Highlights and Commentary

By Roy Weitz

(Originally posted March 1, 2000) [Archive Table of Contents]

Three years, and little to show: Over the past 36 months, a total of 196 funds in the FundAlarm database have posted a negative total return.....In three of our Specialty fund categories -- Metals, Natural Resources and Real Estate -- a negative three-year return is common, and it was even possible to outperform the benchmark with a negative return.....But in all of our other categories, a negative return simply meant that you lost money.....Here's how this month's database breaks out, by category:

Benchmark category	Total # of funds*	# of funds with negative 36-month returns*
Large-cap	1062	1
Mid-cap	305	12
Small-cap	216	18
Balanced	252	2
International	507	59
Specialty:
Communications	14	0
Financial	28	1
Health	34	1
Metals	31	31
Natural Resources	41	22
Real Estate	58	49
Technology	50	0
Utilities	77	0

* In existence at least three years
The accompanying page lists each fund in each category with a negative 3-year return.


Why is a skunk better equipped than a value-oriented fund manager?....A skunk that finds itself in a hostile environment can shoot off a stink bomb, while a value manager can only shoot off a report to shareholders.....For traditional value managers, 1999 was one of the most hostile environments in recent memory.....Several well-known value managers have released their 1999 year-end reports, and we were struck by their very different styles....James Gipson, of the Clipper Fund, sees doom just around the corner, and he almost seems to welcome the possibility.....Robert Sanborn (Oakmark Fund) comes across as a bit STRESSED OUT, but he's still punching away, grappling head-on with investor concerns.....David Dreman (Kemper-Dreman High Return Equity) seems eager to get back to his yacht -- haughty, and slightly peeved that he's required to defend himself.

Value Manager/ Fund Name	1999 Return (%)	Representative quote from the manager's most recent report	Manager's role model
James Gipson/ Clipper Fund	-2.85%	" 'The end was at hand but was not in sight': J.K. Galbraith's description of the stock market's peak in 1929 probably will apply this time too."	Chicken Little
Robert Sanborn/ Oakmark Fund	-16.66%	"Some would say [the old method of determining stock value] is dead and that one must not use "traditional" valuation measures to value the "New Economy" companies...Hogwash!"	Paulie Ayala, WBA Bantamweight champion
David Dreman/ Kemper-Dreman High Ret Eqty A	-15.38%	"The fund stayed true to its contrarian value strategy, while other funds in its peer group altered their discipline to invest in the high-flying growth and technology stocks"	God

Contrary to what you might read, even on the FundAlarm Discussion Board, Gipson and Sanborn are not morons.....Both of their reports make for interesting -- even important -- reading.....(Dreman is also not a moron, but his report is extremely boring) "The Doomster" Gipson's report
"Scrappy" Sanborn's report


Why do they do this to themselves? The S&P 500 index isn't as high-flying as it was a few months ago, but it's still the benchmark that large-cap value managers love to hate.....But if managers like Gipson, Sanborn, and Dreman hate the S&P 500 so much, why do the prospectuses for each of their funds still show it as the "official" performance benchmark?.....Your first reaction might be, "Because the SEC requires it," but that's not true.....A fund has considerable latitude when deciding which benchmark to use, and the only SEC requirement is that a fund's official benchmark be an "appropriate broad-based securities market index".....Well, then, maybe value funds are stuck with the S&P 500 index as a benchmark because they've used it in the past?.....Also not true: According to the SEC, if a fund wants to use a benchmark index that's different from the one it used for the preceding fiscal year, all the fund has to do is "explain the reason(s) for the change and compare the Fund's annual [performance] with [both] the new and former indexes".....In other words, if Gipson, et al., wanted to use a more value-oriented index as their benchmark, they could easily do so.

What accounts for the persistence of the S&P 500 as a large-cap value benchmark?.....One possibility, of course, is masochism, but it seems unlikely that all three of these managers (and the hundreds of other value managers who continue to use the S&P 500) suffer from a common neurosis.....More likely, we think, is something value managers don't want their investors to know: For all its faults, the S&P 500 is still the premier large-cap index, and it's the standard that even value managers know they have to beat in order to be taken seriously.....There's probably something else going on here, too: Many of the leading value managers have outperformed the S&P 500 in the past, and they're probably confident that they can do so again.....If they change the benchmark to one that seems easier to beat right now, they just might be shooting themselves in the foot.


