Highlights and Commentary
By Roy Weitz
(Originally posted March 1, 2002)
[Archive Table of Contents]

Gold funds for all seasons, and gold funds for none: In case you hadn't noticed, gold funds are by far the hottest Specialty sector in this month's FundAlarm database, with an average 12-month return of +34.38%.....And, in case you weren't looking at FundAlarm two years ago, in March 2000, gold funds were the second-worst performing Specialty category, with a 12-month return of -4.89%.....When market conditions change so dramatically, particularly in a Specialty area, one of the signs of a good fund manager is the ability to change along with the market, and maintain benchmark-beating performance.....Conversely, a poor fund manager will underperform in both types of markets.....This month's FundAlarm database contains 33 Gold/Precious Metals funds.....Five of these funds are on the FundAlarm Honor Roll this month, and were also on the Honor Roll two years ago, in a very different market.....At the other end of the spectrum, four Gold funds are 3-ALARM today, and were also 3-ALARM funds in March 2000.....In other words, the five Honor Roll funds seem to thrive in any market, while the perennial 3-ALARM funds can't seem to find a market they like..... For a complete list of Gold funds in this month's database, and their ALARM status today and two years ago, please see the accompanying page.


National brokerage firms sell huge quantities of load mutual funds.....National brokerage firms also maintain "preferred lists" of funds, and if you run a fund company you want to be on as many of those preferred lists as possible.....So, what does it take?

Mutual funds will occasionally earn a spot on a broker's preferred list as a result of exceptional performance, but money is by far the most common persuader.....National brokers, like Morgan Stanley and Edward Jones, reportedly sell spots on their preferred fund lists for initial fees ranging from $500,000 to $1 million.....But to stay on the list, fund companies must be willing to dig into their own pockets and share their revenue.....For example, Putnam might be required to kick back 0.25% of Putnam fund sales by Morgan Stanley brokers, and/or 0.25% of all Putnam fund assets that come through the Morgan Stanley sales force.....Fund companies also might agree to make a certain number of trades with brokers, which generates commissions, and fund companies are often expected to pay a steady stream of small bribes, for example, $20,000 to host a broker's regional meeting, or $100,000 to attend a broker's convention in Hawaii.

What's wrong with preferred lists?.....Consider the situation at Edward Jones: Theoretically, brokers at that firm can sell funds from 180 different families.....In reality, there are seven fund families on the Edward Jones preferred list, and about 95% of all Edward Jones fund sales come from that list (FYI, the preferred fund families are American, Federated, Goldman Sachs, ITT Hartford, Lord Abbett, Putnam, and Van Kampen American/Capital).....And what if there's a fund from a non-preferred family, which might be more suitable to your needs?.....If your broker is extremely conscientious, you might hear about that fund.....More likely, though, you won't.....Preferred lists are also a significant cost of doing business for fund companies, and that cost is inevitably reflected in the fees that investors pay.....Think of the cookie business.....If Nabisco pays "slotting fees" to ensure that Oreos get favorable shelf space, you can bet those fees are reflected in the cost of each Oreo package.....Likewise, you can bet that Putnam's outlays for preferred lists are recovered through higher management fees.

Preferred fund lists aren't all bad, since preferred fund companies often provide brokers with extensive training, and some individual brokers become quite knowledgeable about the funds in a particular family.....And even without preferred lists, most brokers would probably develop a short list of favorites, and there would always be hundreds of funds that your broker couldn't investigate in detail.....Perhaps the best you can hope for is that your broker keeps an open mind, and preferred fund arrangements don't muscle out all of the other possibilities.....At the very least, ask your broker if he or she works from a preferred list and, if so, what fund families are on it.....For each fund recommendation, ask what other funds were considered.....If your broker never considers anything other than preferred funds, you might start to feel uneasy.....Finally, compare your broker's load-fund recommendations to comparable, no-load alternatives.....If your broker's picks always seem second-rate, you either need a new broker, or you might want to take another look at do-it-yourself investing.
"The Dirty Little Secret of Mutual Funds," Lewis Braham, Business Week, February 25, 2002; "The Fund Industry's Dirty Little Secret," Richard Bierck, Bloomberg Personal Finance, March 2002



