HISTORY teaches us about the great explorers -- men who sailed off to discover new lands and became famous forever.
Seldom do we hear about the poor fools who sailed off and sank before discovering anything.
It's the same way with mutual funds, where nascent, immature, undiscovered funds are often treated like a prize. But for every Internet fund, which emerged from nowhere due to eye-popping performance, there is more than one Teddy Roosevelt Total Return, unknown and unloved to the day it was killed off.
There are thousands of funds below the public's radar screen, too small to make the newspaper fund listings, some operating without ticker symbols (the letter code for an exchange-traded fund). In general, such funds come to an investor's attention in one of a few ways, the most obvious being enormous returns. The second most likely way is through the advice channel, by which a money manager or investment adviser recommends a small fund run by a colleague.
There are some success stories, cases such as the Hotchkiss & Wiley funds that were started to service people who didn't have enough money to pay for the firm's private services.
But sizing up a fund of which no one has heard is difficult. There are no Morningstar reports to review, no buzz on the Internet, and not much press. In general, you are relying on raw numbers and what you glean out of a prospectus, and the numbers don't always tell the whole story.
For the 12 months that ended June 30, for example, Thurlow Growth was the top-performing growth fund in Lipper Inc.'s enormous database, posting a gain of nearly 125 percent. This year alone, Thurlow is up more than 70 percent.
But as of that June 30 date, Thurlow had about $2 million in assets and 96 shareholders. Virtually all of the fund's money had come from manager Tom Thurlow's friends and family.
Since topping the charts, the fund has doubled in size. "We are not well-known and well-connected," Thurlow says of his Palo Alto, Calif.-based funds, "but we will be if we run a quality mutual fund."
Small funds with big returns make for a great story, and Thurlow acknowledges that some of his new investors might have simply been people throwing cash his way due to Lipper's charts.
Performance-chasers hoping to catch a star should learn from other tiny chart-toppers of the past.
American Heritage fund was a big winner in the early 1990s, grew to well over $100 million and has spent most of the remaining years of the decade losing everything. Tiny Frontier Equity fund also had a good stretch of performance, before it was weighted down by an oppressive expense ratio and an investment strategy so volatile that boom or bust (but mostly bust) seemed to be the norm.
Thurlow's strategy involves market timing -- moving to cash if he dislikes the market's direction -- which could make the fund highly volatile. Performance-chasing investors can't be so blinded by performance that they miss red flags like that.
What attracts those investors to developing funds is the perception that many of today's household names had their best years at the beginning, when they were small and maneuverable, with less money and a more-concentrated portfolio.
There can also be some hype. Firms such as Lipper and CDA Wiesenberger often "discover" a new fund when the manager calls to tell them about it and ask for coverage.
The untold flip side is that some new fund companies enter the business undercapitalized and inexperienced. And undiscovered funds can be particularly volatile because the cash that floods in when they get noticed often rushes out just as quickly when performance falters, often because the fund is still an unknown quantity rather than a Janus or a Vanguard.
Look for clues in the prospectus. If the names of the auditors, transfer agent, and custodian are not brand-name firms, you may be dealing with a fund that's on a shoestring.
"Someone who is investing in these funds may face more risk, but also more opportunity," says Robert Wadsworth of the Wadsworth Group, a firm that helps launch new funds. "Look for an assurance that this fund is going to be around for a while."
If you choose to venture into uncharted funds, look for a strategy you can't find elsewhere (akin to the early days of the Internet fund), coupled with solid financial footing.
Says Terence P. Smith of the Declaration Group, which helps small firms start new funds: "You have thousands of other funds to choose from, so be sure there is something to a fund besides just being small and new."
Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at email@example.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.
Pub Date: 10/10/99