Perhaps the most unappealing lead-in to a financial story that we've ever seen:

From "Get Your Portfolio Moving Again" "How Many Mutual Funds Do You Need?", iVillage.com


Goose me once, then goose me twice, then goose me once again: Over the past couple of years, many mutual funds have goosed their returns with initial public offerings (IPOs).....Now, a new goosing technique is beginning to attract the attention of fund managers.....It's called the "PIPE deal"....."PIPE" stands for "Private Investment in Public Equity," and it's a relatively simple concept: In exchange for committing to a large block of publicly-traded stock, fund managers (and other large investors) get those shares at less than market price.....For example, in one recent PIPE deal involving shares of NPS Pharmaceuticals, four fund companies (Janus, Putnam, AIM, and Invesco) picked up shares at $12 each.....At the time, NPS stock was selling for about $16 on the open market.....In another recent PIPE deal, Janus picked up almost $1 billion of Healtheon/WebMD shares at about a 7% discount.

Companies like to sell shares via PIPE deals because they don't have to pay underwriting fees, and fund managers like the deals for the obvious reason: An instant goose to share value.....Well, almost instant.....PIPE deals must be approved by the SEC and, during the approval period (about a month), the acquiring fund is locked into the PIPE shares at the agreed-upon price.....During the lock-up period, it's possible for the market price of the PIPE shares to drop below the contract price (yes, it really is).....In that case, the fund will have negotiated a nice loss for itself.

Fund managers are already reluctant to announce their stock purchases, and PIPE deals are no different.....In fact, as PIPE deals become more common, fund companies might have even less of an incentive to make timely disclosure of their new holdings.....It's bad enough to announce that you've bought XYZ Company at $15 a share in the open market, only to see it drop in the next few days....It's even worse to lock yourself into some big-time PIPE deal at $15, and then be under water by the time you finally get your hands on the shares.....Timely or not, it will also be interesting to see if fund companies start disclosing the existence of PIPE deals in their ads and prospectuses.....It seems clear to us that they should, but it may take a little SEC slap on the wrist to get their attention.....And that could take years.

Initial reaction to PIPE deals has been generally positive ("Oh, goody, fund investors can finally get a piece of the big-boy deals!").....But we're not so sure.....Fund managers tend to be intensely competitive people, with intensely large egos.....Soon, every manager of a small- or mid-cap fund will want to do his or her own PIPE deal, and the favorable price spreads for the smaller deals will start to shrink.....At that point, only the largest PIPE deals will offer attractive spreads, and the risks will increase accordingly.....Eventually, something will happen that catches all PIPE-dealers by surprise, at which point everyone involved will say how stupid they were, and vow never to do it again.....In the meantime, investors are saddled with another layer of undisclosed risk.
"'Pipe" Deals Bring Fund Investors Hot Stocks at Bargain Prices," Ian McDonald, TheStreet.com, February 16, 2000


Hey, where's my goose? The average high-yield bond fund has returned 2.17% over the past 12 months, but the range of returns is huge: From a high of +21.29% (for Third Avenue High Yield), to a low of -15.49%, for Pilgrim High Total Return II (A,B,C).....Many long-suffering bond fund investors aren't going to complain about an above-average return, but some may be interested in how it was achieved.....According to a recent article,* several high-yield bond funds have recently boosted the percentage of common stocks in their portfolios, and that has resulted in equity allocations (often technology stocks) that now consistently exceed 5% to 10% of total assets.....The accompanying page lists 150 of the largest high-yield bond funds, and their respective 12-month returns.....If your fund returned significantly more than the group average, you might want to take a closer look at how it did so.
* "Excuse Me, Sir! But There Are Tech Stocks in My Bond Fund," Pui-Wing Tam, The Wall Street Journal, February 14, 2000




Manager's Brain to Leave Fund, Body Will Remain

Source: Investment News

NEW YORK ----- Craig Ellis, manager of Orbitex Info-Tech and Communications Fund, recently announced the formation of a private hedge fund that will invest in most of the same stocks owned by his mutual fund. Mr. Ellis, who does not intend to resign as mutual fund manager, expects to run his hedge fund out of the same office building.

According to industry sources, the proposed arrangement subjects Mr. Ellis to at least two potential conflicts: The amount of time and attention he devotes to each fund, and the stocks he chooses to allocate to each portfolio. Wall Street insider Tony refers to the first problem as "brain float," and he predicts that Mr. Ellis "is gonna have it real bad. It may look like he's sitting at his desk, managing the mutual fund, but his brain's gonna be floating down the hall to take care of that hedge fund."

