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For Funds, Here's the Rub

By Albert B. Crenshaw
Washington Post Staff Writer
Thursday, October 16, 1997; Page C01

For many investors, the stock market crash of 1987 is just a fading memory. By the end of the month, for hundreds of mutual funds, it won't even be that.

This month marks 10 years since the great market swoon, and the crash and its impact on returns will drop out of the 10-year ratings of mutual funds -- the longest period commonly used to compare fund performance.

The effect will be to make many mutual funds look dramatically better. According to Lipper Analytical Services Inc., a New Jersey firm that tracks fund performance, the average stock fund returned 12.21 percent a year for the last 10 years when October 1987 is included. When that month is dropped, the average 10-year return leaps to 15.1 percent.

The reason is simple.

October 1987 was a stunningly bad month for investors. The previous Aug. 17, the Dow Jones industrial average had closed above 2700 for the first time. But after slipping through much of September, the Dow suddenly dropped 108 points on Oct. 16 -- the first time the average had ever dropped more than 100 points in a day -- and then plunged a breathtaking 508 points on Oct. 19.

The plunge cost the market more than 22 percent of its value -- 36 percent from its August peak of 2722 -- and wiped out what had been generally an excellent year for stocks.

The decline also massacred a lot of mutual funds. While some managers were smart enough or lucky enough to have much of their money in cash, most took a major beating.

That decline has been a millstone on these funds' returns ever since. Five years ago, it dropped out of the five-year ratings, producing a nice jump in that yardstick. Now, at last, it is about to go away entirely.

Many funds, of course, were not in existence in October 1987, and are not affected by this particular calendar event. But expect those that are to make good use of the new numbers in their advertising and promotion.

But experts caution investors not to be misled. Among the points they urge investors to consider:

The 10-year numbers will now include no major market declines, though history is full of them and they strongly affect investment returns.

Performance of conservative funds will pale compared with that of aggressive growth funds, which the bull market of recent years has richly rewarded. However, conservative funds generally fare better in market declines, and if there is one, as most experts expect, they may do much better.

The riskiness of aggressive growth funds will be masked because the depth of their losses during the crash will drop out of the calculation.

"The aggressive funds will look better but it doesn't make them any safer," said Jim Raker of Morningstar Inc., another mutual fund ratings firm. "The potential for great losses is still prevalent in the more aggressive funds."

As October is dropped from the ratings, investors will see not only funds' 10-year performance improve, they also will see their standing relative to other funds change.

For example, the Vista Growth and Income Fund A, which according to Michael Lipper was mostly in cash at the time of the crash, returned 24.07 percent annually between Sept. 30, 1987 and last Thursday. Between Oct. 31, 1987 -- dropping out the crash -- and last Thursday, its return was essentially the same -- 24.29 percent -- but its ranking drops from second to 12th in Lipper's rating of equity funds.

On the other hand, the Kaufmann Fund returned 21.97 percent with the crash included and 27.02 percent with the crash excluded -- "a 5.05 [point] pop," said Lipper -- and climbs to second from eighth.

Steven E. Norwitz of T. Rowe Price Associates Inc., the big Baltimore mutual fund operator, noted that his firm's Capital Appreciation Fund had been 80 percent in cash at the time of the crash and its standing has benefited from that, while the Science and Technology Fund had the misfortune to open for business on Sept. 30, so "it ought to look relatively better" when October 1987 drops out.

"The lesson here is that depending on what your starting point is, performance numbers can vary tremendously," he said.

A preliminary analysis by Morningstar showed that in its rating system, which assigns one to five stars to funds based on return and risk, 4 percent of conservative funds will gain stars while 23 percent will lose stars. Among aggressive funds, 24 percent will gain stars and 15 percent will lose.

"In a way," Morningstar concluded in a recent newsletter, "all of this just ain't fair. During this long bull market, funds that have bought small, expensive or otherwise speculative stocks [still] have made far more money with far less volatility than any reasonable observer would have expected 15 years ago." Now that the effects of the 1987 crash are about to be eliminated, their extra returns that reward investors for their risk will appear even greater, it said.

THE BIGGIES

Ten-year average annual returns for the 10 largest stock mutual funds, with and without the Black Monday month of October 1987.

Including Excluding

Fund Oct. '87 Oct. '87 Point gain

Fidelity Magellan 15.82% 19.50% 3.68

Vanguard Index 500 14.77 17.77 3.00

Investment Company of America 13.87 16.21 2.34

Washington Mutual Investors 14.79 17.22 2.43

Fidelity Growth and Income 16.71 19.64 2.93

Fidelity Contrafund 19.33 23.67 4.34

Twentieth Century Ultra 18.93 23.90 4.97

Fidelity Puritan 13.04 14.99 1.95

Vanguard Windsor II 15.14 17.59 2.45

Vanguard Windsor 14.41 16.65 2.24

THE WINNERS

The 10 top-performing stock funds, as ranked by Lipper Analytical Services before and after the Black Monday anniversary.

Rank 10-year return, Rank

after Fund excluding Oct. '87 before

1. Fidelity Select Home Finance 27.95% 1

2. Kaufmann Fund 27.02 8

3. Seligman Communication A 26.98 4

4. Fidelity Select Electronics 26.56 10

5. T. Rowe Price Science and Technology 25.87 7

6. Fidelity Select Regional Banks 25.82 3

7. John Hancock Regional Bank B 25.70 6

8. Invesco Strategic Technology 25.42 15

9. Invesco Strategic Financial Services 25.19 5

10. AIM Aggressive Growth 24.33 1

SOURCE: Lipper Analytical Services

RISING AND FALLING STARS

Funds expected to receive modified ratings from Morningstar when October 1987 falls off the books.

Stars Stars

Fund Loss in Oct. '87 before after

AIM Constellation 32% 3 5

Twentieth Century Giftrust 32 4 5

Matterhorn Growth 50 1 3

Clipper 7 5 4

Investment Company of America 17 4 3

Baron Asset 16 5 4

SOURCE: Morningstar

© Copyright 1997 The Washington Post Company

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