TCS Daily


Wanna Beat the Market? The Feeling's Mutual

By James K. Glassman - December 4, 2001 12:00 AM

It`s been a miserable couple of years in the stock market, but investors in a remarkable mutual fund, based here in Washington, aren`t complaining. Since the start of 2000, the benchmark Standard & Poor`s 500-stock index has lost 22 percent of its value, but Washington Mutual Investors Fund has risen 9 percent.

Over the past year, it is far and away the top performer among the 10 largest stock mutual funds. But the folks who run Washington Mutual Investors Fund don`t gloat over such stellar short-term statistics. It`s not their style to get overheated. This is a fund for shareholders and managers who are comfortable with their investing philosophy and keep their eyes on the far horizon. It`s kind of a club -- with very low dues -- for the calm, cool and self-assured. Excitable investors need not apply.

If you`re choosing a stock mutual fund as the core of your portfolio, Washington Mutual is the platonic ideal. It has had a clear-cut strategy for nearly half a century. Its managers buy relatively inexpensive stocks with strong fundamentals and hold them in a broadly diversified portfolio for a long time. The fund stays fully invested in stocks (no market timing -- i.e., jumping into cash -- allowed). Annual expenses are low, risk moderate and returns high.

If you had invested $10,000 in the fund at its inception on July 31, 1952, and consistently reinvested the dividends, you would have more than $4.5 million today. The fund has beaten the S&P 500 over the past one, five, 10 and 15 years. Its riskiness -- that is, its vulnerability to extreme declines -- is 30 percent below the average. Morningstar, a mutual fund research company, calls the fund "a great choice" and "an excellent pick." John C. Bogle, the founder of the Vanguard Group, the mutual fund company, goes further. In the current issue of Forbes, he chose Washington Mutual as one of America`s five best mutual funds and one of the two best stock mutual funds (the other was TIAA-CREF Equity Index).

But Washington Mutual is run in such a low-key, aw-shucks, stick-to-business manner that when I called to talk last week to the chairman, Steve Hartwell, he didn`t even know about the Bogle recommendation. Hartwell, by the way, joined Washington Mutual in 1968 and became chairman 16 years ago. He is now a spry and natty 87 years old. Bernard Nees, who founded the fund while working at the venerable local brokerage firm, Johnston, Lemon & Co., died four months ago at age 93.

But this isn`t a fund that relies on the brains of a couple of geniuses. Instead, like all great portfolios, it relies on a sound, consistent investing philosophy. This one had its origins in the British House of Commons in the early 18th century and was embodied in U.S. law in Harvard College v. Amory, the 1830 Massachusetts case that established the concept of the "prudent man." Trustees, said the ruling, have to make the kind of sensible, conservative investments that a prudent person would make. Later, a D.C. court actually created a list of stocks that were permissible for trusts, and that list -- abolished by the court in 1973 -- became the basis for Washington Mutual`s original selections.

The fund has changed the rules, but very slowly. Its list of acceptable stocks has grown from about 200 to 500. In April 2000, the board lifted a ban and allowed managers to buy stocks that don`t pay dividends. As a result, the fund began dabbling in beaten-down tech shares such as Sun Microsystems, Oracle, Dell Computer and Microsoft. None of these stocks, though, ranks among the fund`s top 50 holdings, and, in all, technology accounts for just 5 percent of total assets, compared with a 25 percent share for financials and 14 percent for industrial cyclical stocks such as Kimberly-Clark, International Paper and Weyerhaeuser (all among the top 30 holdings).

"We carved out exceptions, so that if they meet our criteria for financial strength and so forth, we can own them sparingly," Hartwell told me. So what are those criteria? I asked. "We have never published the exact list," he said. "We consider it proprietary." Like the formula for Coca-Cola.

Still, it`s not hard to determine that the nine fund managers -- led by James K. Dunton, who has 23 years` tenure -- like to own companies that are strong, silent types with great brand names and decent dividend yields. The top five holdings, as of Oct. 31, were Bank of America, Texaco, AT&T, Wells Fargo and J.P. Morgan Chase.

