FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

(Originally posted March 1, 2003) [Archive Table of Contents]

Do you own a 3-ALARM manager? Even if you own a 3-ALARM fund, you may not own a 3-ALARM manager.....To understand the distinction, consider two hypothetical funds.....ABC Fund is 3-ALARM, but its manager has been on the job for only one year..... XYZ Fund is also 3-ALARM, but it's run by a manager with a six-year tenure.....Since a 3-ALARM rating requires at least five years of underperformance, the one-year manager of ABC fund is responsible, at most, for one-fifth of ABC's poor performance......On the other hand, the six-year manager of XYZ bears full responsibility for that fund's 3-ALARM rating.....The accompanying page lists all 3-ALARM funds in this month's database where the current manager has been in charge for at least five years.....With these funds, it's fair to say that you do own a 3-ALARM manager.....And, unless you know something we don't, do you have any reason to believe that performance over the next five years will be any better?

[View the complete list of 3-ALARM managers]

Here's the theory: Fund giant Fidelity hires fund tracker Morningstar to come up with a list of "favorite" Fidelity funds......Morningstar carefully analyzes 150 Fidelity funds, using both objective and subjective criteria, and presents its list of up to 30 favorites to Fidelity.....Then, Fidelity responsibly presents Morningstar's conclusions to a confused public that is eager for independent, third-party fund advice.....Now, here's the reality, from a recent Fidelity print ad:

Morningstar did, indeed, come up with its list of "favorite" Fidelity funds, for an undisclosed fee, and Fidelity is, indeed, running with that list like a dog with a stolen bone.....And, contrary to our theory, Fidelity's ad does everything it can to make Morningstar's list look like a ringing endorsement.....It's only in the incredibly small print (not shown above) that some of the interesting details of the Fidelity/Morningstar relationship are revealed.....(For example: The list has been prepared by a subsidiary of Morningstar that was formed to work with institutional clients, and not by Morningstar's regular team of fund analysts.....Also, Morningstar agreed to classify Fidelity's funds into several non-standard categories, presumably with Fidelity's consent, and presumably because it achieved a result that Fidelity was satisfied with).....Meanwhile, Morningstar seems determined to push the limits of its public identity: Is it the champion of individual fund investors, or a hired gun for deep-pocketed financial services firms?.....And you know what?.....Without any serious competition, Morningstar just might be able to have it both ways.
Ian McDonald, of The Wall Street Journal Online, was the first to break this story ("Morningstar's Deal With Fidelity for 'Favorites' Earns Jeers, Fears," February 4, 2003

Like many fund firms, the PBHG Web site offers a brief "manager commentary" for each of its funds.....But what do you do if you need a manager commentary for the fourth-quarter of 2002, and the person who ran the fund during that quarter has since been fired?.....Well, you fake it.....A case in point is the manager commentary for PBHG Emerging Growth.....Erin Piner was fired as manager in January of this year, and Peter Niedland took over.....Having Piner write the fund's fourth-quarter 2002 commentary would have drawn unwanted attention to manager turnover, and having Niedland write the manager commentary, without any explanation, would have been outright dishonest.....So, with the help of a little asterisk, PBHG tried to slither down the middle:

The asterisk after Niedland's name, which leads to a spot way at the bottom of the commentary, explains that "Mr. Niedland began managing the Fund on 1/1/2003".....Meanwhile, in the body of the commentary, Niedland answers "questions" that make it appear as if he really was managing the fund during the fourth quarter:

This is certainly not the sleaziest example of fund company communication, just another disappointing instance of a fund company that refuses to play straight with its shareholders.

