Highlights and Commentary

By Roy Weitz

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

A wacky market gets even wackier: If you follow technology mutual funds, you've probably become accustomed to some eye-popping 12-month returns.....But even jaded technology investors might be surprised by some of the 12-month returns that appear in this month's edition of FundAlarm.....Even more astonishing is how these returns have increased just since last month.....Consider, for example, Firsthand Technology Innovators......Last month, Firsthand Technology Innovators sported a 12-month return of 189% -- impressive performance in anybody's book.....This month, the same fund shows a 12-month return of 379%.....Not only is the latter return mind-boggling, it also seems impossible that any 12-month return could increase by that much (189% --> 379%) in the space of just 30 days.....But it's true, and it's all a matter of arithmetic: Last month's 189% return covered the period from February 1999 through January 2000, while this month's 379% return spans the period from March 1999 through February 2000.....February 2000 was a record-breaking month for many tech funds, including Firsthand Tech Innovators (up 49.7%), while February 1999, which has now rolled out of the performance calculation, was the second worst month in the fund's history (-9.70%)......In a short-term performance calculation, replacing one bad month (February 1999) with one phenomenal month (February 2000) can have a huge impact.

The accompanying page lists the 48 funds in this month's database that have 12-month returns at least 100 percentage points higher than last month.....As you marvel at this list, we'd also like to suggest that it contains a lesson.....For volatile funds, short-term performance numbers are essentially meaningless.....Investors who base decisions soley on short-term performance are engaged in a futile exercise of the highest order.


For value managers, it has finally come to this:

	"Athletes have to be doing something with their money so they might as well [give] it to us."
	-- Neuberger Berman, a value manager, making a pitch for its new athlete advisory service

Not exactly an epic struggle, but pretty good for the mutual fund world: Most mutual funds dislike short-term investors, because they trigger additional costs that long-term investors must ultimately bear.....About 550 funds now impose fees on short-term redemptions and, in all cases, those fees are paid into a pot that benefits the remaining shareholders, rather than the fund company.....As a general principle, we're in favor of short-term redemption fees, for the same reason that we're in favor of water meters: People who use more of a resource should be asked to pay more.....But we've always been troubled by the "flat" nature of redemption fees: If I'm asked to pay a flat 2% redemption fee, it's extremely unlikely that I've caused my fund exactly 2% worth of damage.....To the extent that a flat fee overstates the real damage I've caused, it's pretty clear that I'm being hit with a penalty.

The preceding discussion is more than academic, since the SEC and several fund companies are currently squabbling over the same issues.....Up until recently, for example, Amerindo Technology fund imposed a short-term redemption fee of 3%.....At the request (read: insistence) of the SEC, Amerindo recently reduced the fee to 2%.....The SEC takes the position that mutual fund shares must remain "redeemable securities," and "redeemable" means that the owner must receive the "approximate" net asset value (NAV).....If more than 2% of the NAV is taken out for an early redemption fee, the SEC says that the fund is no longer dealing in redeemable securities, and no fund wants to go down that road (can you say "big penalties and really bad publicity?").

Incredibly, the SEC doesn't routinely review fund documents for redemption fees, and the SEC only takes action against a high fee that is brought to its attention.....Some troublemaker at Morningstar recently informed the SEC that Fidelity Small Cap Stock imposes a 3% redemption fee, and that news has apparently started some wheels turning in Washington.....Fidelity seems confident that the SEC will allow it to keep the 3% redemption fee, but we wouldn't count on it.....Fidelity's best chance is to prove to the SEC that every short-term investor causes the fund at least 3% worth of damage.....In other words, make the redemption fee look more like a water bill, and less like a traffic ticket.....If Fidelity can't do that, we predict that its 3% fee will fall.


Let's go back to April 1998, and assume you had $270 million burning a hole in your pocket. What could you have done with that money?

