2000 new millennium, new funds.

B.E. finds 12 of the best bets for the new year--and beyond

FOR SHARON AND DARRYL WARD, THE ROAD TO wealth-building is paved with mutual funds. "We're in our 30s, so we have many years of investing before we retire," says Sharon, a financial programs specialist with the U.S. Treasury Department in Birmingham, Alabama. "Therefore, we invest mainly in stocks and stock funds where the long-term returns likely will be superior. I personally like to invest through mutual funds because I feel the diversified holdings provide safety."

Once a conservative investor, Sharon has evolved into a moderate risk-taker. On the other hand, her husband, Darryl, a mortgage banker, is a more aggressive fund picker. "We don't own a lot of small-company or international stocks," he says, "so our portfolio is tilted toward large- and mid-caps. I like to see a lot of technology stocks in the portfolio before I invest: I know they're volatile, but I think the long-term returns will be worth the risks."

As a result, the Wards have crafted an investment program that is a mix of moderate and aggressive funds. And as they have structured their portfolio, they have placed a high premium on consistent returns. "A few years ago, a specialized technology fund was suggested to me," says Darryl. "However, it had just returned 112% the previous year, so I was reluctant to invest because I didn't think it could repeat that performance. Instead, I invested in Fidelity Select Software and Computer Services Fund (FSCSX), which had a record that was good but not as great." Fortunately, he didn't regret that choice. Since he's held the investment, Fidelity Select has gained more than 30% per year.

FINDING FUNDS THAT SIZZLE

Many investors go through the same arduous process as the Wards when it comes to figuring out the next hot fund. The more misguided, however, conduct research akin to throwing darts at a board. So just how can you truly determine which funds will give you the best bang for your buck? To help you make this decision, BLACK ENTERPRISE consulted Morningstar, the Chicago-based mutual fund tracking service. Susan Dziubinski, editor of Morningstar Fund Investor, a monthly newsletter, has reviewed and helped us prepare a list of 12 hot mutual funds for the new millennium (see chart). OK, they may not last a thousand years. But the process that she used to select the funds is one that can easily be passed on to any generation of investors.

Instead of established funds, Dziubinski is drawn to young `uns--those vehicles that have yet to establish track records of more than a half decade. Why new funds? "Young, relatively small funds have some advantages," she says. "They may be more flexible than large, established funds, so they can take advantage of emerging trends."

Indeed, some of the funds on her list have produced a stellar performance. With mouthwatering 12-month returns as high as 98%, a number of them have outdistanced the Standard & Poor's 500.

Other factors for investors to consider: many of these young guns offer tax breaks. She maintains that "when it comes to taxes, they don't threaten investors with a `tax overhang.'" For example, if a fund created a decade ago has been tremendously successful in investing in the likes of Microsoft (Nasdaq: MSFT), Intel (Nasdaq: INTC) and Cisco Systems (Nasdaq: CSCO), you may decide to scoop up shares. The next week, however, that same fund decides to unload all its tech-stock winners and move into utilities. When the fund sells its stocks, all its "realized capital gains" will be passed on to investors, even newcomers. That means you'll owe tax on those gains, even though you didn't fully enjoy them. "Young funds don't pose this problem," says Dziubinski, "so they may be especially suitable for holding in taxable accounts rather than tax-deferred retirement plans."

Some rookies offer lower costs--especially index funds. Byron Snearl of Los Angeles counts himself among those who have found the advantages of such vehicles. "I don't have the time to study the funds closely," says the retiree who now manages his own rental properties, "so I invest through index funds. They mimic the market and I'll settle for those kinds of returns. They're low-cost, tax-efficient and don't present the risks of picking the wrong fund manager."

The bargain-hunting Snearl, of course, prefers "no-load" funds--those without sales charges--because they tend to offer solid returns at cheap prices. His preference: low-cost index funds from Vanguard Group. "I use dollar-cost-averaging to lower my risks even more," he says, investing $400 each month, which gives him the opportunity to buy more shares when prices drop.

ASKING THE RIGHT QUESTIONS

Despite the advantages, these newcomers can be a tad risky. If you can't examine a track record going back several years, it's hard to know exactly what you're buying. So that you don't get stuck, Morningstar suggests that you ask these four questions before buying a new fund:

* Has the manager run a mutual fund before? If not, does the sponsoring fund family have a strong track record and clear approach? The managers of the 12 funds that Morningstar selected generally have had prior experience running mutual funds. Only one was an exception.