No thanks. I prefer mine plain:


--Headline at miami.com (Miami Herald), February 11, 2003

The "poop on mutual funds," above, comes from the March 2003 issue of Consumer Reports magazine, which promises "60 [fund] winners to boost your portfolio".....Consumer Reports may do a decent job rating cars and refrigerators, but they seem a bit out of their league in the mutual fund world .....The magazine offers virtually no explanation for why a fund lands on its recommended list, aside from noting that Morningstar helped in the selection process, and that many of its top picks "have succeeded in both bull and bear markets"......For the first time, with the assistance of Financial Engines (financialengines.com), Consumer Reports also attempts to predict the future returns of its recommended funds.....Before you get too excited about this feature, you should know that it's essentially meaningless.....Ten-year fund returns are predicted only in broad ranges, and only with a 90% confidence level (in other words, there's still a 10% chance that actual returns will fall outside these ranges).....For example, try planning with this information: If you invest $10,000 today in CGM Focus, Consumer Reports predicts that your $10,000 will be worth between $1,000 and $63,500 ten years from now.....Predicted return ranges for other equity funds are considerably narrower, typically between about $8,000 and $45,000 over ten years, but how is this going to help anyone make a decision, especially when they are planning for a specific financial goal?

Michael Oxley chairs the House Financial Services Committee, and lately he's been a man on a mission.....In mid-January, Oxley (an Ohio Republican) sent a tough letter to the General Accounting Office (GAO), asking the GAO to investigate several mutual fund fee practices, and to report back to him by April 15.....A couple of weeks later, Oxley formally announced that his House Committee would examine many of the same issues that he was asking the GAO to investigate, including the adequacy of mutual fund fee disclosures, the continued necessity for 12b-1 fees, and the proper way to report mutual fund transaction expenses, including brokerage commissions.....Why is Oxley suddenly giving the mutual fund industry such a hard time?.....It's possible, of course, that he's a dedicated public servant, who simply knows a good, popular issue when he sees one.....But there's also a darker, more partisan explanation.....Oxley reportedly has some political gripes with the Investment Company Institute (ICI), which is the mutual fund trade association, and by putting heat on the mutual fund industry Oxley is able to embarrass the ICI and make it look ineffective.....Gripe #1: Oxley is said to be "incensed" by the close ties between the ICI and House Democrats, and he's especially annoyed that the ICI still has close contacts with Democrats who used to oversee the fund industry through a predecessor Congressional committee.....Gripe #2: The ICI chief lobbyist is a Democrat, and Oxley reportedly wants her fired and replaced with a Republican, or else he wants a Republican to work alongside her.....According to press reports, members of Oxley's staff have hinted that Oxley's investigation of the fund industry might "ease up" if the ICI complies with his wishes and hires a lobbyist with the proper party affiliation.....The ICI apparently knows how to take a hint.....As you read this, the ICI is looking for a Republican lobbyist
"Why it's open season on mutual funds," Business Week, February 10, 2003; "Congressman Urges Republican Lobbyist," washingtonpost.com, February 15, 2003

If we had any interest in balanced reporting, we would also note the following: The ICI denies that it is looking for a Republican lobbyist and, even if the new lobbyist just happens to be a Republican, the ICI says that he or she will still report to the current Democratic lobbyist.....Also, Oxley's office denies that he has ever offered to go easy on the fund industry in exchange for the hiring of a Republican lobbyist.

Fortune magazine recently listed the "100 best companies to work for," and three mutual fund firms made the list: MFS (#75), American Century (#81), and Vanguard (#83).....Fortune notes that MFS

"...kicks a third of profits back to employees and grants four weeks of vacation after one year. In its first-ever layoffs, 119 people got at least four months' severance"

At American Century, according to Fortune,

"Health insurance can cover another household member (domestic partner, parent, sibling, nanny) if you have no spouse; four-week paid sabbatical after seven years; $5,000 tuition reimbursement"

To round out the trio, Fortune cites Vanguard for its excellent working conditions:

"The mutual funds company has never laid off a 'crew member.' CEO Jack Brennan regularly pitches in and works the phones on busy days. Voluntary turnover is six percentage points below the industry average."

And now, for a change of pace, here's FundAlarm's list of "5 mutual fund companies that aren't so great to work for":

Strong:

"Daily worship service in honor of company founder Dick Strong strikes many employees as creepy. Strong's ego periodically sucks air out of building, creating potentially dangerous working environment. "

Janus:

"Too many investment geniuses in one place makes winning the lunchtime 'Jeopardy' game almost impossible. Coming up with multiple excuses for past investment failures beginning to fray some nerves. "

Putnam:

"Many employees put off by electronic tote board, showing CEO Lawrence Lasser's year-to-date bonus. Trying to rebuild damaged reputation not nearly as easy as keeping it intact in the first place."