Tony believes that the second conflict facing Mr. Ellis could be even more troublesome. "Unless this guy's been to divinity school," said Tony, "he's gonna be tempted to put the hot stocks where they can do him the most good, and that means the hedge fund. On second thought, I don't care if he's a saint. The guy is gonna have a problem."

Officials at Orbitex expressed little concern about the proposed arrangement. According to John Davidson, chief investment officer, "we feel the arrangement with Craig is beneficial not only to him, but also for Orbitex and fund shareholders. It is also not that unusual as there is a growing number of such arrangements."

When asked to respond to Mr. Davidson's comments, Tony expressed surprise. "You're kidding me, right? Did he say if he had any job openings?"


What's wrong with this picture?
The left-hand part of this graphic (in purple) comes from the Berger funds Web site, and it shows the "risk/reward potential" of the 12 Berger mutual funds.....The numbers on the right (in black) were added by FundAlarm, and they show the most recent 12-month returns for the same funds.....This type of chart is fairly common, and most investors are probably familiar with it....According to Berger, the fund at the top right (Information Technology) has the potential for the highest return, but it also has the greatest risk.....The Balanced fund, at the lower left, is considered to have the least potential for return (aside from the Money Market fund), but it should also offer the lowest risk.

Unfortunately, over the past 12 months, this chart has been useless.....The Balanced fund (with a 38% return) has significantly outperformed three of the "riskier" funds above it, while Mid Cap Growth (in the middle of the lineup, at 137%) has outperformed every other fund, above or below.....Charts like this are only rough approximations of reality, and there will always be oddball results.....But even for a 12-month period, these numbers strike us as a fairly dramatic wake-up call -- and we're sure that the risk/return relationship is also out of whack at other fund companies.....Berger has done a decent job designing this chart, and we don't think the chart needs to be revised.....It's much more likely that the market will put these funds back in line.


He came, he saw, he fell into the trap: Here's what Bob Markman, fund-of-funds manager, had to say about the investment scene in October 1996:

"..[I am] extremely disturbed by the almost irrational preoccupation with upside potential and the near total disregard on the part of the investing public for downside risk..."

Today, Markman has an almost irrational preoccupation with upside potential (he buys only large-cap growth and technology funds), and he displays a near total disregard for downside risk (he no longer believes in diversification across asset classes).....But let's give Markman some credit: Three years ago, at least, he knew a foolish investor when he saw one.


Rubber Stamp University? David Ruder, a former SEC chief, has founded an organization that will provide education and other resources for mutual fund directors*.....Ruder has a quaint notion that independent fund directors have a primary responsibility to fund shareholders, rather than fund management, and that's one of the messages he hopes to get across in his classes.....Ruder's biggest problem right now is funding: He says that he won't accept support from mutual fund companies, and the mutual fund trade association is unlikely to help, so he's trying to raise cash from a variety of mutual fund hangers-on, such as custody companies, financial publishers, and accounting firms.....Ruder's school is also likely to need some of the other accouterments of an educational institution, such as a motto, a mascot, and a fight song (preferably non-confrontational).
*"Former SEC chief starts a fund directors school," Michael Fritz, InvestmentNews, February 21, 2000


Wait! We've got the mascots for Ruder's school!


Follow Up:

• In October 1999, Vanguard started publishing tax-adjusted performance numbers for all of its stock and balanced mutual funds.....At the time, Fidelity said that its investors weren't interested in such information, and Fidelity had no "immediate plans" to make it available.....Well, Fidelity investors must have gotten on the phone all at once -- or else Fidelity heard that the SEC was likely to announce its own rules (which it is)......In February, Fidelity announced that after-tax returns for most of its funds, as well as most funds sold through its fund supermarket, would be made available on the Fidelity Web site.....Janus, the other big-three fund company, continues to drag its feet.
  
  
  
• In December 1999, we wrote about bank loan funds, and how Van Kampen refused to value its loan funds (such as Prime Rate Income Trust) using outside pricing services.....Van Kampen recently announced that it will start pricing about one-third of its loans through an outside service.....After a respectable (and face-saving) wait, Van Kampen is likely to price its entire portfolio through outside services, just like almost everyone else.
  
  
  
• In January, we ran a brief item about "hire-out" funds, and FundAlarm readers reminded us that we had overlooked two hire-out families: Idex and Reserve.....(For those who don't recall, hire-out funds are basically administrative and marketing shells, which delegate money management duties to outside firms instead of in-house employees).....This month's FundAlarm database contains 20 Idex funds and, overall, they have outperformed their respective benchmarks in 75% of their measurement periods -- a very impressive result.....But it also helps to remember that 12 of these Idex funds are managed by Janus (the "JCC" in "Idex JCC"), and Janus is one of the hottest fund managers around.....Our database contains only 4 Reserve funds, but they have also posted some excellent numbers, beating their benchmarks in 9 out of 11 measurement periods (or 82% of the time).

