SHELLSHOCKED BY THE MARKET? HUNKER DOWN FOR NOW IN A CASHRICH VALUE FUND

Sometimes, investing is hell. Take January. PLEASE! It began with a record-breaking charge past 2800 on the Dow. But battered by rising rates and earnings disappointments, the index ended the month off 5.6%. Meanwhile, the average equity fund dipped 6.3%. Unnerved? Who could blame you?

Unless you want to flee the market entirely — which is counterproductive in the long run — your best buys now might be value-oriented equity funds holding defensive cash levels of, say, 20% or more, compared with 10% to 11% for the average fund. Such funds won’t be spared entirely from losses in rough times. But by keeping your money in a cash-heavy fund, you let a pro decide how aggressively to play the market. Further, such funds are better able to capitalize on the opportunities that weak markets create. Says Kurt Brouwer, president of the San Francisco money-management firm Brouwer & Janachowski: “A fund manager with a lot of cash has the firepower to go after the bargains out there.”

In the table above, you’ll find a selection of five funds with strong long-term records and recent cash positions of 20% or more. All follow a value-oriented investing style (as do the two funds covered in this month’s Fund Focus on page 44). “Value managers concentrate on stocks that are out of favor,” explains Kenneth Gregory, co-editor of the newsletter L/G No-Load Fund Analyst, “so they tend to hold up better than others in a general market sell-off.” Here, in alphabetical order, is a closer look:

Gabelli Asset (800-422-3554; 1% redemption fee for the first year) is managed by Mario Gabelli, the 1980s champion among value-oriented money managers. The fund is only about four years old. but Gabelli’s privately managed portfolios scored more than 25% annualized for the five years through 1989, compared with 20.4% for the S&P 500. A traditional value investor. Gabelli shuns market and economic forecasts and invests whenever he can find bargains — and when he can’t, he stays in cash. Now. though, he is pulling some of his cash stash back to work in two low-priced media stocks, Affiliated Publications and Media General. Gabelli Asset requires a steep minimum investment of $25,000 but will accept as little as $2,000 in an IRA.

GIT Equity-Special Growth (no load; 800368-3195) has produced a market-beating 21% annualized return over the past five years while taking below-market risks. Manager Richard Carney looks for stocks of small companies with low debt, swift earnings growth and an entrenched position in a profitable market niche. Two examples: lubricant maker WD-40 and FlightSafety International, which trains pilots on flight simulators.

Minneapolis-based IAI Regional (no load; 612-371-2884) puts at least 80% of its assets in fast-growing, generally medium size companies with headquarters in the north-central states. Example: Minnesota’s St. Jude Medical, a manufacturer of mechanical heart valves. Such companies appear well insulated from the recessions in finance and high technology that are rattling the East, says manager Bing Carlin. Over the past five years, Carlin’s invest-in-my-own-backyard style has earned a compound annual return of 20%.

Portfolio manager Diane Jarmusz of Oppenheimer Total Return (4.75% load; 800525-7048) looks for stocks selling at price/earnings ratios that are only half the companies’ growth rates. Jarmusz now has her eye on international engineering and construction firms like Morrison Knudsen.

With a 17.7% compounded annual return, Pennsylvania Mutual (800-221 -4268; 1 % redemption fee for the first year) ranks in the top 30% of all stock funds over the past 10 years, even though it places 36% below average in volatility. Fund managers Charles Royce and Thomas Ebright concentrate on small company stocks selling at a low multiple of cash flow. Two such: credit authorization firm Telecredit and mobile-home maker Fleetwood Enterprises.

FROM THE FOLKS WHO BROUGHT YOU JUNK BONDS — JUNK LOANS

In the past six months, investors have poured close to $3 billion into a heavily promoted new brand of mutual fund known as prime-rate trusts. And why not? Judging from their sales literature, the trusts are nothing less than high-powered versions of money-market funds that happen to deliver yields equal to the prime rate — the banks’ benchmark interest rate, currently 10%.

Now the facts: a) the funds are not nearly as liquid as money funds are, b) yields at four of the five funds have so far fallen short of the prime and c) they’re generally a lot riskier than the brokers are letting on.

Technically, the prime-rate trusts (see the table at right) are closed-end funds that buy up pieces of commercial bank loans known as loan participations. Unlike other closed-ends, however, the primes don’t trade on the stock market. Instead, on four preset dates a year (which vary by fund), the sponsor offers to buy back shares from investors at net asset value, minus a first-year redemption fee. typically 3%. That’s a far cry from money markets, which grant you daily access to your cash.

On top of that, as noted, four of the funds have yet to match the prime. One reason is that their own stiff expenses — typically around 1.4% of assets per year, compared with 0.65% for the average money-market fund— siphon income away from shareholders. And the largest of the breed, the Merrill Lynch Prime Fund, has had difficulty finding enough corporate loans to absorb the $1.7 billion it raised when it was launched last November. With 58% of the portfolio languishing in T-bills and corporate paper, its January yield was 8.55%. That’s less than half a percentage point higher than the average money-market fund.

Whether the funds can deliver even a below-prime yield without risking principal is a stickier question.

True, the funds so far have been able to repay redeeming investors at an unwavering $10 a share. But loan participations trade infrequently, allowing a fund to cling to what may actually be an inflated net asset value. If a fund were forced to mark down its share price, it would be a rude shock for shareholders.

Such an occurrence is more likely than most prime-fund shareholders probably suspect. To earn a yield that approaches 10% after expenses, the funds have to invest in loans to low-rated companies that must pay above prime to borrow. Some of the borrowers have already stumbled.

For example, 20-month-old Pilgrim Prime Rate Trust, the only prime fund around long enough to have published a shareholder report of its holdings, owns loans to two troubled firms: Interco and Southland. While the loans have not traded, junk debt specialists estimate that they are worth no more than 80¢ on the dollar, judging from the prices on the companies’ bonds. Pilgrim retorts that as long as the companies continue to make timely interest payments, the fund has no reason to accord their loans anything but full face value.

In further defending their portfolios’ credit quality. Pilgrim and other sponsors emphasize that they buy only senior collateralized loans. In a bankruptcy, this gives the fund first claim on specific assets that the borrowers pledged when they took out the loans. But when a company goes belly up. the collateral often turns out to be worth substantially less than expected. For example, when Seaman Furniture restructured last fall after a 1987 buy-out. banks had to settle for 62e on the dollar plus stock of indeterminate value. ” ‘Senior’ does not mean ‘riskless,’ ” says Prudential-Bache senior banking analyst George M. Salem.

Conclusion: prime-rate funds may be too much worry for too little yield. Jonathan Pond, editor of Riesenberger Mutual Funds Investment Report, suggests that you instead lock in a reasonable rate with a federally guaranteed certificate of deposit — recently paying around 8.3% for two-year maturities. Says he: “I could sleep a lot better with a CD than with a prime-rate fund.”