Firsthand:

"Office calendars stuck on March 10, 2000, the day of the Nasdaq peak, so employees find it difficult to schedule meetings. Anyone uttering the word "bubble" is shot, which has a negative impact on morale. "

Weitz:

"Employees get tired of telling people that company founder Wally Weitz is not related to Roy Weitz of FundAlarm."

Briefly noted:

Good for the goose, but the gander thinks he's special: When a Vanguard fund invests in a company's stock, Vanguard CEO John Brennan believes that "meaningful holdings of stock [by a company's management team]...is the best way to link our interest as a holder for the long haul with management's interests".....Brennan, of course, is absolutely right.....But wouldn't you think that owners of Vanguard mutual funds, especially its actively-managed funds, also have a right to know how much of each fund the manager owns?.....Maybe Mr. Brennan will address that issue in his next interview.
Vanguard CEO Jack Brennan Makes His Demands Heard," Aaron Lucchetti, The Wall Street Journal, February 6, 2003
Alfred Harrison is planning to retire in the next 12 to 24 months.....Harrison manages Alliance Premier Growth, and he was the poster child for the clueless fund manager during the recent Enron collapse, purchasing large positions in the company and never adequately explaining why Enron was worth even a nickel of his shareholders' money.....Even apart from the Enron fiasco, Premier Growth has been a weak performer over the past five years, and it's overdue for a shakeup.....Thomas Kamp will co-manage the fund with Harrison, and Kamp will take over when Harrison departs.
Yuka Hayashi, The Wall Street Journal, February 4, 2003
Shareholders from all walks of life react to the upcoming retirement of Alfred Harrison:
One more time: Rep. Jim Saxton (R-NJ) has introduced a bill that would allow mutual fund shareholders to postpone paying tax on reinvested capital-gain distributions.....This bill may sound familiar, and it probably should, since this is the third time that Saxton has introduced it.....The last two times this bill was up for consideration, fund companies were distributing some serious capital gains, so the immediate revenue loss for the government seemed huge.....Now, with capital gain distributions way off, there's a chance that the fairness argument will prevail: In most other areas of the tax code, the obligation to pay taxes arises only when cash changes hands, so why should mutual fund distributions be treated differently?.....If you're interested, you can read a [what's a breakpoint?], or write your Congressional representative.....(For each of these links, a new browser window will open on top of the current one. You can close each window by clicking the "X" in the upper right-hand corner.)
Speaking of tax rules, did you know that millions of dollars of mutual fund capital losses are likely to be wasted over the next few years?.....This is a relatively obscure area of the law, but the cost to fund shareholders could be significant, and it's worth a quick look.....Basically, a mutual fund is required to internally offset its gains and losses from the sale of securities, and any net capital gains must be distributed to shareholders annually......Net capital losses can't be distributed.....Instead, losses stay within the fund, and can only be used internally to offset future capital gains (which is still a valuable benefit).....Under current tax law, a mutual fund's capital loss can only be carried on its books for eight years and, if the loss isn't used to offset gains within that period, the loss is wiped out.....So what's the problem?.....Many funds have accumulated huge net losses over the past several years, and there's virtually no chance that these funds will incur enough gains to internally absorb all of their losses before they expire (for example, Fidelity Aggressive Growth, with about $4 billion in assets, has built up over $11 billion in capital losses).....In effect, hundreds of mutual funds are going to lose a potentially valuable benefit -- their capital loss carryover -- before they get a chance to use it.....Congress could solve this problem by allowing mutual funds to carry their losses indefinitely, which is what individuals are currently allowed to do.....But with so much else on the legislative plate, and with such an obscure tax rule, relief is unlikely any time soon.
"You can't win for losing," Charles Jaffe, CBS.MarketWarch.com, February 16, 2003
Ohmygod, they might have to start thinking for themselves: Instead of relying on research from third-party analysts, there seems to be a mini-trend among fund companies to beef up their in-house research staffs.....American Express and Janus have each added more than a dozen analysts over the past couple of years, and Federated, Neuberger Berman, and Columbia have made the development of in-house brain power a high corporate priority*.....This little piece of news highlights a much bigger issue: Analysts are a critical element at many fund companies, especially the larger ones.....The public hears almost nothing about analysts, but the role of analysts can be a major element in defining a fund company's culture.....Federated, for example, is moving toward a structure where analysts create "action lists" of stock, and fund managers must pick stocks from those lists.....Contrast this with the more common situation, where fund managers have almost unlimited discretion in picking stocks, and the analysts work on projects dictated by the manager.....Federated also wants to make the analyst job a career track in itself, rather than a steppingstone towards a portfolio manager position.....We can't prove it, but we'd be willing to bet that a fund backed by career analysts is generally more conservative, and less volatile, than a fund where each analyst eventually hopes to run the show.
* "Some Fund Firms Hire More Analysts for In-House Research," John Shipman, Dow Jones Newswires, February 10, 2003
Here's what's happening at Vanguard International Growth -- just don't ask us why: Current manager (subadvisor) Schroder Capital Management is being relieved of about $1 billion in assets, and those assets will be handed to a new subadvisor, Baillie Gifford Overseas (the fund holds about $5.5 billion in assets total).....Schroder's performance has been decent, if not great, so that doesn't seem to be a compelling reason for the change.....And even if Vanguard wanted to take a look at a potentially better manager, Baillie Gifford seems like a long shot (it's only mutual fund, Guardian Baillie International, has a mediocre record).....Vanguard says that the change is being made, in part, to "accommodate long-term growth in assets," but International Growth is currently at about 60% of its peak size, and investors aren't exactly throwing money at it.....Something else is going on here, and Vanguard has a responsibility to tell its shareholders more.
Just think of "ING" as "Information Not Given": ING announced that three funds, each previously managed by a human being with a name, will now be managed by an anonymous "team of investment professionals" (ING Equity and Bond, ING High Yield Opportunity, and ING Strategic Bond).....Investors who like their fund managers accountable might want to consider walkING away, or at least squawkING to fund management.....Last year, Putnam tried the same kind of individual-to-team switcheroo, and a public outcry forced the firm to back down.
"ING Says Teams Will Take Over Management of 3 Funds," John Shipman, Dow Jones Newswires