"If you want an investment with the EKG of a dead person, buy Treasury bills"

---Tom Fitzgerald, manager of Reserve Informed Investors Growth. As the quote suggests, Fitzgerald is not overly sympathetic to investors who worry about risk. According to thestreet.com, he also has "total disdain for Wall Street research." We think we could like this guy.

We get showered with honors: Whenever FundAlarm is recognized by one of the major financial publications, we're not sure if it's appropriate to say "thank you"......"Thank you" sounds like they're doing us a favor, which is certainly not their intent, but then again they are, but they don't mean to, but that's the effect.....What the heck: Thanks to Forbes for naming us the top site in the Mutual Fund Selection category and, once again, a "Forbes Favorite".....Wayne Harris, writing in the April issue of Mutual Funds magazine, selected FundAlarm as one of four "great Websites for fund investors".....Finally, the leading consumer testing magazine (which must remain nameless) liked our "peppy acceleration," but said that we could use a little more rear legroom.....Oops, wrong issue.....In the annual mutual funds issue, this consumer magazine selected FundAlarm as one of the top "research and screening tools" for mutual funds.


Briefly noted:

• Sometimes, it seems, everyone is doing it: Behind those drawn curtains, in the office, maybe even in that parked car.....But when you actually look at the numbers, technology funds (and the people who invest in them) still represent only a tiny portion of the overall mutual fund market.....By our calculation, all U.S. stock and balanced funds recently held about $3.7 trillion in assets, while all technology and communications funds held about $126 billion.....In other words, all those tech funds that you hear so much about account for only about 3.4% of total mutual fund assets.....To put things in perspective, the State of Michigan is home to about 3.4% of the U.S. population.....Granted, Michigan isn't as hot as the Firsthand funds, and Governor Engler doesn't have hair like Ryan Jacob.....But next time you start feeling like you're the only one who doesn't invest in tech funds, consider how many people you know who don't live in Michigan.*
  * Michigan residents, please substitute Connecticut and Virginia
  
  
• If the preceding pep talk doesn't help, try this anecdote from a recent column by Jason Zweig (Money magazine):
  
  

  "Abraham Lincoln liked to tell the story of a Middle Eastern ruler who asked his wise men to invent a statement that would be true in every place and at every time, no matter what happened. After mulling it over, they answered: 'And this, too, shall pass away.'" "Diversification overrated? Not a chance," January 26, 2000; for an archive of Zweig's sensible columns, see Selected Web links at the top of this page

  
  
• When it comes to IPOs, nobody should be surprised that the largest mutual fund companies receive the largest allocations.....After all, getting a piece of a hot IPO is just another way that good customers (i.e., mutual funds) are rewarded for their brokerage business.....What is surprising, however, is the hyper-aggressive way that Fidelity protects its turf.....Fidelity reportedly asks each IPO broker for twice the allocation of any other fund company.....If Fidelity doesn't get its double allocation, Fidelity threatens to pull its substantial brokerage business.....Janus and Putnam also wangle a disproportionate amount of IPO business.....Vanguard presumably could get a sizable chunk of IPOs, but it rarely asks for them.
  "Major Institutions Get Most Of the Hot Initial Public Offerings," Randall Smith and Suzanne McGee, The Wall Street Journal, January 27, 2000
  
  
  
• The way of the world:
  
  

  He threatens harm to a business unless he receives a cash payment. Goes to jail.

  He threatens harm to a business unless he receives a huge IPO allocation. Gets a bonus.

  
  
  
• Robert Zidar, co-manager of Merrill Lynch Internet Strategies, is mega-bullish on Internet stocks, and he recently assured investors that we are "absolutely not in a bubble".....However, Zidar does recognize that some Internet companies will not be successful.....In the case of these soon-to-be failures, Zidar acknowledges that current valuations "might be a little stretched."
  
  
  
• Might be stretched?
  
