Fund Watch

Don't Fall for This Top Fund

Reynolds Blue Chip Growth may not have what it takes to stay on top.

By Elizabeth Ody, Associate Editor, Kiplinger's Personal Finance

February 16, 2009

In today's environment, you should be skeptical of stock funds landing at the tops of the charts with minimal or no losses. Why? Most got there by loading up on cash or Treasury bonds over the past year. When choosing funds, you shouldn't necessarily disqualify ones that employ market timing. But if you invest in such a fund, you'd better have a high degree of confidence that its manager can time the markets consistently well enough to make it worth your while. Most can't.

For a case in point, look at Reynolds Blue Chip Growth (symbol RBCGX). For the past year through February 12 it ranks number one among funds that invest in large growing companies, with a 2.8% loss. On average, large-capitalization growth funds have tumbled 36% over that period.

Reynolds shareholders can thank a timely move to a 100% cash position for insulating them from the market's plunge. Manager Fritz Reynolds says he began cashing out of stocks in October 2007 because of concerns about the housing market and the previous summer's stock-market gyrations. By the end of 2007, he had stashed more than 90% of the fund's assets in the green stuff, leaving just two stocks in the portfolio: Apple (AAPL) and Google (GOOG). He sold both in the first few weeks of 2008.

So why, if it only held cash, is the fund in the red for the past year? Last October, sensing that many investors had capitulated to the bear market and had finished disgorging stocks, Reynolds moved 50% of the fund's assets back into the market. But two weeks later, he reconsidered and sold his stock holdings. Those transactions, plus the fund's higher-than-average expense ratio of 2%, account for loss.

This isn't the first time that Reynolds, who started his fund in 1988, has shot to the top. His fund was a top performer over the second half of the 1990s -- returning 39% annualized from 1995 through 1999. In 1998, he appeared on "Wall Street Week" with Louis Rukeyser, who proclaimed him to have "one of the best long-term investing records in the world of mutual funds." After that, says Reynolds, the "next thing you knew we were printing a million prospectuses." Assets poured in -- peaking at nearly $700 million in early 2000.

But his subsequent descent was just as swift, as the same high-growth industry leaders that had fueled his rapid rise led the market's decline. Says Reynolds: "I was early on Microsoft. I was early on Cisco. I was early on Wal-Mart. But I overstayed my welcome." Reynolds moved to a large cash position partway through the 2000-02 bear market. But the fund still lost 77%, or 30 percentage points more than Standard & Poor's 500-stock index lost, over the course of that debacle. Assets have trickled out ever since, and currently stand at $21 million.

Reynolds never quite recovered his mojo after the bear market. Although his fund delivered stellar returns in 2003, it was in the bottom 20% of its peer group in each year from 2004 through 2007. And Reynolds can't quite explain how his fund lost money in 2004 and 2005-years when the broad market delivered positive returns.

It could be that his intuitive approach to stock picking was simply better aligned with the markets of the '90s. He buys market leaders in fast-growing industries, and he will sell and replace a stock if another company surpasses it as the leader within that industry. "I make a bet that the number-one company stays number one," he explains.

Although Reynolds was still fully invested in cash in early February, he says he'll resume buying stocks if share prices fall much more from current levels. If or when that happens, Reynolds will look first at large, steady makers of consumer necessities, such as Johnson & Johnson (JNJ), Procter & Gamble (PG) and Colgate-Palmolive (CL), because "there will be a tomorrow for those companies."

But there's no guarantee he'll get it right. The fund has already missed out on the market's 11% gain from November 20, 2008, through February 12. Paying 2% a year to someone who has a spotty track record and a portfolio filled with low-yielding cash investments doesn't seem particularly cost-effective. Moreover, when the market does turn around, you're likely to miss out on some -- maybe a major part -- of the gains. So don't be wowed by this one-year wonder. Next year's record may not be such a hit.

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