Rydex Ursa is a bear-market fund that seeks to generate a return inverse (opposite) to the S&P 500.....Therefore, it's no surprise that Rydex Ursa is this month's top-performing large-cap fund over the past three years.....But take a look at the #2 large-cap fund in this month's database:

Top-ten large-cap funds	3 yr. return (% annlz'd)
Rydex Ursa Inv (RYURX)	17.32
Yacktman (YACKX)	17.10
ProFunds Bear Inv (BRPIX)	15.62
Fairholme (FAIRX)	14.64
Yacktman Focused (YAFFX)	14.37
PBHG Clipper Focus (PBFOX)	13.75
Oakmark Select I (OAKLX)	13.16
Clipper (CFIMX)	12.49
Potomac U.S./Short (PSPSX)	12.27
Vontobel U.S. Value (VUSVX)	11.66

Yacktman is a straight-up, long-only fund that has managed to return just 22 basis points less than Rydex Ursa over the same three-year period (17.10% vs. 17.32%), a fairly remarkable accomplishment....Five other long-only funds (Fairholme , Yacktman Focused, PBHG Clipper Focus, Oakmark Select I, and Clipper) have managed to outperform the bearish Potomac U.S./Short, also very respectable performance.

We're good guys! We're good guys! We're good guys! Just coming off one of the biggest scandals in mutual fund history -- the bonehead, possibly fraudulent, mispricing of its high-yield muni bond funds -- Heartland would now like to be known as the enlightened, consumer-friendly fund firm.....More than a year ahead of the SEC deadline, all of Heartland's proxy votes are now being published on its Web site.....Aside from the suspicious timing of this move, and aside from the somewhat sleazy, self-congratulatory tone that Heartland has adopted, the firm has done a nice job of organizing and presenting its proxy vote material.....If you'd like a preview of what's coming next year, and an early standard that other firms might want to match, check out the Heartland Web site .....(A new browser window will open on top of the current one. You can close the window by clicking the "X" in the upper right-hand corner.)
Here's Tom Price, co-manager of Strong Ultra-Short Term Income, commenting on the prospects for his fund:*

"...we think total return should be fairly positive, all else being equal, if interest rates remain stable on the short end, which we think they will."