	Alternative #1: Invest in the Vanguard Balanced Index Fund	Alternative #2: Buy the Founders family of mutual funds
Appropriate for:	Conservative, relatively unsophisticated buy-and-hold investors	Corporate big-shots (like Mellon/Dreyfus) who are seeking to build a mutual fund empire
Ways to screw up:	None	Fail to understand the business you are buying, fail to understand the corporate culture, change compensation systems that already work, fail to bind key mutual fund managers
Value of your $270 million investment, as of February 29, 2000:	$331 million	It's got to be better than a balanced fund. Right?

In fact, Mellon/Dreyfus did buy the Founders funds in April 1998, and they did screw up in every way indicated above.....CEO Jon Zeschin left a short time after the Mellon purchase, star manager Ed Keeley fled right after Zeschin, morale suffered, and assets under management shrank.....Tracy Stouffer, who took over Founders Passport (Now Dreyfus Founders Passport) in July 1999, has been about the only positive news at Founders since the Dreyfus purchase.....We estimate that Founders is currently worth about $310 million (this assumes the company would fetch the same multiple of assets as it did in April 1998).....An unsophisticated investor who took $270 million in April 1998 and simply invested that sum in the Vanguard Balanced Index Fund would now have about $331 million in value, or $21 million more than the hot-shot corporate dealmakers at Mellon/Dreyfus.....So much for thinking those big, strategic thoughts.
"Mellon's Fund Deals: Slow to Bear Fruit," Ken Brown, The Wall Street Journal, March 15, 2000


Pump me up:

Vanguard CEO John Brennan (left), with a friend

For the first time since 1996, Vanguard is adding an actively-managed fund to its line-up, and this time it's a muscular growth fund.....If shareholders approve, Turner Growth Equity fund will become Vanguard Growth Equity fund early this summer......Exactly why Turner Growth Equity shareholders should approve the transformation of their now-successful fund into a soon-to-be-bloated behemoth eludes us, but we're assuming that approval will be granted.....Vanguard's motivation is much easier to discern.....Vanguard stands to inherit a terrific track record from this fund, and Vanguard will get a badly-needed infusion of growth-stock hormones.....In an apparent act of contrition, Vanguard also announced that it's starting a new U.S. Value fund, which will be managed by the folks who manage the GMO family of funds.

Remember the good old days of colonialism, when big powers would swoop down on little powers and take whatever they wanted?.....Isn't that pretty much what Vanguard is doing with Turner Growth Equity?.....Well, not exactly, because Turner shareholders have the right to refuse Vanguard's offer, but Vanguard is counting on the fact that mutual fund shareholders almost never vote against management .....As we noted above, we can't think of a single reason why Turner Growth Equity shareholders would be better off as Vanguard shareholders, except for a slightly lower expense ratio (worth about $35 per year on a $10,000 account).....And even if the move to Vanguard were a non-event -- which is far from certain -- why should Turner shareholders agree to rock their boat so that Vanguard can annex a track record?.....If Vanguard wants a growth fund, it should go out and build one of its own......But as long as Vanguard has decided to take the lazy way out, and it's asking for permission to colonize, Turner shareholders should answer with a resounding "No."


Be careful how you mix 'em: Some funds fit together well, some don't, and even index-fund investors need to be aware of the difference.....Herewith, some good and bad index fund combinations:

	Bad mix: If you already own an S&P 500 index fund, you probably don't want a fund based on the Wilshire 5000 index (for example, Vanguard Total Stock Market).....In terms of market capitalization, the S&P 500 index already includes about 70% of the Wilshire 5000, so a fund based on the larger index adds little diversification.
	Good mix: On the other hand, "extended-market" index funds typically track the Wilshire 4500, an index that excludes all S&P 500 stocks.....Extended-market funds are available from Vanguard, Fidelity, and T. Rowe Price (among others), and they provide good small- and mid-cap diversification -- exactly what you're missing with an S&P 500 fund.
	Bad mix: If you already own an S&P 500 index fund, and you want an index fund that provides additional exposure to technology stocks, the Technology Sector Spider is not the way to go.....The Technology Sector Spider, an exchange-traded fund, represents the 91 tech stocks that are included in the S&P 500.....By adding the Tech Spider to an S&P 500 index fund, you merely increase your position in tech stocks that you already own.
	Good mix: On the other hand, the S&P 500 and the Nasdaq 100 tracking stock (ticker: QQQ) have only 33 stocks in common.....The QQQ is an exchange-traded index fund, which includes the 100 largest nonfinancial stocks on the Nasdaq.....Currently, 73% of the QQQ is made up of technology stocks and, as a whole, the QQQ consists of younger, hotter tech companies than the S&P 500.

