Mutual Funds Can't Avoid Latest Downturn

THE SUBPRIME AND credit crises finally caught up with Wall Street on Sunday as a staggering series of announcements brought the U.S. financial system to its knees. Lehman Brothers Holdings (LEH), a 150-year-old institution that had survived past market downturns, announced it intended to file a Chapter 11 bankruptcy petition. Merrill Lynch (MER), one of the country's largest broker-dealers, hastily sold itself to Bank of America (BAC) in a $50 billion deal. AIG (AIG) executives spent the weekend trying to raise $40 billion to prevent the company from spiraling out of control. And late Sunday came word that 10 banks were creating a $70 billion pool of capital they could borrow from in order to shore up their ailing balance sheets.

It was a historic set of circumstances, to say the least.

No doubt many mutual fund investors are now wondering, "How does this impact me?" Unfortunately, most investors, regardless of their sophistication, won't be able to avoid getting hit. The companies at the epicenter of these calamities -- and the firms that got into trouble last week, too -- were major components of both conservative index funds and actively managed mutual funds. Even if a given fund didn't own Lehman Brothers or AIG or Fannie Mae (FNM) or Freddie Mac (FRE) or Merrill Lynch, the reverberations of their fallouts will be felt throughout every nook and cranny in the stock market.

Gauging your exposure to this recent round of bad news won't be easy. The problem with owning mutual funds in a situation like this is that they aren't exactly transparent. You can see what a certain fund owns by looking at its web site or by pulling up the latest SEC filings. But in many cases that data are stale. Indeed, given the recent market conditions we would be amazed if a manager hadn't made substantial portfolio changes. The best thing to do is call your fund company and ask.

That said, according to fund data firms, individual fund web sites and the most recent SEC filings, fund families like Fidelity, Vanguard, Janus and T. Rowe Price (TROW) all had exposure to Lehman Brothers, AIG or Merrill Lynch. As for individual funds it appears Legg Mason Partners Aggressive Growth (SHRAX), Janus Twenty (JAVLX), Fidelity Growth & Income (FGRIX), Balanced (FBALX) and Equity Income (FEQIX), Vanguard 500 (VFINX), Total Stock Market (VTSMX) and Wellington (VWELX), Columbia Value & Restructuring (UMBIX) and Putnam Fund for Growth & Income (PGRWX) all owned or recently did own at least one of those stocks. Indeed, Morningstar says there were 469 funds alone that owned Lehman.

Fidelity says it has a policy of not commenting on specific stocks. T. Rowe Price says it's in the process of figuring out its exposure to these companies. Vanguard says Total Stock and 500 owned a modest 0.02% position in Lehman. The company says its actively managed funds, like Wellington and Windsor II (VWNFX), also sold relatively small positions. Vanguard Capital Value (VCVLX) had a 0.69% position. Vanguard spokesman John Woerth adds, though, that investors can gauge the impact of Lehman on their portfolios because the falling share price "over the past year through Friday is already reflected in the net asset values of funds owning the securities during that period," he says.

Other fund firms didn't return calls as of press time.

If, indeed, you haven't been able to step out of the way of these events, here's some advice to follow before the next downturn comes along (and, by all accounts, the next one may be sooner rather than later). First, don't make any knee-jerk reactions. If you think you can stave off further loses with a couple of trades you're fooling yourself (and probably selling at the worst possible time). If you are living off your retirement account, you may want to reconsider how much you are pulling out of it for household expenses. At least one study has shown that you can severely cut into the life of a retirement account by tapping it at its lowest balance.

You should also check to see how your funds react to these big downturns. We like the idea of a diversified portfolio in these situations. In concept, at least, a diversified portfolio should smooth out any wild rides. If, say, your portfolio of large-cap stocks takes a sharper dive than the overall market you may want to re-evaluate it, especially if you realize you can't stomach these ups and downs.

Finally, every investor needs to sit down after days like these and do a gut check. Once the dust settles there will be some prime buying opportunities for those with cash and the nerve to put it to use. This week investors should get some news on interest rates from the Federal Reserve and on the status of firms like AIG and Washington Mutual (WM). After that, no doubt there will be some well-run, well-capitalized companies that emerge with discounted share prices. Indeed, last week we polled some fund managers about where they saw bargains in the financial-services industry. This morning one of our interviewees, Anton Schutz, who runs Burnham Financial Services (BURFX), reiterated on CNBC what he told us last week: "There will be great opportunities."