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Shares Are Too Tempting Not to Bite

Jonathan Cheng

Apple Inc.'s surging shares have prompted hundreds of mutual funds to buy the stock—including many that aren't expected to invest in a giant, U.S.-based technology company that pays no dividends.

At least 50 small-cap and midcap mutual funds—which focus on small and midsize companies—own Apple, the world's largest company by market value, according to analyses for The Wall Street Journal by market-data firms Morningstar Inc. and Ipreo Holdings LLC. Non-U.S.-focused funds also own it. Apple doesn't pay a dividend, but about 40 dividend-focused funds hold its stock. And Apple shares can be found even in one high-yield bond fund.

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Although such moves are permitted by securities rules and have so far paid off because of Apple's successes, they could expose investors to unexpected risks should the company falter. They also underline the leeway given to fund managers when choosing investments even when they explicitly contradict their stated objectives.

"It would clearly be inappropriate for a midcap fund to hold Apple. You've got to say that manager is violating his reason for being," says John C. Bogle, founder of Vanguard Group. "I can't help but believe that is going to end up in disappointment for his shareholders. I don't know when, but it will."

The reason Mr. Bogle and others are concerned: Many investors in these funds may not realize they have exposure to Apple, and indeed may have invested in the funds to get exposure to a different segment of the market. Investors' concentration in Apple raises the risk that a big reversal in its shares would reverberate beyond the technology sector.

Apple's popularity with investors of all stripes is a testament to its historic climb. The stock has soared nearly sevenfold since its March 2009 lows. In the past year alone, Apple has jumped 61% to close Tuesday at $568.10 a share, an all-time high. The gains helped push the Nasdaq Composite Index, where Apple is the largest weighting, to close above 3000 on Tuesday for the first time since late 2000.

Robert S. Bacarella, president and portfolio manager at Monetta Mutual Funds in Wheaton, Ill., targets companies of up to $10 billion in market value for his Monetta Mid-Cap Equity Fund. He made an exception for Apple.

"I'm going to hold it until it gives me a reason not to," says Mr. Bacarella, whose firm manages about $100 million. "If you have a good company, why shouldn't you let it run?"

Under a 2001 securities rule, managers like Mr. Bacarella can apportion up to 20% of their portfolios to investments that aren't part of their mandate. Funds discuss this flexibility in their prospectuses, which are published online, and disclose their holdings in quarterly reports. But few investors read them, and some financial advisers admit they don't always scrutinize quarterly updates.

If they did, they would find some of the biggest names in investing have reached beyond their stated focus. BlackRock Inc.'s $5.9 billion High Yield Bond Fund held Apple shares worth $8.3 million at the end of 2011, according to Morningstar. BlackRock declined to comment.

Fidelity Investments manages three Europe-focused stock funds that hold Apple. A spokeswoman declined to comment. Goldman Sachs Asset Management's U.S. Equity Dividend and Premium Fund holds Apple as its largest position. A Goldman spokeswoman said the fund holds "some stocks that pay no dividend."

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"I have no idea how a fund manager even justifies that," says Timothy Parker, an investment adviser in Midland Park, NJ. "Is Apple a great company? Yes. Is it a good stock? Yes. But that is not what I'm hiring you to do."

Managers of dividend funds argue Apple may soon pay a dividend, given its $100 billion in cash and signs from Apple chief Tim Cook that he would be more amenable to a payout than his predecessor. Judith Saroyan at Eaton Vance Investment Managers bought Apple shares for two dividend-focused funds. She believes the company will pay a dividend within six months.

"Apple is a great company, it's well-managed, and if they do pay a dividend, they'll bring in a whole new set of investors," Ms. Saroyan says.

At New York firm Cohen & Steers, which manages $41 billion in assets, fund manager Richard Helm says he too is "trying to get ahead of a dividend," adding Apple to the Cohen & Steers Dividend Majors Fund and the Cohen & Steers Dividend Value Fund.

Many fund managers are joining a bet that hundreds of others are making—that Apple will continue to churn out ever-more-popular consumer gadgets, driving up revenue, profit and ultimately, its share price.

About one-third of all U.S. stock mutual funds own Apple's stock, up from 21% five years ago, according to Morningstar. One in five hedge funds holds Apple among their 10 largest bullish positions, according to Goldman Sachs . Of the 54 analysts that follow Apple, just two recommend selling the stock, according to Thomson Reuters.

Some investment advisers worry about the impact if Apple cools off. "Yes, these funds may have performed well, but things could just as easily have gone the other way," says Andrew Feldman, a Chicago-based registered investment adviser. "When you're holding things that you shouldn't be and they're doing great, there's no problem. But when it fails you're going to have a lot of very upset people."

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Chace Brundige, portfolio manager at Waddell & Reed Financial Advisors, says Apple's growth is why the stock is the largest in his two international growth funds. The funds together have about $750 million in assets and are tasked with investing primarily in stock of foreign companies.

Mr. Brundige says he initially planned to buy Asian suppliers to Cupertino, Calif.-based Apple, but decided it was simpler to own Apple itself. He says his investors understand the company fits within his global perspective: "If the stock is down 40% in a flat market, though, then we'll get a lot of pushback."

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