Mutual fund managers are paid to understand how companies work, and if there's one business you'd expect a manager to understand, it's the mutual fund business.....That's why we were surprised to read some recent comments by Robert Loest, who manages two funds for the IPS family (Millennium and New Frontier)......In commentary posted on the IPS Web site, Mr. Loest argues that mutual fund expense ratios are actually low, and that fund management companies are underpaid:

"Good fund managers are hard to come by. The financial press ought to give them a break, and stop beating up on them for making a margin of profit that's often a fraction of what a bank or grocery store makes."

Elsewhere on the site, Loest continues with the same theme:

"Not many businesses can survive on a 0.2% - 0.5% profit margin per year. Grocery stores make 4 - 10 times the profit margin [that mutual fund companies] do. "

One hopes that Mr. Loest understands his beloved technology companies better than his own industry, because his numbers are simply wrong and ridiculous.....Mutual fund companies like IPS, which manage relatively small funds, may struggle for a while to break even.....But once a mutual fund passes the break-even point, it becomes a money machine for its management company, with profit margins that can easily reach 70% to 90%.....For example, let's take the IPS Millennium fund: Every additional $10 million that is invested in the Millennium fund currently means an additional $115,000 in fees for Loest's management company.....Assuming that Loest's company is already covering the fixed expenses of the Millennium fund, which seems likely, the additional cost of taking another $10 million under management is minuscule -- perhaps $5,000 in postage, printing and other expenses.....Small fund companies like IPS do have an extra cost burden, since they must pay over part of their management fee to the mutual fund supermarkets (like Schwab) that help them raise their money.....But even with a supermarket charge, which typically runs about 0.25% of assets, Loest's company probably nets about $85,000 for every $115,000 it earns in management fees.....In my accounting book, that works out to a pre-tax profit margin of 74%.

The next sound you will hear is a thud, as I tell my local grocer that his store makes "4 - 10 times the profit margin" of a mutual fund company.

		Poor Janus: Even though a number of the Janus funds are closed, and some don't even exist yet, investors still insist on sending checks.....Instead of going through the "hassle and headache" of returning those checks (open envelope, identify check as incorrect, type mailing label, insert check in return envelope, seal, stamp, mail), Janus has instituted a new policy: All incorrect checks will automatically be deposited in a Janus money market account.....Janus will close the money market account upon request, or transfer the money into any available Janus fund, but now it's the investor who will have the hassle and headache, along with an unexpected 1099 form.....Meanwhile, Janus earns the management fee from the money market account.
	"Shut Out of a Janus Fund? Don't Expect Your Check Back Right Away," Ian McDonald, TheStreet.com, March 21, 2000

For those who worry that the U.S. economy may be overheating, here's some encouraging news: The average annual pay of the top 50 mutual fund directors rose only about 2.5% last year, to just over $234,000.....But even with such a modest increase, these public-spirited corporate citizens are still managing to put food on the table.....For example, Joseph DiMartino, a director for 189 Dreyfus Funds, receives an annual paycheck of $642,000.....Assuming that DiMartino spends a generous 10 hours per fund per year, that works out to a rate of $340 an hour, which is actually on the low side among his peers (thanks, Joe!).....John McDonald, a director for eight of the penny-pinching American funds, earns $229,500 per year, which is equivalent to about $2,869 an hour.....Wayne Whalen, a director for 105 Van Kampen funds, toils away at $272 per hour ($285,000 per year), but at least there's light at the end of Whalen's long tunnel: When he retires as director, Van Kampen will pay him $157,500 per year for 10 years.....Of course, some directors can't take the risk of a pension that will end after 10 years, so fund companies also offer lifetime retirement benefits.....Manuel Johnson, a director for 93 Morgan Stanley funds, scrapes by on $224 an hour ($208,000 per year), but he's looking at a lifetime pension benefit of $75,000 per year.....When a fund director spends his entire career schmoozing and pushing pencil, it's nice to know that some employers still care.
"Fund pay: $1,000 an hour," Ilana Polyak, Investment News, March 20, 2000