  
  
• In any event, Zidar raises an interesting issue, which is likely to become more relevant in the weeks and months ahead: How does one value a defunct dot-com company?.....If Internet investors scoff at applying traditional valuation measures to solvent dot-com operations, then surely they won't be satisfied applying traditional measures of value to bankrupt Internet companies.....Zidar claims that the best metric for measuring dot-com success is revenue and revenue growth, but he sheds little light on the best measure for dot-com failure.....We can envision several possibilities, but the most logical would appear to be some percentage of former revenue.....For example, a company going through bankruptcy proceedings might be valued "as if" it still earned 50% of its former revenue, while a company that has ceased to exist might be worth only 25% of what it previously earned.....As Zidar and his Internet-fund colleagues gain more experience with failure, they will undoubtedly develop better and more sophisticated metrics.
  
  
  
• Hambrecht & Quist Healthcare and Hambrecht & Quist Life Sciences are two closed-end mutual funds.....Recently, Life Sciences was trading at a 16% premium to net asset value, while Healthcare was trading at a 10% discount.....Since there's "not a dime's worth of difference" between the two funds, why are Life Science investors willing to pay almost 29% more for the same underlying portfolio of stocks?.....As far as anyone can tell, it's the name: Life Sciences has a biotech ring, Healthcare suggests bedpans.
  Sandra Ward, Barron's, February 21, 2000
  
  
  
• Did you know?.....250 stock and bond funds were liquidated during 1998.....In the first half of 1999 (the most recent data available), the number of vanishing funds jumped 74%.....In addition to the liquidated funds, another 387 funds were merged out of existence in 1998.....Among the fund families most active in the merger/liquidation game: AIM, Kemper, Prudential, Alliance, Invesco, Evergreen, and Van Eck.
  "Beware of Problem Fund Families," Alan Lavine, CNBC.com, February 24, 2000
  
  
  
• Europe is currently hosting its own version of America's technology/communications/Internet party and, in the midst of all the festivities, several European mutual funds look like pretty sad wallflowers.....Vanguard European Stock Index is a good example of a fund that isn't getting much action.....Unlike the Vanguard 500 Index fund, which participated nicely in the U.S. tech boom, European Stock Index doesn't hold enough of the big tech winners (Nokia, Telefonica, Mannesman, Vodaphone Airtouch) to overcome the drag of laggards such as Royal Dutch Petroleum, Amoco, and Roche*.....Over the past 12 months, 33 of the 40 European funds in this month's FundAlarm database have outperformed Vanguard European.....Over the past five years, Vanguard European rises to the top third of its European peer group, but a couple of funds -- Invesco European and Scudder Greater Europe Growth -- have dramatically outperformed the Vanguard fund over almost all periods.
  * "A Vanguard Fund Misses Europe's Party," Gregg Wolper, morningstar.com, February 22, 2000
  
  
  

• Andrew Cupps

  According to a recent article in The Wall Street Journal, revenue at Healtheon/WebMD, a dot-com company, might not be all that it seems*.....If you're in a charitable mood, you might describe one of Healtheon's largest revenue-generating agreements as convoluted.....If you're feeling cranky, you'd probably describe that same agreement as a shell game, designed to deceive potential investors.....Andrew Cupps, manager of Strong Enterprise, is a current Healtheon investor, and he falls into the category that might be described as Don't Worry, Be Happy.....Cupps acknowledges that Internet companies often face questions about revenue recognition.....But in the case of Healtheon's revenue (or alleged revenue), Cupps recently blew off a reporter's question....Cupps said that he didn't want to get swallowed up in "minutiae." * "Is Healtheon Pushing Limits on Revenue?," Robert McGough and Elizabeth McDonald, February 7, 2000

  
  
  
• There's nothing like the personal touch that comes from working for a large company.....Alliance Quasar fund got a new manager recently, and even Alliance can't figure out how to spell his name.....In the fund fact sheet, available on the Alliance Web site, the new manager is shown as "Mark Cunneen".....In filings with the SEC, he is merely "Mark Cuneen."
  
  
  
• Janus recently opened a new Strategic Value Fund, and many investors seemed to welcome the possibility that Janus might finally be moving beyond hot-shot growth funds.....Fortunately, a Janus spokesman was able to set the record straight: "The key at Janus is that labels such as growth or value are not important to us"*.....The SEC probably has a different opinion about fund names, but no one was available for comment.
  *"Janus looks back at growth and ahead to value," Frederick P. Gabriel, Jr., Investment News, February 7, 2000
  
  
  
• Janus believes that its Global Technology fund, which now holds about $11 billion in assets, is "small and agile"*.....In a related story, 96% of hippo mothers believe that their babies are "small and cuddly."
  * "Rookie Lu Becomes Most Valuable Player at Janus...," Aaron Lucchetti, February 16, 2000
  
  
  

---

[Top | Home]

FundAlarm © Roy Weitz, 2000