Some cut exposure to large-cap value funds


INVESTORS always hunger for one crucial bit of information: What's next? It could be the "next big thing" that is going to take off and shoot a stock to the moon, or the next hot sector worth investing in or, on the downside, the next company likely to be caught in a corporate scandal or whose industry is about to get tight.

Forecasting what's next, particularly when it comes to bad news, is tricky. But if you review mutual funds right now and want to find a danger spot, large-cap value funds have an ominous shadow about them these days.

That dark spot is being caused by worries about how the old-line, staid, big-business giants are going to cope with problems arising from their pension plans.

Specifically, because of losses incurred over the past three years as well as changes in funding regulations, the fate of pension plans at many large companies has changed.

Some of the pension plans, because of federal accounting rules, were profit centers for the employers just a few years ago, with the investment gains of the pension funds contributing directly to the bottom line; today, many of the pension plans are big, underfunded liabilities.

"I don't want to own stocks with albatrosses around their necks," says Michael D. Hirsch, a senior portfolio manager at New York-based Advest Inc., who runs private portfolios that invest in mutual funds. "By extension, that means I don't want to have too much money in large-cap value funds. I think these problems have to be sorted out before we can look at large-cap value funds and think they're attractive again."

In trying to quantify and study the problem, Hirsch created a list he calls "The Pension 100," which is the 50 corporations with the largest unfunded pension liabilities, as well as the 50 corporations with the highest expected rates of return in their pension funds.

The list is a veritable Who's Who of large-cap companies, which is not necessarily surprising considering that more than 70 percent of the Standard & Poor's 500 companies have defined benefit plans.

Through the first two months of the year, according to Hirsch's research, the S&P; 500 was off 0.9 percent, while the Pension 100 fell roughly 6.8 percent. Just 22 of the 100 companies were positive during the period, while 28 had double-digit losses over the two months.

Hirsch and other observers believe that the pension situation will prove to be a steady drain of capital from the company into its pension plan, with the results affecting cash flows, profits and more.

"Two months of data is not the kind of eternity we want to have when we draw conclusions about investments," says Hirsch, "but these pension problems are too huge to go away, and it's altering the way these companies do business. ... This is a bullet that these companies cannot dodge, that much we do know."

Adds Leonard Goodall of the No-Load Portfolios newsletter: "This is one of those rare times when you can see trouble on the horizon, because you've got a very real situation involving big-name companies like General Motors and Ford. Seeing that kind of problem brewing may make you want to avoid exposure to those companies."

The question is what move an investor might want to make.

Cutting back on exposure to large-cap value funds is one option, but given how many of the S&P; 500 companies have pension plans, investors fearing trouble could be looking at whether to cut a true core holding.

"The worry is warranted, but I'm not sure of the right way to react to it," says Jeff Tjornehoj, research analyst at Lipper Inc. "Most people who are relying on asset allocation will still want large-cap exposure, and aren't going to want to throw away the strategy they've been investing with.

I'm not sure there is a lot you can do besides be aware that the problem is out there for some companies and be prepared to roll with it when it surfaces."

Hirsch, however, suggests scaling back on large-cap value, which he now ranks with "aggressive growth funds" at the high end of the risk scale.

Currently, in most of his portfolios, Hirsch has cut his exposure to large-cap value funds roughly in half.

Ultimately, avoiding the issue may rest on the skill of value fund managers and their ability to weed out the companies likely to suffer.

But any fund that has to remain fully invested may find it difficult to avoid trouble.

Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at or Box 70, Cohasset, Mass. 02025-0070.

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