One on one: "I don't see any reason why bond prices would go down a lot"

Feb 14, 2000 @ 12:01 am

By Sarah O'Brien

Despite skyrocketing returns delivered by the technology sector last year, the manager of Baltimore-based T. Rowe Price's Spectrum Income and Growth funds still believes in the virtues of portfolio diversification.

Ned Notzon's funds -- and the Spectrum International fund -- offer investors a simple way to diversify without putting too much thought into exactly what market sectors they should be in: they invest in other T. Rowe funds. And while that means Mr. Notzon, 54, can't directly pick stocks and bonds, the system suits the affable 11-year T. Rowe veteran just fine.

"I like it," he says. "I can't go tell a manager what to do, but I do have a lot of information on what he's done."

Even with that information, he doesn't make unilateral decisions. Once a month, an investment committee meets to determine if changes need to be made in positions. And thus far, relying on his peers' expertise has worked well.

Spectrum Growth invests in eight long-term funds and a money market portfolio. Spectrum Income invests 50% in three domestic investment grade funds and 50% in four other bond funds, a stock fund and cash.

Spectrum Income, meanwhile, remains popular among fixed-income fund watchers. Though it can invest up to 25% in equities, its weighting at yearend was just 11%.

Q You have your eye on a lot of different sectors. Where do you anticipate the most strength this year in the stock market?

A This is a tough year in which to make that judgment because the equity markets have been so strong that you could see some sort of a correction this year. But, you might not. If you're just looking for sectors that are probably undervalued, the most obvious candidates are international stocks, which for many years, until last year, underperformed domestic stocks to the point that their relative valuations made them appear much less expensive. You could make somewhat the same comments about small-cap growth stocks.

Q Have you changed your weightings to reflect this?

A We had been overweighted in small-cap growth for a couple of years. We've increased our allocation [2 percentage points]. But that was to reflect the fact that the sector holdings had actually gone up [2.5 percentage points] just from outperforming other sectors. We either could have taken our profits off the table and rebalanced back to our previous target weighting or we could have moved the target to where the new asset values were, so we moved the target.

Q Some analysts say that because there is so much strength domestically it's not worth the risk to include international stocks in a portfolio. What's your take?

A Well, I don't have anything against someone who says "I'm going to put all my money in the U.S. domestic market and be broadly diversified." But a lot of the foreign companies, statistically, behave differently from U.S. stocks. If you look at the total returns, the statistical correlation is about 0.65. It's quite low. This means that even though international stocks are somewhat more volatile than U.S. stocks, you can put 20% or 30% of your money in foreign stocks and not increase the volatility of your overall portfolio. We include international in our long-term allocation because we think diversification is a virtue.

Q Diversification actually resulted in lower returns last year. How would you convince an investor that diversification is still a good thing?

A Well, I wouldn't. If someone wants to have a certain percentage of their portfolio in really aggressive sectors, that's fine. But say an investor had a mix of 80% across the whole market and 20% in technology, and then finds that technology is now 35% of their holdings, I think they ought to think about whether they want to rebalance back to their original risk tolerance.

Q How are weightings distributed for the Growth Fund?

A We have two (large-cap) value funds, the Equity Income Fund (13%) and the Growth & Income Fund (13%). We have two domestic growth funds, the Growth Stock Fund (10%) and the Blue Chip Growth Fund (9.5%). We have a small-cap growth fund, the New Horizons Fund (23%), and a Mid-Cap Value Fund (4%). We also have a natural resources fund, New Era (2.5%). And then there's the International Stock Fund (25%). We also have a money fund, whose current allocation is zero. The Spectrum Growth Fund has less volatility than any of the sectors we invest in. When one sector's doing well, another's volatility may be canceled out.

Q What about the bond market? After being hammered last year, do you think things will improve this year?

A I think interest rates are likely to increase moderately. Bonds are good long-term investments for people who want to get a large income. They're also good at dampening the volatility of your portfolio. That's the principal virtue of the bond market going forward, for the next year. I don't see any reason why bond prices would go down a lot. We have a very strong economy and there are more reasons to think that the Fed will continue tightening until they are comfortable with the strength of the economy.

Q How often do you shift weightings in the Growth Fund?

A The same committee meets once a month. Most of the time we adjourn without making any changes. Three or four times a year we decide to move something. Generally it's not very much, 1 or 2o percentage points.

Q Coming on the heels of the high returns of tech-oriented funds, have you seen any money flow out of either of the funds?

A Yes, lately. When the stock market has done really well, frequently we see withdrawals as people rebalance their portfolios. More recently we've been seeing some withdrawals from people who are retiring and rolling over into some other vehicle.

Spectrum Income has been having some withdrawals for the last few weeks -- $2 million or $3 million a day, which is not particularly troublesome.

I suspect people are rebalancing portfolios, but I'm not sure. It could be that people say, "Boy, did you see how small-cap growth stocks did -- I'm going to put all my money in small-cap growth."

It could be that people are moving into a sector that they want to be in, it could be people rebalancing, it could be people retiring.

Q Could it show there might be some fear about the bond market?

A A rational reason would be that "the economy is strong and interest rates are going to go up, so the bond market is not where I want to be."

The only problem with that is that if the stock market is overvalued and there is a correction, you could lose more money in the stock market than in the bond market.

Q Do these funds give you enough latitude in where you think money would be best invested?

A I think there's a huge amount of latitude. We started with seven funds [to pick from] and then a couple years ago we added two more funds. They're really in all major sectors of the market. There may be some specialty sectors that an investor might be particularly interested in, but you're getting a lot of exposure to that anyway from the funds we already have you in.


Edmund M. Notzon, 54, managing director, T. Rowe Price Associates Inc. in Baltimore.

T. Rowe Price Spectrum Growth (assets $3.03 billion): year-to-date return, -3.67%; 1-year, 21.2%; 3-year; 15.49%; 5-year; 19.49%

Morningstar large-blend funds: ytd,

-4.2%; 1-yr, 19.47%; 3-yr, 22.62%; 5-yr, 23.89%

T. Rowe Price Spectrum Income (assets $2.55 billion): ytd, -1.26%; 1-yr,

-1.11%; 3-yr, 5.73%; 5-yr, 8.37%

Morningstar mutltisector bond funds: ytd, -0.95%; 1-yr, 2.55%; 3-yr, 4.02%;

5-yr, 7.57%

Source: Morningstar Inc.


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