Mutual fund companies haven't made significant operational or investment strategy changes to "crashproof" their offerings, interviews with fund executives and consultants show.
Mutual fund managers said they will continue to manage their funds according to their stated mandates. Consultants, meanwhile, said they suspect cash positions have been kept somewhat higher than normal to ensure liquidity.
"We won't do anything fund-specific to crashproof our offerings, but we've worked hard over a decade to stick to our investment discipline. We are confident that maintaining discipline within an asset class will be enough to perform well vs. peer funds," said Anne Hodsdon, president of John Hancock Advisers Inc., Boston.
The approach of Federated Investors Inc., Pittsburgh, is typical. "We haven't made any changes in our investment management approach to crashproof our mutual funds, despite our concern that the market is overvalued. We remain fully invested with a cash position at 5% or less. We use futures and options moderately to maintain market exposure in funds where we want to take our time to invest the money. These provide broad market exposure while we wait to invest the cash," said J. Thomas Madden, chief investment officer for U.S. equities and high yield bonds.
"I've been in the business since 1973, and I've seen it all. The 1973-75 bear market, the worst post-war bear market; the late 1980s textbook bear market for high yield; and the deep valuation discounts of 1987," noted Mr. Madden.
"If we have a real, Japan-style bear market, there is no way for most managers to protect portfolios against declines. Managers can mitigate damage in an environment of cascading stock valuations, but they won't escape.
"The challenge will be declining liquidity in a sell-off market," Mr. Madden said.
"There will be no way to get off the train tracks. You can arrange to have only one leg cut off, but no one will emerge unscathed."
Stephen R. Petersen, portfolio manager of the $19 billion Fidelity Equity-Income Fund, said the odds that a statistically significant crash will happen are so low that "I won't do anything to offset or mitigate the potential effects."
"With very dramatic short-term drops, the trick is not to panic, to do the fundamentals and talk to the companies you invest in to see if the market was justified in dropping stock prices. It's possible that you might sell something, if it does turn out that the market was justified in devaluing the stock," Mr. Petersen said.
"I look at small market drops as opportunities to buy. In a longer, slow downturn, I might own defensive stocks. For example, during the dip in March and April last year and again that summer - which was caused by interest rate volatility - I did add to the portfolio stocks that were sensitive to upside interest rate expectations, like financial stocks," said Mr. Petersen.
But if they're not doing much to crashproof their offerings, mutual fund companies are actively urging 401(k) participants to stay the course in the event of a market downturn.
They have joined with plan sponsors in using printed materials, Web sites, meetings and videos that preach the value of asset diversification and long-term investing. They hope - but don't guarantee - that the repeated messages will help plan participants stick to their investment plans no matter what the market does. Still, no one is taking bets on defined contribution plan investors should the stock market crash like it did in 1987.
"It's impossible to predict how individual investors will react to a sharp market downturn. No one knows - there is not empirical evidence about what an individual will do under those circumstances," said Robert Brown, managing director-research, SEI Capital Resources, Chicago.
Said Stephen Nesbitt, senior vice president of Wilshire Associates, Santa Monica, Calif.: "There is a certain amount of flight money in mutual funds, the hot money that chases returns. The average mutual fund holder in a defined contribution plan is more stable and long term than the retail investor.
"But no one knows what the psychology will be in a crash scenario. Emotion takes over, reason goes by the wayside, and that flight money will move.
"People will be people and you have to assume some will be hurt" by moving into, and staying in, cash, Mr. Nesbitt said.
Still, observers point to several important factors that have made 1997 a much different situation for individual investors than 1987.
"People are used to more volatility, they are more seasoned investors than they were in 1987, said Robert C. Pozen, president and chief executive officer of Fidelity Management & Research Co., Boston.
"One- or two-day drops are considered now to be more of a buying opportunity than a reason to panic and move out of equities.
"It's going to take a protracted, more gradual downturn of between, say, four and six months, before defined contribution plan investors begin to move out of the equity market," Mr. Pozen said.
Collectively, 401(k) plan investors may be protected by their tendency toward inertia, said Steven M. Graziano, senior vice president and director of marketing for Pioneer Funds Distributor Inc., Boston.
"Plan participants are basically inert. They just don't move their money around a lot. And retirement plan participants are bound somewhat by the fact that they have to keep on making contributions every month to the mutual funds they choose. There isn't anywhere else to go with the money, and participants tend to recognize that," he said.
Plan sponsors, meanwhile, probably will be protected from liability in a crash scenario if "they've accurately outlined the risk of the investment options they offer," Wilshire's Mr. Nesbitt said.