Officially, not a factor
in the FleetBoston
name change		 About six months ago, FleetBoston acquired the Stein Roe, Acorn, Crabbe Huson and Liberty mutual funds.....When added to Fleet's existing fund families (Galaxy and Columbia), these new funds meant that Fleet had suddenly become (a) another star in the mutual fund universe, or (b) a mess (Hint: It's (b)).....Since the acquisition of these funds, for a billion dollars, the folks in charge of Fleet have been trying to figure out what to do with their mess, and they've finally come up with some answers......Fleet Asset Management is changing its name to Columbia Management Group (no benefit for fund shareholders), it is going to partner with a hedge fund shop (no benefit for fund shareholders), it will start offering separate and 529 college savings accounts (no benefit for fund shareholders), and it is weighing plans to drop its no-load funds (ditto).....We'll check back in another six months, when Fleet (sorry, Columbia) might be ready to announce something really significant for fund shareholders, like a new typeface for its annual reports.


As a group, mutual fund directors are probably as useless as the Enron Code of Ethics.....It's not that fund directors are dishonest, it's just that directors almost uniformly fail to carry out the job they are paid to do, which is to protect the interests of fund shareholders.....Now, perhaps, fund directors will have a bit more incentive to fire an underperforming manager, or negotiate a lower management fee......As of January 31, 2002, the SEC is requiring funds to disclose considerably more information about the folks behind the scenes, and this information should help weed out directors who are overextended, have conflicts of interest, or don't put their money where their paychecks are (i.e., who don't invest in the funds they purport to supervise).....Unfortunately, these new disclosures will be scattered across two different fund documents, and the most revealing disclosures will be located in the Statement of Additional Information, a document that's almost as hard to locate as a humble Janus fund manager.....Still, these new disclosures are a start, and here's what to look for:

Newly-required disclosures about
independent fund directors 		Document where found:
Annual
report		Stmt of
Addtl Info
Name, address, age
X
X
Principal occupation
X
X
Current term and years served
X
X
Number of funds overseen
X
X
Other outside directorships
X
X
Holdings in each fund overseen
X
Aggregate holdings in fund family
X
Conflicts of interest
X
Basis for approving the fund adviser's contract
X
Source: Business Week

The last disclosure is perhaps the most interesting one, and potentially the most useful.....Now that directors must state their rationale for hiring (or rehiring) a fund manager, and the directors know that plaintiff's lawyers will be eagerly second-guessing them, it's possible -- just possible -- that a few marginal fund managers will find themselves pursuing new career opportunities sooner than otherwise expected.


More baskets mean fewer broken eggs:

"Since the beginning of 2000, nearly one of every five U.S. stocks has fallen by two-thirds or more, while only 1% of diversified stock mutual funds have swooned as much..."
--The Wall Street Journal, February 15, 2002


Enron Corp. was part of the S&P 500 index until November 29, 2001, which means that the Vanguard 500 Index fund owned Enron all the way down.....Other Vanguard funds, such as Vanguard Total Stock Market Index, are based on larger indexes, but they also owned Enron until the bitter end.....Overall, according to Vanguard, its index funds lost between 0.47% and 1.12% of their value as a result of the Enron debacle*.....So here's an interesting coulda/shoulda question: Could Vanguard index funds have sold their Enron holdings earlier, and thereby cut their losses?.....And, even if the answer to the preceding question is "yes," should they have sold?

Could Vanguard have bailed out of Enron sooner? Vanguard runs two basic types of index funds -- replication and sampling -- and the answer to this question initially appears to turn on the type of fund being considered.....For example, Index 500 is a replication fund, which the Vanguard prospectus describes as follows:

"[Replication] means that a fund holds each security found in its target index in about the same proportion as represented in the index itself. For example, if 5% of the S&P 500 Index were made up of the stock of a specific company, a fund...[replicating] that index would invest about 5% of its assets in that company."

Therefore, until Enron was officially removed from the S&P 500 index, it seems clear that Index 500 manager Gus Sauter had no choice but to hold that ill-fated stock.

A sampling index fund, such as Vanguard Total Stock Market, works differently..... Here's how Vanguard describes it:

"Using sophisticated computer programs a [sampling] fund selects from the target index a representative sample of securities that will resemble the target index in terms of key risk factors and other characteristics. For stock funds, these include industry weightings, country weightings, market capitalization, and other financial characteristics of stocks."

