Job Security Went the Way of Funds’ Performance in ’94

Let’s say your stock or bond mutual fund had a bad year in 1994. Was it bad enough to warrant your fund manager’s resignation?

In the normally genteel mutual fund business, forced resignations and outright firings of portfolio managers have been a rarity over the past decade.

But in the wake of the performance egg the industry collectively laid last year, job security may no longer be such a sure thing.

Not only did stock and bond funds have their worst year since 1990 and 1974, respectively, but the variations in performance were extreme. Fund managers who bet big, and wrong, in certain market sectors lost extraordinary sums for shareholders.

Some of those managers now are paying the ultimate price, in a round of dismissals and retirements that may mark a sea change for the industry:

* Jeffrey Malet, whose Pacific Horizon Aggressive Growth stock fund in La Jolla slumped 11.5% in 1994 while the average stock fund lost 1.7%, was removed by parent firm BankAmerica Corp. in November, after 4 1/2 years at the helm.

* The manager of the Salomon Bros. Capital Fund in New York, Robert S. Salomon Jr., recently took early retirement at the age of 57 after his stock fund crashed 14.2% last year.

* T. Rowe Price Associates in Baltimore effectively demoted Richard Swingle, long-time manager of the company’s High Yield bond fund, in the wake of its 8% decline last year. Swingle then quit.

* In the latest resignation tied at least partly to performance, giant Fidelity Investments in Boston said Tuesday that Thomas J. Steffanci resigned as head of the company’s bond investments.

Fidelity said Steffanci left for “personal reasons,” and will return to his native Southern California to take a new job as a principal with Alpha Select Investments. “There was no disagreement between Tom Steffanci and Fidelity,” a Fidelity spokeswoman said.

But after Fidelity’s steep losses in Mexican bonds and other Third World debt in ‘94, industry insiders contend that Steffanci would ultimately have been held responsible--and may not have agreed with Fidelity management’s decision to significantly pare such holdings in recent months.

Fidelity’s New Markets Income fund, which owns Third World bonds, dropped 16.5% last year, one of the worst performances in its category; the average world-bond fund fell 6.5%.

For mutual fund companies and fund managers, dealing candidly with resignations or dismissals still is difficult at best. None of the managers mentioned here could be reached for comment.

BankAmerica’s official response to a question about Malet was that “we don’t comment on why people leave.” In Swingle’s case, T. Rowe Price admitted that its High Yield fund’s directors were “in agreement that a change was in order.”

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What does it take to get fired in the mutual fund business? In 1994, many of the managers whose ships ran aground had one thing in common: They had placed substantial bets on stock or bond categories that were devastated by rising interest rates. And as rates continued to rise all year, those managers typically failed to take off those bets--or worse, they added to them.

The Salomon Capital fund, for example, was buying rate-sensitive stocks like Mellon Bank and Ford Motor in the third quarter, just before the Federal Reserve boosted short-term rates sharply again. Worse, the fund dove into Mexican securities in the third quarter, many of which sank with Mexico’s currency devaluation in December.

Foreign securities, in particular, got many normally plain-vanilla stock and bond funds in trouble last year, notes Don Phillips, publisher at fund-rater Morningstar Inc. in Chicago. “A lot of funds went out and courted new and different risks” in the bull-market year of 1993, Phillips said. “The way you win accolades as a fund manager is when those kinds of bets go right.”

The problem is that when high-risk bets go wrong, they go very wrong--as the clients of Orange County’s bankrupt fund found out too late last year. Similarly, big bets that Fidelity had made in emerging-market bonds powered its New Markets Income fund up 39% in 1993. But when those bonds’ values collapsed late last year, sparked by Mexico’s financial crisis, Fidelity didn’t get out of the way as fast as some of its peers.

Still, the difficulty for fund directors and shareholders in deciding whether to terminate a manager is that performance is a continuum: Should a manager be sacked if a very bad year follows a very good year, especially in a fund category expected to be volatile? The next year, after all, could be spectacular again--who knows?

“You have to ask, ‘What is extreme underperformance, and what is just a bad year?’ ” for an individual fund or a fund sector, said Robert Markman, whose Markman Capital Management in Minneapolis selects funds for investor-clients. After all, some entire sectors go out of style periodically--”growth” stocks in 1992 and 1993, for example. But that’s not a reason for growth-fund managers to abandon those stocks, and their long-term shareholders shouldn’t want them to.

Yet as the fund industry has exploded in size since 1990, competition has become heated and the focus on short-term relative performance has intensified. The growing danger is that fund managers could be held to impossible standards, especially in the short run, Markman says. “It’s not in the best interest of investors for fund managers to be treated like NFL coaches,” he says.

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Even so, Markman admits that the industry’s bigger problem historically hasn’t been rapid turnover of managers--but rather that too many mediocre managers have viewed their tenure as a “divine right” irrespective of performance.

With stock returns having shrunk in recent years, and with bonds potentially on the cusp of a similar era, the time is ripe for more fund shareholders to ask whether they’re getting the performance they’re paying for, Markman said.

He considers the past five years’ performance for any fund a long enough time period on which to judge a manager, because that period includes both bull and bear markets for stocks and bonds.

If a manager has markedly underperformed the average stock or bond fund over the past five years, there may still be justification for that person to keep his or her job, says Michael Lipper, head of fund-rater Lipper Analytical in New York. But at that point, he says, “the burden of proof shifts to the manager” to justify tenure.

At Salomon Capital, five-year performance through 1994 was 27.8%--well below the 55.6% earned by the average stock fund. The T. Rowe Price High Yield fund had gained 49.8% over the five years, versus 65.6% for the average high-yield bond fund.

For fund directors, who are supposed to be looking out for and representing shareholders, numbers like those ought to be a powerful force for introspection in 1995. The manager changes stemming from 1994 performance suggests that’s happening. But shareholders should be taking that responsibility on themselves as well. If for whatever reason--tax issues, for example--you don’t want to simply sell out of a lousy fund, your only other option is to stay and fight to improve it. And unpleasant as it sounds, that may well involve making noise about firing the manager.

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Changing Managers

Managers of these mutual funds quit or were otherwise replaced last year, amid steep losses. Also shown are performance benchmarks for three fund categories.

Total return: Fund 1994 5 years T. Rowe Price High Yield -8.0% +49.8% Putnam Global Govt. Inc. -10.0% +43.1% MIM Stock Appreciation -10.4% +95.0% Pac. Horizon Agg. Growth -11.5% +67.1% Paine Webber High Income -11.7% +80.2% Salomon Capital -14.2% +27.8% Managers Intermed. Mtg. -25.1% +20.3% Oppenheimer Glo. Em. Gro. -27.5% +38.4% Avg. general stock fund -1.7% +55.6% Avg. high yield bond fund -3.8% +65.6% Avg. world income fund -6.5% +43.8%

Source: Morningstar Inc., Lipper Analytical Services