It`s not just the stocks that distinguish Washington Mutual; it`s what the managers do with them. Over the past five years, the portfolio`s turnover has averaged just 23 percent. In other words, the fund holds onto the typical stock for more than four years -- compared with just one year for most mutual funds. For the six months that ended April 30, 2001, a time of turmoil for the market, the fund eliminated only four stocks from its portfolio of 162.

Washington Mutual appears to have one glaring flaw. Its shares are sold only through third parties -- that is, brokers, bankers and financial consultants -- who receive a front-end load that can be as high as 5.75 percent. Why would Bogle, a passionate advocate of low-cost mutual funds, recommend one that charges any commission at all? The answer is simple. The high upfront fee is balanced by a low annual expense ratio -- just 0.65 percent, compared with an average of about 1.5 percent for equity mutual funds. Spread out over a long period, the load becomes insignificant.

Comparing fund expenses has become a lot easier, thanks to a calculator on the Securities and Exchange Commission Web site. I assumed that an investor would buy $10,000 worth of shares in Washington Mutual and that it would return 12 percent a year (actually, the fund has returned 13.5 percent on average since 1952). After 10 years, minus the load and all expenses, the investor`s account would be worth $27,424. Then I used exactly the same assumptions for a fund with no load but with 1.5 percent expenses. The value after 10 years: $26,701.

If you can hang on for 20 years, the results are even better. With Washington Mutual, $10,000 grows to $79,799 after expenses; with the average fund, to $71,299. And don`t forget that I estimated that both funds would produce the same returns, while, if history is a guide, Washington Mutual will do a lot better. Over the past 15 years, it has outperformed 91 percent of all funds, according to Morningstar.

Of course, the past doesn`t precisely predict the future, and, while Washington Mutual is undoubtedly a great fund, it may not be the best. You should do your own fund searching -- both for funds like this one, which can be the "core" or base for your portfolio -- and for more specialized funds to balance it. Washington Mutual tilts toward large-capitalization value stocks -- that is, big companies that are out of favor and, thus, somewhat cheap. If such a fund represents 40 percent of your total stock holdings, then you may want to put 20 percent into a more aggressive large-cap growth fund, 10 percent into a small-cap fund, 10 percent into a foreign-stock fund and a final 20 percent into a mix of 10 to 20 individual stocks in different sectors.

In selecting mutual funds, here`s what I look for: a clear philosophy or style, a manager who has been running the fund for at least five years, low expenses (preferably below 1 percent annually), low turnover (50 percent or less), strong diversification (the top 10 holdings should represent no more than one-third of assets), low levels of cash and bonds (5 percent of assets at most), and above-average long-term performance. I don`t care about the past year; I care about the past three years and more.

It`s impossible to find funds that meet the entire wish list, but additional longtime favorite core funds include Growth Fund of America (which, like Washington Mutual, is part of the American Funds family), Fidelity Contrafund (which I own myself) and Growth Company, T. Rowe Price Dividend Growth, Torray Fund, TIAA-CREF Growth & Income, Smith Barney Aggressive Growth, AIM Constellation, Legg Mason Value, Dreyfus Appreciation and Merrill Lynch Fundamental Growth.

But don`t get obsessed with my names. The fun part of investing is ferreting out your own. And remember that what you buy is less important than what you do after you buy. For example, investors who sold their shares of Washington Mutual after it dropped 7 percent in the last half of 1999 missed the fund`s superb performance the next year, when it beat the S&P 500 by 18 percentage points. In fact, you aren`t the Washington Mutual type if you can`t stay cool and think long term. After the September terrorist attacks, stock mutual funds experienced the largest one-month outflow of money in U.S. history. When I asked Hartwell how his investors reacted, he said softly, "In that horrible month, September -- oh, we had a net inflow of $167 million."

If you can keep your head like that, you can join the club.
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