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BUYING & SELLING STRATEGIES
Time to Ditch Your Fund?
by Elizabeth Frengel

As hard as it can be to decide when to cut your losses on a stock, it's even harder to let go of a losing mutual fund. After all, funds are nurtured by professionals with market know-how. Pervasive buy-and-hold wisdom implies that a fund that's down on its luck has to come back eventually.

That doesn't always happen, of course. And it can be tricky telling the difference between a fund that's hit a speed bump and one that's dropped out of the race entirely. Here are some tactics to help you identify and unload the losers:

Look out for the laggard

The first tip-off that a fund is struggling is usually lagging returns. Negative returns aren't necessarily a reason to run. If fact, with the lousy performance of the stock market lately, losses should be expected. But funds that consistently return less than their benchmark -- and their fund peers -- are often signaling that more serious trouble is afoot.

Benchmarks are indexes (the Standard & Poor's 500-stock index, for example) used to measure a fund's performance. Which benchmark to look at depends on what types of companies the fund invests in and is usually listed on the fund's prospectus. (For more on benchmarks, see "Demystifying the Mutual Fund.")

Brown Capital Management Small Company fund (see that the fund outperformed its benchmark for most of this year until April 2002, but now it's underperforming it.

But that's not necessarily a reason to sell, cautions Roy Weitz, publisher of FundAlarm.com. It's something to keep an eye on, certainly, but if you look at the fund's three- and five-year record, it's exceptional. Plus, Brown Small Company is a growth fund, and growth funds are having a tough time right now, he says. Brown's losses aren't out of line with its peers, and the managers of the fund will likely adjust their holdings so the fund can regain its momentum.

FundAlarm does track funds that could be candidates to sell. For example, Janus fund (JANSX) gets a three-alarm designation because it underperformed its benchmark (the S&P 500) for one, three and five years. That doesn't necessarily make it a no-brainer candidate to dump, but it qualifies for further investigation.

The site also keeps a running list of funds whose nose-pinching performance you'd be better off without. Dreyfus Aggressive Growth (DGVAX), a large company fund, is a repeat offender on the "Most Alarming 3-ALARM" list. Its three- and five-year performance is weighted against the Vanguard 500 Index, and it routinely shows up near the top of the ignominious list, Weitz says. Six months or more on the most alarming listing is reasonable cause to sell, he adds.

To see if there's anything alarming about a fund you own, check the list or enter its symbol at FundAlarm and get the gory details.

Make sure the manager's not new

If there's a change at the helm, there's likely to be some turnover in the fund's holdings -- and that can affect performance, says Deena Katz, a partner with the financial planning firm Evensky, Katz and Brown.

You should know how long the manager has been there before you buy into a fund. If there's a change, keep a close eye on returns. If performance starts to deteriorate, you may want to get out.

Watch out for asset shrink -- or bloat

Shrinking assets are an obvious sign of investors taking flight from a fund that's gone bad. But burgeoning assets can signal trouble too. For small cap -- especially microcap -- funds, too much money can cramp the manager's investing style. At that point the fund usually has two options: It can close its doors to new investors or it can keep trying to manage the massive inflow, at least initially by parking the money in cash holdings.

But if the managers aren't buying stocks with your money, you're not getting the fund that you originally bought into, Katz says. She points to Fidelity Magellan (FMAGX), whose assets shot up so astronomically in the mid 80s that even then-manager Peter Lynch said the fund would never be the same. Fidelity Magellan's assets are still a staggering $78 billion.

Think it through

Ultimately, deciding to cut a fund loose takes careful consideration. Look at the fund's overall trend, and if it's pointing downward, keep a close eye on it. Give it a few months -- even a year if there's no change in management or asset shift -- to redeem itself.

Above all else, stick with no-load funds. It will make getting rid of a dog a heck of a lot easier if you don't have to pay a backend sales fee or worry about how much commission you paid when you bought it.