CHICAGO - John C. Bogle used his keynote address at Morningstar Inc.'s conference here last month to push the concept of rating mutual funds by their costs.
Mr. Bogle, chairman and founder of The Vanguard Group of Investment Cos., Malvern, Pa., analyzed the performance of mutual funds within the nine compartments of Morningstar's "style" box. He concluded the odds are against picking managers who significantly outperform the market.
But when Mr. Bogle divided the data into cost quartiles, with the funds with the lowest expense ratios in the first quartile and the highest expense ratio in the fourth quartile, he found funds with the lowest expense ratios had the highest net returns over five years. Volatility, he said, was identical.
"With risk astonishingly constant, high returns are directly associated with low cost . . . . So why not take the position that investors should act on the full implications of the thesis that costs matter. Because the lowest cost funds out there in the marketplace are index funds, why not just buy index funds in each of the nine style boxes? It is hardly a specious argument," Mr. Bogle said.
Vanguard, of course, is the leading provider of indexed mutual funds.
"If you believe (the market) is efficient (and you are right) .*.*. the best strategy is to buy an index fund. If you believe it is efficient (and you are wrong) . . . you will earn the market's return but a few actively managed funds will beat you. But if you bet that the market is not efficient, the probability of underperforming is high.
"The risk, in short, is much greater if you bet on inefficiency rather than on efficiency. And that is ultimately the conclusion of equity style analysis in the mutual fund industry: No matter what fund style you seek, emphasize the low-cost funds, eschew the high-cost funds. And, if you want the best bet of all, you should consider indexing in the category rating box in which you seek style representation in your portfolio," Mr. Bogle said.
Meanwhile, in a separate address, Don Phillips, president of Morningstar, said investors must scrutinize a mutual fund's portfolio characteristics as closely as they would an individual security.
Mr. Phillips also stressed the importance of personal meetings with fund portfolio managers. Investors can assess the managers' personalities, and learn the inner workings and strategies of individual funds, he said.
Another speaker, J. Mark Mobius, managing director of Templeton Asset Management Hong Kong, touted emerging markets.
Rather than accepting that it may be too late to profit from emerging markets investment, Mr. Mobius pointed to the huge rise in the number of privatizations of national industries globally.
He said privatizations have caused stock markets to develop much more quickly in emerging markets than they would have otherwise, making it easier for international investors to get into these markets. Stocks traded in exchanges in emerging markets zoomed to 14% of world stock market volume in 1997 from from 4% in 1987, he said.
The Morningstar conference also featured panels of portfolio managers. Among the revelations:
Brinson likes Canadian bonds
Gary P. Brinson, chief investment officer of Brinson Partners, Chicago, said Canadian real return bonds are one of the most attractive options in the current market.
Mr. Brinson also likes Australian bonds, with their 7.5% yields, which were "great relative to inflation there."
Brinson Partners is also investing in 20-year STRIPS in the United States, because of the 10% to 20% price appreciation the bonds are getting on a 7% yield.
On the equity side, Mr. Brinson said he only favored emerging market equities.
He did say he would add a short position in futures based on the Standard & Poor's 500 Stock Index, a hedge against the likelihood of too much correlation between global markets, at least in the short term.
Cash isn't 'trash'
Jean-Marie Eveillard, manager of the $3.9 billion So-Gen International Fund, managed by Societe Generale Asset Management, New York, said he likes cash "because it's not trash" and gold because "it's not dead."
Mr. Eveillard is investing globally in industrials, especially paper and metals. He said there are "tremendous inefficiencies" in stocks from continental Europe, since, after adjustments, they are currently much cheaper than U.S. equities.
Still, he said he likes Manpower Inc. because it is priced at 20 times earnings and Dole Food Co., "because bananas are good for you."
Vinyl extruder a favorite
Paul H. Stephens, managing director and chief investment officer of Robertson, Stephens & Co., San Francisco, said he loves a little-followed company, Royal Group Technologies, Toronto, a vinyl extruder helping to modernize and revitalize the Chinese building sector.
China will be "absolutely critical" to world markets, said Mr. Stephens, but he favors getting exposure to China through investments in well-run U.S. companies with a lot of reliance on China as an export market.
Such companies will "understand the needs of U.S. investors, but will be making their money in emerging markets," said Mr. Stephens.
Railroad stocks 'irresistible'
Relative value proponent David L. King, manager of Boston-based Putnam Investments' $25 billion Fund for Growth & Income and the more than $600 million New Value Fund, said railroad stocks are irresistible.
Railroad companies are the ultimate franchise, he said, and after likely consolidation, there will be only two coast-to-coast railroads left within 10 years.
The stocks are undervalued and therefore, cheap, and the potential for positive change - such as an increase in freight traffic - is very high.
Mr. King, who selects stocks using two criteria - cheapness and change - said electrical utilities meet his cheapness criteria, but violate his requirement for successful change management. The industry is handling deregulation issues poorly, has a bad track record of executing management goals and has been slow to consolidate, according to Mr. King.
Life after Fidelity
Brian S. Posner, a managing director at Warburg Pincus Counsellors, New York, and manager of the $474 million Growth & Income Fund, said he has found his transition from Fidelity Investments, Boston, "easier than I expected, emotionally, and professionally."
Mr. Posner had managed Fidelity's Equity-Income II Fund, which had almost $16 billion when he left.
"With a larger fund, you sort of tend toward Hamburger Helper in order to handle all the cash. In a smaller fund, every stock really counts," said Mr. Posner.
One advantage of working for a smaller firm is he's able to get closer to companies he invests in and tracks, as well as to Wall Street research analysts. He also works more closely with the company's 12 analysts and has had "plenty of very high-quality input from this team into my investment choices."
Mr. Posner has just about finished repositioning his Warburg Pincus fund, managing it similarly to the Fidelity fund.
He uses a conservative, value-oriented, total return philosophy.
Oil stocks, such as Exxon Corp., Parker & Parsley Petroleum, Total Petroleum North America, SONAT Inc., Noble Drilling Corp. and Reading and Bates Corp., are beginning to look attractive to Mr. Posner.