Gale McEvilley, a financial planner with Rinehart & Associates in Charlotte, North Carolina, believes that nothing beats an old hand who has been successful in racking up returns."If it's an experienced manager and the fund is the same type that the manager has run successfully in the past, a new fund may be worth considering," she says.

* Does the manager have a clearly articulated strategy, and is it reflected in the current portfolio? Some funds will hold dozens of stocks while others stockpile hundreds. Some invest in name-brand companies while others will gamble on unknowns. By examining a fund's current holdings and reading the prospectus, you'll have a better idea of its investment philosophy and future direction.

Investors like Dr. Derek Lewis, a family physician in Little Rock Arkansas, seek new funds that fit their aggressive bent. "I won't be retiring for at least 15 years, so I'm comfortable taking risks," he says. "Generally, I buy large-cap stocks directly and use funds for small-cap and international funds to balance my portfolio."

To select new funds, Lewis looks at past performance records and the type of stocks they hold. "I like to see a large portion of technology and healthcare stocks," he says, "because I think these are outstanding growth areas."

* How much will it cost? Here, Morningstar is referring to a fund's expense ratio: the percentage of assets that goes to its management. The average expense ratio is a bit over 1%, but that figure can vary from fund to fund "If stocks are up 20% and its 2% expense ratio reduces your return to 18%, that's not a big deal," Dziubinski concedes. "However, in a year when stocks are up only 8%, a 2% expense ratio will knock off a quarter of your return. That is a big deal."

Monroe Miller is one investor who heeds this creed. For one, the Concord, North Carolina, professional, who retired from IBM in 1998, focuses on fund expenses. "The stock market bubble of the past few years is bound to burst," he explains. "When that happens, and returns come down, I don't want to be in a fund with a 2% expense ratio."

* Will this fund be devoted to me and offer tittle "extras"? Among these so-called extras, Dziubinski likes to see a fund manager with ownership or a big position in a given fund as well as a commitment to close the fund to new investors once total assets reach a certain level. The reason: as funds grow, managers may be forced to compromise their strategies to accommodate new inflows of cash. Small, nimbler funds that close before they become too massive tend to stick to their knitting.

Once again, Miller looks hard at a manager's tenure with the fund. "I want to see continuity," he says. "It doesn't matter if a fired has an excellent track record if the manager who was responsible for that record left yesterday. Team management is all right, as long as the leading members of the team are still in place when I invest. Even though I'm usually a buy-and-hold investor, I changed funds last year after the manager left."

A BUMPER CROP OF TOP-PERFORMING FUNDS

The 12 funds that Morningstar recommends provide investors with solid management, a consistent and coherent investment philosophy, low expenses and special bonus features. The picks, selected by Dziubinski, include a mid-cap index fund, two quasi-index funds and nine actively managed funds. These dynamic dozen also represent nine domestic stock funds, one bond fund and two foreign stock funds.

The four large-cap picks are:

Metropolitan West AlphaTrack 500. "Instead of buying the stocks in the S&P 500, we buy futures contracts on the S&P 500," says co-manager Stephen Kane. "The rest of the money we invest in a mix of short-term bonds."

The math works this way: investing in futures contracts will produce a return equal to that of the S&P 500, minus a short-term financing cost. If the bonds bought by the fund outperform the short-term financing cost, the fund's investors will come out ahead. "Recently," says Kane, "we've been paying about 5.4% and earning about 7.5% on the bonds. Thus, we expect our investors to top the S&P 500 by one to three percentage points."

As a performance pledge, the fund's managers have set a modest 0.20% expense ratio--unless the fund tops the S&P 500. If it does, the expense ratio will gradually rise to a maximum of 0.9%.

Dziubinski advises that investors hold this fund in a tax-deferred account because its strategy produces short-term capital gains and significant tax consequences on ordinary income.

TIAA-CREF Growth and Income Fund (TIGIX). The company is best known for managing teachers' retirement funds. The fund, however, is available to the public and offers a mix of active and passive management. "If our research staff has a hard time finding good stock market buys, perhaps because the market seems pricey, we'll put as much as 70% to 80% of our assets in the S&P 500 and use the other 20% to 30% for our best ideas," says manager Carlton Martin, the fund manager featured as a BE private screener in October 1998. (To find out how his picks fared over a year, see "Putting the Growth in Growth and Income," Moneywise, October 1999.) "At other times, we'll go as high as 60% in selected stocks and only 40% in the S&P 500." Considering the active management involved in this fund, the expense ratio is extremely low, a factor Martin attributes to a lean staff and TIAA-CREF's status as a not-for-profit organization.

