyond that I think the situation calls the sheer

economics of the situation call for no load funds but a broker would never recommend in a low voice. Not that I have ever heard of. Ed why should they pay up at the front end and take some of the money that would otherwise be invested and give it to some brokers sell them. Well I think it's really a very easy decision and it's no different from discount brokerage or full service broker. If an individual needs the advice of what type of fun needs that financial planning information from a independent person a broker can provide that and that's where that low goes that low goes to compensate the broker. The other thing that has to be remembered least in our organization you are the average holding period is in excess of five years and they pay roughly 4 percent commission upfront. That obviously doesn't get charged each year. That's a commission they pay at one time and that last about the life of that investment which is typically rather long. And there is no cost typically for transferring within our family which we offer a tremendous amount of fund alternative. So that cost really isn't a big number. When you sit down and think about it and probably really the overriding

issue is performance what is the net return to the investor. After all costs I praise you justifiably for your record with no cap. You have another fun fund hasn't done nearly as well it was 670 out of nine hundred fifteen over the past five years. Doesn't that suggest that even an experienced high performer like yourself can foul up and that maybe people ought to have more than one fund. Well no it doesn't. And the argument is very simple the trend fund is a very aggressive fund and it takes a lot of risk. And frankly in the last five years small cap stocks very small cap stock have underperformed the S&P as an index if you will dramatically. And we've done better than the Nasdaq and the Russell 2000. So in fact we outperform the peer group that we should be ranked. Again not the market not the S&P if you will and the people that wanted that amount of risk. You know we're going in with their eyes wide open and taking it and that's why you know it will we think outperform and long term it has over 10 years and we think it will also over the next 10

years over a short period of time. Not always. You think that the time for small company stocks has now finally come around again and we really do. Small company stocks have underperformed since really June of 1983. If you look from 1925 or 1929 no pre or post Depression they've outperformed large cap stocks by greater than 20 percent on a relative basis year in and year out over a short period time they've underperformed valuation analysis shows that they have very low levels views of the large cap stocks. We think they're poised for a three to five year recovery. My body your ranking show about low versus no load well over a period that people should be using funds for to invest perhaps 10 years. We can't see any significant difference. However if you are going to quote trade funds then I think the load is a significant hurdle. But if you want to participate in Ed's fund you would have had to

pay the load. And certainly in terms of his fund it would have been well worth it. So I think it's like buying a car on the basis of gas mileage only. You say over 10 years you couldn't see a significant difference does that mean that the load funds after taking out the initial sales charge caught up with the others. Yes. How do you respond to that. Well I'm very much of a cynic of that backtesting kind of way of looking at data. I'd say on the face of it I'd be very skeptical. What we know is that you start out with 100 cents on the dollar compared to 92 93. What we know also is that low cost sales charge probably could be said to cost you three quarters one percent a year. You can also pay easily another to two and a half percent a year in operating expenses and that three or three and a quarter percent that comes out of your return can be devastating and that's why a lot of to me at least a lot of the talk that goes on about selecting a whole bunch of funds and paying

sales charges and expenses. It seems funny when you can buy an index fund get the entire market you know select anything and pay no load and really no anything else. How many funds do you think the average person should own. Well I'd say if they want more and if it's an index fund I'd say one if they want. We should explain that index fund is one that is exactly matching the performance of the stock and matches the performance of the stock and usually the S&P 500 or the S&P 500. And we now have them at Met Europe the small cap indexes Japan bonds the works. So you can do an awful lot and the market's up your fund is up Markis down your fund is down. Right. And over a long period of time you're gaining on your competitors by about 3 percent a year because you're operating at much lower cost. John Templeton the great mutual fund investor when I asked him once about why people should try to beat the market when so many fail. He said half the people who play tennis lose. But that's not a reason not to play tennis. Well it's a little different in the market because because of the costs the managers are as good as the market

