by: Paul Katzeff
from: Investor's Business Daily
April 24, 1998

You wouldn't buy a car without kicking the tires. You shouldn't buy a mutual fund without checking under the hood, either.

After first making a short list of top-performing funds, you should ask the five vital questions listed below about the fund managers' strategies. If performance tells you how a fund has done in the past, understanding the manager's strategy gives you insight into the fund's future.

Understanding strategy "helps you understand how much risk a fund takes, how diversified it is, how it goes about achieving its goals and how consistently it sticks to its own game plan," said Scott Lummer, chief investment officer of 401k Forum Inc., a San Francisco investment advisory firm.

The five questions:

1. What is the fund's investment objective? "You need to go beyond one-word descriptions," said Lummer. "Funds in the same category may pursue their objectives very differently. You may be a lot more comfortable investing in one than the other."
   
   Janus Fund and Dreyfus Appreciation Portfolio are two growth funds with dissimilar styles.
   
   "Janus (managed by James Craig) buys stock in big businesses, waits for their stock to hit its target price, then sells it and uses the proceeds to buy more stock," said Roxanne Fleszar, president of Financial Resources Management Corp., in Peabody, Mass. "They had 132% turnover in 1997."
   
   "Dreyfus, which is managed by Fayez Sarofim, sticks with big, huge multinationals that Sarofim believes will produce long-term growth. He had only 1% turnover in 1997. One good thing about this is that people will have less tax liability from capital gains."
   
   
2. In what segment of the market does the fund invest? This helps fine-tune your understanding of a manager's strategy.
   
   AIM Blue Chip and Oberweis Emerging Growth are both growth funds, but they fish in opposite ends of the market pool for good catches. "Both seek capital appreciation without concern of current income," Lummer said. "But Oberweis is over three-quarters invested in smaller-cap (businesses). AIM looks for well-established, larger companies with good growth prospects."
   
   As a result, Oberweis is more volatile. Lummer reasoned, "Their 10-year records are comparable, but in any one-year period Oberweis has higher highs and lower lows. Some investors may prefer the stability of a larger-cap fund regardless of return."
   
   Most long-term investors, however, should be less concerned with short-term volatility since they have time to recover from market-related dips.
   
   
3. How does the fund start its search for securities? Using different selection yardsticks can lead funds in the same category to dissimilar portfolios and dissimilar results. John Hancock's Sovereign Investors Fund and Independence Equity Fund are both growth-and-income funds. But Sovereign's John Snyder III starts screening by looking for businesses that have increased dividends at least 10 consecutive years, according to spokeswoman Susan Bishop.
   
   The first screen of Independence Equity's Paul McManus is the S&P 500; his second is rate of growth.
   
   In part due to those different opening moves, McManus has earned a five-year annualized return of 18.33% (with the maximum sales charge factored in) on his A-class shares, beating Snyder's class-A shares' return of 14.09%.
   
   
4. What non-financial factors does the manager consider? "Some managers look at geographic location," said Fleszar.
   
   He added, "Heartland Value Fund (is a small-cap stock fund) managed by Bill Nasgovitz, in Milwaukee. Heartland buys companies in the Midwest because Nasgovitz feels he can visit them, and there aren't as many analysts following them. So he has more opportunity to buy an undervalued business."
   
   Lummer said, "You can't diminish the importance of being able to know whether someone you're about to invest in is for real. Financial statistics are useful, but a fund manager's skill at gauging the ability of business managers may show up in other ways."
   
   
5. When does the manager sell a security? Lummer advises individual investors to look for a fund manager whose sell criteria are as consistent as his or her screens for buying.
   
   "This shows you something about a manager's consistency," said Lummer.   "It helps you see whether you are getting what you're paying for. It tells you whether the manager has a strategy or is just guessing."