Thus, sampling funds aren't required to own every stock in a large index, and it appears that the manager of Vanguard Total Stock Market (again, Gus Sauter) could have bailed out of Enron early if he wanted to.....But would it have made any difference?......Since the mission of Total Stock Market is to replicate its underlying index as closely as possible, and Enron would have remained a part of the index even if Total Stock Market sold it (say) in August 2001, getting rid of Enron would have put Sauter in the bizarre position of trying to replicate the negative impact of Enron without actually owning it.....Sauter's Enron dilemma highlights one of the problems faced by pure (as opposed to "enhanced") index funds: Even if you see a train coming right at you, the fund's mandate essentially requires the manager to take the hit.....The manager of an enhanced index fund is expected to outperform the underlying index, so removing Enron from an enhanced fund would have caused no inherent problems.....But for every easy call, like removing Enron, enhanced index fund managers might face two or three difficult calls, which is why enhanced index funds, overall, have been uninspiring.
* "Index Funds Limit Enron's Damage," Claire Mencke, Investor's Business Daily, February 12, 2002


Also known as mediocrity:

"Instead of shooting for the top of the category, Sola's goal is to land the fund solidly in the tech category's second quartile on a regular basis."
--Sola is the new manager of T. Rowe Price Science & Technology. Source: morningstar.com


If Enron is the financial Titanic of our generation, then many fund managers bought tickets on the doomed ship before it sailed.....To our knowledge, however, only one manager bought fistfuls of tickets while the Enron Titanic was sinking, and that manager is paying the price, both in lost reputation and a swarm of lawsuits.....Alfred Harrison manages Alliance Premier Growth and, as of September 30, 2001, Harrison's fund owned almost 17 million shares of Enron, which made up about 4.1% of fund assets.....This appears to be the largest mutual fund holding of Enron as of that date but, wait, it gets worse.....For a large private account, Harrison bought 2.7 million shares of Enron in October and November, at about $9 to $10 per share, after the SEC had announced it was investigating the company.....Presumably, he also bought shares for Premier Growth at about the same time.....On December 30, it appears that Harrison finally sold all of the Enron stock in the private account, at 28 cents per share.....How do we know so much about the private account?.....It's the State of Florida pension fund and, in addition to firing Harrison after a 17-year tenure, it's considering a lawsuit (the Florida attorney general is also investigating).....Over on the fund side, Harrison already faces three shareholder lawsuits, alleging breach of duty and loyalty, because an Alliance board member was also an Enron director.
"Money manager on firing line," The Miami Herald, February 3, 2002; "Alliance battered by Enron losses and lawsuits," Heike Wipperfurth, Investment News, February 11, 2002


Roy has a new tech fund: As we promised last month, T. Rowe Price Science & Technology and RS Internet Age were booted out of Roy's personal portfolio in early February.....The Price fund was kicked for poor five-year performance and a recent manager change, the RS fund because it was a relatively small holding that never realized its promise, and was only adding to portoflio clutter.....The entire amount from both sales was invested in RCM Global Technology D (now a part of the PIMCO family, and formerly Dresdner RCM Global Technology).....This is a fund that I had never followed very closely (OK, I never followed it at all), but it consistently turned up in a number of tech fund screens that I ran in early February.....Taking a closer look, I learned to like the fund, though I'm still not enormously excited about it -- which was pretty much my attitude towards TRP Science & Technology when I first invested, so I'm not sure what that means.....On the plus side for RCM Global Tech: Great three- and five-year performance, with above-average numbers in both up and down years.....Seasoned managers with serious technology backgrounds.....Relatively small asset base, and relatively concentrated holdings (about 80 stocks total, and about 30% of the fund in the top-ten holdings)......The fund also offers a sensible and interesting mix of bottom-up and top-down investment approaches (about 80%/20% respectively)......On the negative side: About 25% of the fund is typically invested in foreign stocks, which is not something I'm particulary interested in with a tech fund.....The fund is also somewhat pricey, with an expense ratio of 1.21%.....As always with such decisions, I tried to do the best I could with the information, experience, and instincts that were available to me at the time.....We'll keep you posted.


Back in November, we ran a brief item about several manager changes at the SSgA funds, as follows:


Recently, a FundAlarm reader suggested that this item didn't quite capture the extent of change at SSgA, and he suggested that we take a closer look at what really happened there.....We did, and the results don't inspire confidence.....The three departing managers noted above (Tuttle, Allinson, and Smith) were the heart of SSgA's "Global Fundamental Strategies Group," and all three were hired away by a new investment subsidiary of Mellon Financial.....As part of this Mellon "lift-out," SSgA also lost two junior portfolio managers, and its only two analysts in the financial sector.....A couple of months prior to the lift-out, and probably triggering it, two top executives also bailed out of SSgA (the CEO and the well-respected Chief Investment Officer).....Since these changes, SSgA has managed to cobble together a functioning investment team, but the funds above deserve especially careful watching.


