If you buy stocks directly – especially shares of small- or medium-size companies – you’ll want to figure out who owns the largest stakes. First, find out what percentage of the outstanding shares are owned by institutions, such as banks, mutual funds and pension funds. Some institutional ownership is good. Too much means “the game is over with. You’ll see those stocks drift down for two or three years,” says Jim Collins, who publishes OTC Insight, a newsletter. He gets cautious when institutional ownership hits 45 percent. You can get this information from companies like CDA/Spectrum (800-854-2532), a Rockville, Md., research firm.
The second question to ask: how heavily are aggressive mutual funds into this stock? Since these big investors are among the quickest to jump ship, you could be flattened in a single day of trading. Conversely, if you see that mutual funds hold one or two large stakes, but few other institutions are involved, you may have found a stock that’s about to soar. Just remember to get out early. For a $60 minimum fee, Disclosure (800-777-3272) will compile an ownership report. Their data is also online through CompuServe. CDA/Spectrum will list a stock’s top institutional holders and fund investors for $20. Look for a Morningstar Mutual Funds newsletter in your local library to help you figure out how aggressive the fund is.
In theory you’re relatively protected if you’re in a mutual fund. A halfway decent professional is going to hew to investment guidelines that maximize a fund’s great advantage: diversification. Here are the kinds of funds that don’t: sector funds, which specialize in one industry; aggressive growth funds that use rapid-fire, price-oriented trading strategies, and other diversified funds, such as Magellan, that take large stakes in certain stocks or industries.
If you own a technology-sector fund, congratulations. You did well last year. But technology is notoriously volatile. If you’re still committed, why not leave your original stake in the fund but reinvest your profits elsewhere? There’s no quick, easy way to find out if your equity fund is engaging in risky momentum-style investing, but here are some characteristics to look for in Morningstar’s newsletter: high turnover, which measures how quickly the manager buys and sells stocks; a portfolio with a price-to-earnings ratio that’s 40 percent or more than the Standard & Poor’s 500 Index’s – which you can also find in Morningstar – and a preference for buying companies with fast-growing earnings. Some of the best-known momentum-fund companies are Twentieth Century, AIM, Berger, Founders and Nicholas-Applegate. You don’t need to stay completely away from such funds – they can deliver great results – but don’t overdose on them.
And what of the funds that buy large stakes in companies? When the market is going up, they’re fairly safe because they’re often the first ones into winning stocks. But if the manager’s picks head south or fundholders start cashing in their shares, they are without question one of the most dangerous places for investors to be. Are these aggressive funds worth the risk? Sure, when part of a smart portfolio of investments. But just don’t think of them as diverse and conservative. They aren’t.