in the aggregate which is a reasonable assumption if you're paying 3 percent a year to get them it's not half that lose it's the data on the on the market matching indexes would say that's the typical mutual fund manager has one chance out of three. Well that was my next question. Why don't why doesn't the average mutual fund manager beat the index. Well it's by and large cost but because we know all managers put together have to do the same as the entire market and the index has to do the same as the entire market. So the difference is cost and it's night sales charges it's expense ratios and it's also high portfolio turnover which is a number that impacts upon performance. That is never quantified. When you were here a few years ago the no load funds seem to be on a roll. They were taking an increasing share of the industry. Now this seems to be a new trend in which there are more and more load funds. Why. Well I think the trend took place I believe it's coming to an end but the trend took place because a great many of the broker dealers were selling bond funds government plus funds high yield bond funds to

their customers. And that was not something in either case that the no load industries no load part of the industry became major participants and now that that's died out and add back the mutual fund the no load share has risen back to its customary level. So you've been in this business 40 years. How long should the fund be in existence before you buy it. Well. Unfortunately like so many things that depends. Take a very good example an index fund I don't mean to belabor the point of index funds but if one starts tomorrow or tomorrow night it won't matter. In general I would like to see a five year record or a longer than five year record for a fund. You clearly have shown a special skill for picking stocks. Where do you think good stock selection is finding value now. Where are you fun. We're we're pretty excited about the consumer area right now. Real spending has declined since pretty much beginning in 1990. The consumer really likes to spend and we're seeing some increased activity now in that area.

What kinds of stocks does that suggest are retailers restaurants stock any of those names. Yeah we like West Coast retailer name got Shox. We like a broad based retailer named charming shops both very well-run companies that are seeing big pickup in their business right now. We're also like some of the fabric companies that sell fabric clothing and even some of the electronic retailers who've been in a real dry spell for quite a while. They're all coming back pretty well now. What do you hate and what are you out of because you didn't believe it any longer. Well the areas where more nervous about health care would be an area we're nervous about where we're concerned it's going up so fast. No not really. We think there's a social issue in the country or we're worrying about reducing the cost to health care and we think that's going to affect margins. A lot of health care companies would rather own health care companies that reduce the cost of medicine not just the company that comes out with a new drug but a company that can reduce the cost of healthcare.

My Clippard I don't want to leave the subject of index funds on which Jack has been so eloquent without giving you a chance to comment. What's your view. Well I think number one Jack was referring primarily in terms of stock funds to S&P 500 related index. There was a question whether that is the market in the 1980s the new buyer in town was the leveraged corporate buyer and that he operated primarily in the S&P 500 because of the problems of the 80s. That buyer has stopped buying. And I think we're going to see a broadening out. And I think as all performance is cyclical I think we'll start to see as you've already mentioned that funds in general general equity fund are beating the index. But perhaps most importantly Lou is people can't spend relative performance. People should buy funds to participate in the market.

We're going to have a minute or so left. Let me ask you quickly get Jack in on this as well. What do you think of these sector funds. How do they differ from buying a stock. I think they're somewhat broader than buying a stock and a particular industry group is what as a particular industry group. For example the one that has been spectacularly good is the health and biotech area. On the other side they're certainly not as diversified as a general equity fund and therefore they have more risk. Jack I'd say at sector funds leave me quite nervous because they fly in the face of the industry's tradition of very broad diversification. I don't think you can win the sector fun game by jumping back and forth. If you have enough of them though you'll always have one that's performing well. That is absolutely correct. Ed what's your view on sector funds. Well you know I think if you can go out and find a great manager and you know history shown they're out there you know. You know if you you know it's the cheapest way to beat the market. And it's a lot easier and trying to do it one at a time or

trying to pick what the what industries hot and how often do you turn over your portfolio. We only turn our portfolio around 50 percent a year which for growth stock portfolio is quite low. Well thank you all three for us going 100 percent for our viewers tonight. Thanks very much. Jack Bogle and toy and Michael Lipper. I hope you'll be back with us again next week. Then we'll take the temperature of an industry whose future affects every one of us health care just mentioned by Ed my guest Mario Ahaggar is a leading analyst of health care companies. And she'll be telling us which ones may have the medicine we need to keep our bodies and our finances alive and kicking. I prescribe one half hour taken painlessly. Meanwhile this has been Fleet Week. I'm Louis Rukeyser. Good night. Wall Street Week With Louis Rukeyser has been made possible by the Corporation for Public Broadcasting and by the financial support of viewers like you by Travelers. Over 40 million Americans benefit from our insurance investment services and managed health

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