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- Alan Lavine and Gail Liberman

One reader writes that he is worried because his stock fund owned Enron.

Enron went belly-up and the stock, now almost worthless, dropped from more than $90.75 in August. It marked the largest bankruptcy in corporate history.

No need to worry. One stock should not hurt the overall return of a well-diversified mutual fund--as long as your fund has a good long-term track record.

The average diversified stock fund owns about 140 stocks, according to Morningstar Inc., Chicago.

What about the fund manager? Did he or she screw up by owning Enron? Not really. Jonas Max Ferris, editor of Maxfunds.com, says Enron and Arthur Andersen, the company's auditor, deceived investment pros. The auditor puts a stamp of approval on a company's financial statements as being accurate. The people who analyze the information assumed it was reliable because it was audited.

"Most fund managers run portfolios with hundreds of stocks," Ferris says. "There is no way to know exactly what is going on behind the numbers. The managers rely heavily on data and analysis provided by many sources. This information gets the stamp of approval by accounting firms, who are supposed to represent the numbers honestly and independently."

Nevertheless, the pros were fooled. Let's hope they learned a lesson. We are relying on them. But why didn't they spot the problems? One money manager did in 2000.

James Chanos, a hedge fund manager that manages money for wealthy investors, smelled a rat and "shorted" the stock. In other words, unlike almost everyone else, he invested to profit when the stock dropped in value. Chanos said in a recent report in Barron's that Enron was engaged in some unusual activities. They included:

  • Boosting profits by reporting gains on long-term energy contracts that would not occur for years.

  • Eighty percent of the company's current earnings came from risky trading in energy futures.

  • The company was dumping assets into partnerships footnoted in the company's financial statements. These assets were later deemed to be unprofitable.

    The lesson from the experience: Don't bet the ranch on a single hand. Stick with stock funds that own a large number of stocks in different industries.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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