Marsico Focus Fund (MFOCX). The big draw here is Tom Marsico, who ran the extremely successful Janus Twenty Fund for a decade. Marsico now runs his own company, so he's well motivated to produce outstanding returns. A "focused" fund is one that makes large commitments to relatively few stocks (about 25 in this one), heightening the risks as well as the potential returns.

Masters' Select Equity Fund (MSEFX). This fund has a multiple-manager lineup that Dziubinski terms "a who's who of mutual funds": New York Venture's Chris Davis; Brandywine's Foster Friess; Longleafs Mason Hawkins; Harbor Capital Appreciation's Sig Segalas; Oakmark's Robert Sanborn and Strong Opportunity's Dick Weiss. Each manager picks 15 stocks, for a "best of the best" approach.

In addition to the four large-cap funds, there are three mid-cap funds on Morningstar's list:

Vanguard Mid-Cap Index Fund (VIMSX). This low-cost fund will track the S&P Mid-Cap 400 Index. It's run by Gus Sauter, who's responsible for nearly $200 billion in Vanguard's index funds, including the flagship S&P 500 Index Fund.

Vanguard Capital Opportunity Fund (VHCOX). This fund was launched in 1995, suffered through some tough times and brought in a new management team in 1998. Now, it's run by the same people who operate Vanguard Primecap, a top-rated fund that's closed to new investors. The focus is on growth and recent results have been spectacular (see table).

The Dynamic Dozen 12

B.E. asked Morningstar to identify the next generation of hot mutual funds. The 12 investments below, selected by Morningstar Fund Investor's Susan Dziubinski, represent those that will have the most promise in years to come.

FUND                                TICKER     CATEGORY

Artisan Small Cap Value             (ARTVX)    Small Value
Baron Growth                        (BGRFX)    Small Growth
Longleaf Partners International     (LLINX)    Foreign Stock
Marsico Focus                       (MFOCX)    Large Growth
Masters' Select Equity              (MSILXO)   Large Blend
Metropolitan West Alpha Track 500   N/A(***)   Large Blend
New World(*)                        (NEWFX)    Foreign Stock
Oakmark Select I                    (OAKLX)    Mid-Cap Value
Third Avenue High Yield(**)         (TAHYX)    High Yield Bond
TIAA-CREF Growth & Income           (TIGIX)    Large Blend
Vanguard Capital Opportunity        (VHCOX)    Mid-Cap Growth
Vanguard Mid-Cap Index              (VIMSX)    Mid-Cap Blend

                                           TOTAL RETURNS

                                    YEAR-TO     12     THREE
FUND                                 DATE     MONTHS   YEARS

Artisan Small Cap Value             12.69%    17.87%      N/A
Baron Growth                        17.57     56.00    19.35%
Longleaf Partners International     26.58       N/A       N/A
Marsico Focus                       15.93     51.99       N/A
Masters' Select Equity              16.65     46.03       N/A
Metropolitan West Alpha Track 500    9.34     46.13       N/A
New World(*)                          N/A       N/A       N/A
Oakmark Select I                     8.80     43.47       N/A
Third Avenue High Yield(**)         13.84     15.55       N/A
TIAA-CREF Growth & Income            9.39     41.49       N/A
Vanguard Capital Opportunity        41.87     97.72     24.33
Vanguard Mid-Cap Index               1.55     42.54       N/A

                                      MINIMUM
                                      INITIAL
FUND                                INVESTMENTS    TELEPHONE

Artisan Small Cap Value                $1,000     800-344-1770
Baron Growth                           $2,000     800-992-2766
Longleaf Partners International       $10,000     800-445-9469
Marsico Focus                          $2,500     888-860-8686
Masters' Select Equity                 $5,000     800-960-0188
Metropolitan West Alpha Track 500      $5,000     800-241-4671
New World(*)                           $1,000     800-421-9900
Oakmark Select I                       $1,000     800-625-6275
Third Avenue High Yield(**)            $1,000     800-443-1021
TIAA-CREF Growth & Income                $250     800-223-1200
Vanguard Capital Opportunity           $3,000     800-662-7447
Vanguard Mid-Cap Index                 $3,000     800-662-7447

ALL RETURNS THROUGH 8/31/99

(*) NEW WORLD FUND IS A START-UP WITH NO PERFORMANCE RECORD YET.

