large-cap stocks directly and use funds for small-cap and international funds to balance my portfolio.”
To select new funds, Lewis looks at past performance re-cords and the type of stocks they hold. “I like to see a large portion of technology and healthcare stocks,” he says, “because I think these are outstanding growth areas.”
How much will it cost? Here, Morningstar is referring to a fund’s expense ratio: the percentage of assets that goes to its management. The average expense ratio is a bit over 1%, but that figure can vary from fund to fund “If stocks are up 20% and its 2% expense ratio reduces your return to 18%, that’s not a big deal,” Dziubinski concedes. “However, in a year when stocks are up only 8%, a 2% expense ratio will knock off a quarter of your return. That is a big deal.”
Monroe Miller is one investor who heeds this creed. For one, the Concord, North Carolina, professional, who retired from IBM in 1998, focuses on fund expenses. “The stock market bubble of the past few years is bound to burst,” he explains. “When that happens, and returns come down, I don’t want to be in a fund with a 2% expense ratio.”
Will this fund be devoted to me and offer little “extras”? Among these so-called extras, Dziubinski likes to see a fund manager with ownership or a big position in a given fund as well as a commitment to close the fund to new investors once total assets reach a certain level. The reason: as funds grow, managers may be forced to compromise their strategies to accommodate new inflows of cash. Small, nim
bler funds that close before they become too massive tend to stick to their knitting.
Once again, Miller looks hard at a manager’s tenure with the fund. “I want to see continuity,” he says. “It doesn’t matter if a fund has an excellent track record if the manager who was responsible for that record left yesterday. Team management is all right, as long as the leading members of the team are still in place when I invest. Even though I’m usually a buy-and-hold investor, I changed funds last year after the manager left.”
A BUMPER CROP OF TOP-PERFORMING FUNDS
The 12 funds that Morningstar recommends provide investors with solid management, a consistent and coherent investment philosophy, low expenses and special bonus features. The picks, selected by Dziubinski, include a mid-cap index fund, two quasi-index funds and nine actively managed funds. These dynamic dozen also represent nine domestic stock funds, one bond fund and two foreign stock funds.
The four large-cap picks are:
Metropolitan West AlphaTrack 500. “Instead of buying the stocks in the S&P 500, we buy futures contracts on the S&P 500,” says co-manager Stephen Kane. “The rest of the money we invest in a mix of short-term bonds.”
The math works this way: investing in futures contracts will produce a return equal to that of the S&P 500, minus a short-term financing cost. If the bonds bought by the fund outperform