It was just after 10 p.m. on Friday, February 22.....It was a quiet night on the FundAlarm Discussion Board, and Roy was making another late-night check.....Suddenly, the Discussion Board came alive, and "Ted" was posting again:


And so it goes: Almost every day for the past 18 months, Ted has been posting links to other mutual fund sites on the FundAlarm Discussion Board.....Read a week's worth of Ted's links, and you get a pretty good mutual fund education.....Read a month's worth of links, and you get a veritable Internet Mutual Fund Digest -- free, easy, and brought to you by a dedicated night-owl from Olymipia Fields, Illinois.

Ted is officially retired, but he's probably never been busier in his life. During the day, Ted helps coordinate financial content for a consortium of 72 public libraries in and around his home town (it's a paid job, Ted emphasizes, the result of a special state grant). This includes ordering financial and investment books, arranging financial seminars, and coordinating investment clubs that meet at the library. Ted also has a unique and long-standing relationship with several brokers at a local brokerage firm: These brokers will meet with a new client and then ask Ted, for a fee, to provide a written analysis of the client's portfolio. In the summer, when the library work winds down, Ted also helps manage a golf pro shop.

Where does FundAlarm fit in? Ted typically goes to bed about 7:30 p.m., and wakes about 1:30 a.m. [!] Morning chores taken care of, Ted hits his computer, cranks up two Internet browsers, and methodically works his way through an alphabetical list of about 300 investment-related bookmarks. When an item seems worth posting to the FundAlarm Discussion Board, Ted copies it in one browser and pastes it to the Board in the other browser. Sunday is a special day on the Board, when Ted typicially hits about 25 Sunday papers, in addition to his regular bookmarks. Oh, and one more thing: Ted wanted to make sure that we thank "Karl," another Board regular, for teaching Ted how to link. Before that, Ted would type all of the items he found, and that was getting very old, very fast.

How does the "Linkster" invest his own portfolio? Ted is currently allocated about 80% fixed income and 20% equities, which he calls his "capital preservation mode." Although he may be a mutual fund vacuum on the Web, Ted currently owns just two mutual funds, which he selected because of their talented and successful managers: Smith Barney Aggressive Growth, run by Richard Freeman, and Berger Small Cap Value, run by Bob Perkins. Ted's most successful mutual fund experience: Fidelity Magellan, which he bought in 1972 based on a golf-game tip, and rode to a "1,000% gain" by the time he sold it in 1996. Ted's worst mutual fund mistake (he answered this one quickly): Munder NetNet fund. Ted was also a long-time owner of T. Rowe Price Science & Technology, which he started acquiring in 1992, and finally sold in 2000. "I knew I was playing with fire, and I should have sold after the 100% gain in 1999."

If you're a Board regular, you already know about Ted's posts.....If you're not a regular, we encourage you to take a look .....Follow Ted's posts for a week, along with the posts of the other excellent regulars, and we think it will become habit-forming.


There are plenty of things wrong with the U.S. mutual fund system, and we're grateful for that.....Otherwise, FundAlarm would have run out of material a long time ago.....But for all of its faults, the U.S. fund system still has a lot going for it, and one way to appreciate that fact is to take a look at the fund system in Canada.....Canada's fund world is similar enough to the U.S. to be instantly recognizable, but it's different enough to make us see our own situation in a new light.....FundAlarm reader Ken Kivenko is an investor advocate in Canada, and Ken has been kind enough to put together a brief primer on the Canadian fund system.....It's not that the Canadian fund system is so bad, but the weaknesses in Canada highlight many of the strengths in the U.S., even though many of those strengths are often perceived as weaknesses on this side of the border (Huh?).....For example, Ken notes that good mutual fund information in Canada is hard to come by, while investors in the U.S. often complain that there's too much fund information.....Personally, we'll take more information, any time.....Ken also notes that the Canadian fund world is relatively closed, "clubby," and somewhat sleepy.....By comparison, the U.S. fund world is bouncing off the walls.....While that's often perceived as a problem, it seems like a good problem to have given the somnolent alternative.....If you're interested in Canadian mutual funds, and especially Canadian fund activism, Ken would very much like to hear from you.

[Go to Ken's Canadian fund primer]


Briefly noted:
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FundAlarm © Roy Weitz, 2002