(**) THIRD AVENUE HIGH YIELD FUND IS EXPECTED TO BECOME PIONEER HIGH YIELD FUND, SUBJECT TO SHAREHOLDER APPROVAL.

(***) NO TICKER SYMBOL AVAILABLE; FUND IS INELIGIBLE TO BE LISTED ON EXCHANGE

SOURCE: MORNINGSTAR INC.

Oakmark Select Fund (OAKLX). Bill Nygren, manager of Oakmark Select, is the only manager among the 12 funds who hasn't managed an existing fund. However, he has served as the director of research for Harris Associates, the Chicago-based advisor to the wall-regarded Oakmark family. "Oakmark funds have a `buy list' of about 100 stocks," he says. "Each stock must be approved by a stock selection committee consisting of three members, and I'm one of them."

Oakmark Select is another focused fund, holding between 15 and 25 stocks. "If you're going to buy an actively managed fund," says Nygren, "you want one that won't act like an index fund. To us, that means offering a fund that holds a relatively few top investment ideas."

Another incentive for investment: Nygren has placed most of his own assets in this fund, so he definitely intends to maximize performance. Additionally, Oakmark prides itself on investor communications: shareholders receive a personal answer to all e-mail sent to [e-mail]

In the small-cap arena, Dziubinski has two picks:

Baron Growth Fund (BGRFX). This fund recently changed its name from Baron Growth and Income Fund, representing a change in direction. "The emphasis now is on growth, not income," says Morty Schaja, Baron's COO. "We sold the majority of our high-yielding real estate investment trusts, for example."

Schaja says that the fund will look for small companies capable of doubling or tripling their stock prices in four to six years. Obviously, that's the goal of many mutual funds, but Baron Growth has some credibility here: Bon Baron, the fund manager and chairman of the company, also runs the highly successful, $6 billion Baron Asset Fund.

Artisan Small-Cap Value Fund (ARTVX). Manager Scott Satterwhite compiled an excellent record at Wachovia Special Values Fund, a leader among small-cap value funds. At Artisan, he has promised to close the fund once it reaches $400 million in assets, which should keep it from becoming unwieldy.

As for international funds, Morningstar lists two freshmen:

Longleaf Partners International (LLINX). The fund seeks to buy companies trading at less than 60% of intrinsic value, as determined by several proprietary algorithms. Like focused funds, holdings will generally range between 15 and 25 stocks. "We're now finding the best values in Europe," says Andrew McDermott, assistant portfolio manager, "although we started the year with more exposure in Asia. We also hold some Latin American and Canadian companies." He says this fund actively hedges currency risk so that investors participate in the performance of the underlying companies, as reflected in U.S. dollars.

New World Fund (NEWFX). The emphasis here is on new--as in brand new. At press time, the fund had just completed its initial fundraising and had yet to announce its holdings. It's an entry from American Funds, known for international expertise. As Dziubinski puts it: "awesome management, a deep team and low costs."

Rounding out the roster is the solitary bond fund:

Third Avenue High-Yield Fund (TAHYX). Well, maybe not. Subject to shareholder approval, the fund is scheduled to become Pioneer High Yield to reflect new ownership. Marge Patel, the fund manager, already has been placed on the Pioneer payroll. She expects to continue to combine convertible bonds--a security in which the issuing company grants you the right to swap your bond for shares of common stock at a predetermined price--with junk bonds, a style that has made her a star in the high-yield field. "The fund is likely to have a competitive yield but not the highest current yield," Dziubinski says. "Instead, it seeks bonds with the potential for capital appreciation as well, in order to deliver higher total returns to investors."

Delivering higher total returns certainly is a worthy goal, one that Morningstar's dozen may well attain. Does Dziubinski feel comfortable enough in these picks to put her own money at risk? "I bought TIAA-CREF Growth & Income as a gift for my godchild," she says, "and I'll be buying Oakmark Select the second it becomes available in Morningstar's 401(k) plan, which is soon."

As you decide whether to take a chance on these or other newcomers, you may want to adopt the tack of Sharon and Darryl Ward. Even though they work with a financial planner, the Wards study every investment before they part with a single buck of their hard-earned savings. "We want to know the [fund] manager's investment goals," says Sharon, "and make sure that we're comfortable with them. No one else can make that decision for us."

Or, in the final analysis, for you.3