By our count, this remarkable sentence contains six separate qualifying words or phrases (two "thinks," one "fairly," one "if", one "should" and one "all else being equal").....Besides that, we don't understand what he's talking about.
* Fund of Information column, Erin Arvedlund, Barron's, February 10, 2003
The folks who run the Pax World Funds are some of the most outspoken proponents of corporate disclosure, and Pax World was a vocal supporter of the recent move to require proxy-vote disclosure by mutual fund companies.....Closer to home, however, Pax World seems to have a disclosure problem of its own.....For over a year now, fund companies have been required to report (in the Statement of Additional Information, or SAI) how much their directors have invested in the funds they oversee.....Pax World neglected to include this information for three of its four funds in an SAI dated August 31, 2002.....Said Pax World: "This inadvertent oversight on our part in no way reflects upon our support for mutual fund disclosure".....Pax World added that its oversight is "being corrected and will not be repeated."
"Some Funds Slip Up On Current Disclosure Regulations," John Shipman, Dow Jones Newswires, February 12, 2003
It's contagious: Speaking of oversights, several months ago we reported that the managers of the FBR Funds had inadvertently let their investment contract expire, and they had to go hat in hand to fund investors to get their management fees paid in arrears.....FBR didn't discover its bungle for eight months, which seemed bad enough, but Credit Suisse has taken this form of ineptitude to a new level, allowing seven different investment advisory contracts, for seven different funds, to lapse for almost three years.....It's a long, convoluted story, but basically what happened is this: In 1999, Credit Suisse Asset Management (CSAM) acquired several funds from another fund company, and those funds came with an investment contract that was due to expire in April 2000.....The directors of those acquired funds, apparently overburdened by their other weighty responsibilities, got the notion that the fund investment contracts had to be approved each November, and the directors dutifully approved the CSAM investment contracts in November 2000 and November 2001.....Meanwhile, of course, the investment contracts had already expired in April 2000, as scheduled, so the subsequent director approvals were meaningless.....In effect, CSAM has been managing these funds without a contract, and receiving unauthorized management fees (about $10+ million), since April 2000.....CSAM is now asking shareholders to approve those past management fees.....If investors don't approve, CSAM has indicated that it will sue the funds to collect its fees, based on the legal theory of "stupidus recoverus" (actually, it's called "equitable restitution").
"Credit Suisse Trips Up on Advisory Renewal," Lori Pizzani, Mutual Fund Market News, February 10, 2003
North-of-the-border nightmare: A computer hard drive, with personal information on about 650,000 clients of Investors Group Inc (Canada), was stolen from an office of the company's data management firm.....The good news, if you can call it that, is that the hard drive did not contain social insurance numbers, dates of birth, or banking information.....However, the drive did contain client names and addresses, account numbers, portfolio holdings, and beneficiaries.....The drive was recovered a couple of days later, but all of the personal data had been overwritten.....Police were unable to determine if any of the information had been copied.
We can't afford to license any of those New Yorker cartoons for our site, so we're taking the cheap way out: We'll give you word descriptions, and let you imagine the drawings for yourself.....Thanks to Paul Farrell of cbs.marketwatch.com for recommending these cartoons in a recent column, and for providing the descriptions:
- A smiling broker tells an angry couple: "Your money was working for you, but it suddenly quit and now it's working for me."
- After-work cocktails. The balding broker with a cigarette and martini is musing out loud to his buddy: "I want my bubble back."
- Couch potato staring at the tube: "News that a meteor would destroy the earth in 48 hours sent the market sharply lower, before it rebounded on rumors that the discount rate would be cut again."
- The chairman sitting in his plush office, talking on the phone: "A billion is a thousand million? Why wasn't I informed of this?"
- Big-time investment banker in the clouds, trying to get into heaven. St. Peter is unimpressed: "You had more money than God. That's a big no-no."
- A broker on phone with client: "I won't be able to handle your account anymore, as it suddenly appears that you're a small investor."
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FundAlarm © Roy Weitz, 2003