Funds’ Record Rise Triggers Caution Lights

Mutual funds, which exploded in popularity during the ‘90s and continue to be Main Street’s investment vehicle of choice, were never designed to help people get rich quick.

But you wouldn’t know it from what happened to many funds last year.

A record 171 stock mutual funds, most of them loaded with highly volatile technology and Internet stocks, surged 100% or more in 1999, doubling their investors’ money in a single calendar year.

To put that in perspective, through 1998 only 23 mutual funds had ever accomplished that feat.

Even during the so-called go-go era of growth-stock investing in the 1960s--also a period when investors were infatuated with technology stocks--only four mutual funds topped 100% returns in a year.

Peter Lynch, the legendary former manager of Fidelity Magellan fund, in his best year produced a return of 70%. That was in 1980.

As with so much else about the latest phase of the 9-year-old stock bull market, the gigantic 1999 returns on many funds, in a year when the Dow Jones industrial average rose 25%, are flashing warning lights on Wall Street.

With each new rise in shares of fledgling Internet companies--many of which have little in sales and as yet earn no profit--the risk of an eventual meltdown also rises sharply, some analysts warn.

Should the stocks collapse, the fund managers who have helped bid up those shares--and who now look like heroes to their small-investor shareholders--could quickly become vilified.

And that, in turn, could jeopardize the overall image of the $6.4-trillion-asset fund industry, which has long touted the fund concept of pooled money under professional management as a way for average Americans to diversify and reduce risk.

Even if the technology-stock bubble doesn’t burst any time soon, the willingness of professional fund managers to ride this boom may alter more investors’ perceptions of what mutual funds should do for them.

“People’s expectations are certainly rising,” said Philip Edwards, managing director for Standard & Poor’s Fund Services in New York. “And if we [begin to] have market returns of 8% to 10%, people will get depressed. I’d be worried about that.”

Doubling in value is spectacular enough, but 20 of the 171 top-performing funds more than tripled in value last year, something no fund had ever accomplished in a single calendar year. Three funds gained 300% or more.

And the top-performing fund, Nicholas-Applegate Global Technology, returned nearly 500%, a fund industry record that shattered the old mark of 196% set in 1998 by the Internet Fund.

The Nicholas fund’s gain also surpassed the dramatic 1999 gains of such individual tech shares as Yahoo and America Online.

But far from being spooked, many small investors in these stock funds are thrilled with their winnings.

“This has been just one amazing ride,” said Jim Hayden, a retired investor in Falls Church, Va., who owns shares of five mutual funds: Janus Global Technology, Fidelity Aggressive Growth, Rydex OTC, Janus Olympus and Fidelity Growth Co.

In 1999, those funds delivered returns of 212%, 103%, 101%, 100% and 80%, respectively.

Now more than half of the 63-year-old retiree’s entire fund portfolio is invested in the highflying tech sector.

A few years ago, he did own conservative, diversified funds such as Fidelity Value and the Fidelity Fund. But look at them now, he said: One was up 9% for 1999 and the other, 24%.

“Who needs them when you look at Janus Global Technology?” he said.

As for the notion that a mutual fund ought to be a slow-and-steady investment, “That’s a great message,” Hayden said. “It’s a wonderful way to go [for long-term investors]. But I’m not following it. I’m a results-oriented guy.”

Charles Leeper, 69, of Rancho Mirage spent most of his life investing in ultra-safe bank certificates of deposit because, he said, he “came from a very poor childhood, where I watched my parents scrimp and save.”

But he said even he has “learned to accept greater volatility in funds. It will happen to those who are willing to seek greater opportunity.”

His funds include Janus Global Technology and Firsthand Technology Leaders. The latter rocketed 153% last year.

Until last year, investor Richard Underhill, 55, of Los Angeles thought a 30% annual gain was exceptional. In 1999, shares of his Invesco Technology fund zoomed 146%. “I’ve never owned a fund that performed as well,” he said.

Russel Kinnel, equity editor for Chicago-based fund tracking service Morningstar Inc., pointed out that, for the most part, only the most aggressive funds managed to post triple-digit returns for 1999.

“Some are so aggressive that you can treat them like [individual] stocks,” said Jeffrey Van Harte, manager of the Transamerica Premier Equity Fund.

In other words, these aren’t your father’s mutual funds.

Some analysts say the fund industry could hardly ignore the same hot tech stocks that individual investors have flocked to for the last two years. As marketing-driven companies whose earnings depend on the amount of assets they’re managing, it behooves fund companies to create products--or revise them--to suit the public mood.

Whereas the average stock fund has less than 20% of its assets in tech stocks, the public clearly has been favoring something racier.

For instance, the 20 most popular funds last year (as measured by the amount of new money that flowed into these portfolios in 1999) had much bigger bets in tech: 35%, on average. Some had even more than two-thirds of their assets in technology stocks.

As usual, in the investment world, performance begat performance, by attracting more investors. Americans poured more new money into technology-sector funds in 1999 than in the last 10 years combined.

Said S&P;’s Edwards: “Since all the [market] volatility has been positive [in recent years], investors have gravitated right to volatility.”

Ed Rosenbaum, director of research for New York-based fund tracker Lipper Inc., cautions investors not to get too excited about short-term fund performance. Historically, funds with above-average returns tend to cool down quickly.

Often, investors will shovel so much money into hot funds all at once that it becomes difficult for those funds’ managers to put all that cash to work in the stock market effectively.

Nevertheless, investor interest continues to fuel a boom in aggressive fund offerings in general.

Over the last two years, the number of technology-sector funds has doubled to 101.

In addition, diversified-fund managers’ willingness to load up on tech or other volatile sectors has grown. And in a related trend, fund companies have been creating more so-called concentrated funds--that is, funds whose managers are able to make big bets on a smaller number of stocks.

That would have been considered “outrageous three years ago or five years ago,” said Bill Dougherty, a mutual fund analyst with the Boston-based consulting firm Kanon Bloch Carre. “Today, because so few securities have driven this market up, fund companies and managers are saying, ‘Maybe we should concentrate more.’ ”

That is what many of last year’s hot funds did. Whereas the average equity fund holds 138 stocks, those funds that doubled their investors’ money or more in 1999 held 68 stocks, on average.

“Today, the life of a diversified-mutual-fund manager strongly biases him or her toward shooting high because the rewards are very high,” Rosenbaum said. “Fund managers have a very strong incentive from investors and their own organizations to increase returns for their clients.”

What about the risks?

Managers such as Bob Turner believe a fundamental shift is taking place in the economy and the markets that rewards risk-taking--and favors the tech sector.

“If the rules change, you have to change accordingly,” said Turner, who co-manages the Turner Micro Cap Growth fund and Turner Growth Equity, which were up 144% and 54%, respectively, for last year.

“We don’t make the rules, we play by them,” he said. “This just happened to be a year where the rules changed phenomenally.”

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Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.

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Record Returns

Until last year, only 23 mutuals funds in history had ever doubled their investors’ money in a single calendar year. But in 1999, a record 171 accomplished this feat, thanks to big bets they made on technology and the foreign markets. Number of funds gaining 100% or more each year:

1999: 171

1998: 6

1997: 0

Source: Morningstar Inc.

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Annual markets and mutual fund review and outlook, with Morningstar data. See Section S