Disinflation strategy proves a winner for funds ducking recession
In January of 1980, Robert Brody sold his oil stocks, took his profits, and started investing for disinflation.
Mr. Brody, who heads up the Denver-based American Growth Fund, plunked his fund's money into such unexciting areas as utilities, food stocks, and regional banks. Thus, when the stock market plunged - in large part in reaction to falling earnings - Mr. Brody's portfolio rose.
Mr. Brody was not alone. A relatively small group of mutual funds anticipated that the Reagan presidency meant the economy would shrink and inflation would be tamed. Disinflation is a term economists use to define a reduction in the general level of prices. It's the opposite of inflation, or rising prices.
A. Michael Lipper, the president of Lipper Analytical Services, a New York-based research firm, notes that most of the best-performing stock-oriented mutual funds last year, and so far this year, have been those that invested for disinflation.
As of May 27, Lipper found that the net asset value of the average growth fund (focused on capital gains) with dividends reinvested, was down 6.01 percent for the year. However, the top of these equity funds, investing in utilities and disinflation stocks, were up about 8 to 10 percent. And last year the average growth fund dropped by 2.76 percent, while the top funds rose by 8.75 percent.
At Value Line, the disinflation strategy was applied to four of the mutual funds it manages. Mark Tavel, research director at Value Line, says the strategy was prompted in 1979-80 by a feeling that, if inflation continued to get worse, ''it would be useless to hold any financial assets other than commodity plays. We felt the people just would not stand for letting inflation continue.'' Thus, the fund began structuring its portfolio to deal with the slowing of inflation - as caused by the recession and the policies of President Reagan.
What this meant for the fund was investment in companies that would benefit from lower commodity prices and whose unit volume was growing. This sales growth allowed the companies to avoid getting squeezed by other rising costs. Thus they invested in such companies as Nabisco Inc., Pepsico Inc., and Dillon Companies - all in the food, beverage, or utilities businesses.
Utilities, says Mr. Brody, whose fund has invested 25 percent of its $30 million in assets in electric utilities, see their earnings and dividends rise even during recessions.
''They have a high yield,'' he adds, ''and they aren't very vulnerable to stock-price declines.''
Such investments helped limit losses for American Growth Fund. It is only off 0.4 percent since the beginning of the year. In fact, so far, two of the year's best-performing equity mutual funds tracked by Lipper were the Franklin Utilities Fund, up about 9 percent, and the Chancellor Tax Managed Utilites Fund , up about 10 percent.
Naturally, not all of the best performers were investing for disinflation. The IDS Progressive Fund, which is up nearly 9 percent so far this year uses puts and calls to hedge its risks. The IDS fund was also heavily invested in aerospace and airline stocks, both of which performed creditably.
Another mutual fund, the NEL Growth Fund, up over 8 percent, was only partially invested in disinflation stocks. It also bought retailing and insurance stocks.
Mr. Brody's American Growth Fund was bolstered when it tendered 50,000 shares of its Financial General Bankshares to a group of Arab investors who took over the Washington, D.C.-based bank. The fund had bought the shares originally for $ 7 a share, and sold them for $33.80 a share.
In May the disinflation strategy unravelled a little bit as interest rates rose and utilities stocks, sensitive to fluctuations in rates, started to weaken. However, adherents of the strategy say they aren't worried.
Mr. Brody comments: ''The policy of disinflation will continue as long as Ronald Reagan is in the White House. Inflation is not something that can be wiped out overnight, and the Reagan administration will continue to work on it as long as it's in power.''
Mr. Tavel at Value Line believes inflation will start to reappear again, but in much more moderate doses. ''The CPI may run at 6 to 7 percent once the economy strengthens,'' he comments, ''but that compares to 15 percent the last time the economy was strong.'' Mr. Tavel doesn't believe the economy will get back to full recovery for at least another year.
Fred Frankel, an economist at E.F. Hutton & Co., a brokerage house, agrees: ''Probably the best news about inflation is out already,'' he says. But he adds, ''I think the disinflation psychology will basically stay intact.'' He notes that workers, now used to lower inflation, are asking for lower wage increases. ''This is good news for disinflation,'' he concludes.