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Briefly noted:

• According to a recent press release, Morningstar has agreed to provide mutual fund content for a new Web site, called 4realmen.com.....(Among the prominent features on the manly site is a "Honey Minder," which helps readers keep track of those all-important birthdays and anniversaries).....Billed as the "only Web site for traditional men," 4realmen.com is also rumored to be negotiating with Morningstar for some exclusive manly content.....Among the possible new Morningstar features: "Belching with Rekenthaler" and "Scratching with Kinnel."
  
  
  
• Good move: Transamerica Investment Services has formed a new company to manage the Transamerica funds, and fund managers as a group will be able to accumulate about 20% of the equity in the new entity.....The percentage is stingy, and an arrangement like this won't stop manager turnover, but it can certainly help.
  "Managers Get Slice of Transamerica Entity," Laura Saunders Egodigwe, The Wall Street Journal, February 24, 2000
  
  
  
• Recently, technology stocks have been propelling the NASDAQ composite index and, even as you read this, technology is making your life more wonderful.....But there's one area in which technology appears to be stymied: Creating an index fund that duplicates the entire NASDAQ composite, which contains about 4,800 stocks....."It would be virtually impossible to run," says one fund company exec, so investors must settle for close substitutes.....The QQQ, an exchange-traded fund, tracks the top 100 nonfinancial NASDAQ stocks, and the QQQ often (though not always) tracks the larger NASDAQ composite.....Several actively-managed funds also have a high historical correlation with the NASDAQ Composite, including Fidelity OTC, Fidelity Aggressive Growth, AIM Summit, and IDEX Alger Aggressive Growth.....A Vanguard spokesman recently sneered at the thought that Vanguard might offer a NASDAQ index fund, saying that the index was too heavy on technology, and such a fund might attract vermin (i.e., "speculative investors").....Perhaps the spokesman wasn't aware that Turner Equity Growth, the fund Vanguard soon hopes to colonize (see above), is also highly correlated with the NASDAQ composite.
  "Investors Find Nasdaq Funds Are Elusive," Aaron Lucchetti, The Wall Street Journal, March 10, 2000
  
  
  
• Still giddy from her "call" of the 1987 stock market crash, Elaine Garzarelli has been named new manager of the Forward Equity fund....This is the same Garzarelli who delivered dismal performance at the late and unlamented Shearson Sector Analysis fund, who folded her own fund (Garzarelli Balanced) after only seven months, and who advised her newsletter readers to sell their stocks in the Summer of 1996, just as the market was getting ready for one of its biggest growth spurts in history.....Garzarelli's fund will be renamed Forward Garzarelli, and it joins another renamed fund, Forward Hansberger International Growth, which used to be called Forward International Equity*.....Some irresistible names for future fund offerings: Forward March (perhaps an aggressive growth fund?), and Forward Reverse (the perfect name for a market-neutral fund).
  * "Guru Garzarelli Takes Reins at Forward Funds," Dan Culloton, Morningstar.com, March 1, 2000
  
  
  
• Kinetics Asset Management, the firm that runs the Internet Fund and several other Internet sub-sub-sector funds, recently announced a $4 million advertising campaign.....To put that amount in perspective, Fidelity spends only about 10 times as much on advertising ($40 million per year), even though Fidelity manages about 650 times the assets of Kinetics (almost $1 trillion)....."We're heavily into brand-building mode," says the Kinetics CEO, as if anybody really pays attention to (or cares) who runs a small, hot mutual fund. "We view ourselves as an Internet organization.".....In other words, look for an overvalued IPO, coming soon.
  "Kinetics Asset to Launch Its First TV Ads," Pui-Wing Tam, The Wall Street Journal, February 22, 2000
  
  
  
• Did you hear the one about the guy who kept trying to send an e-mail, but couldn't get the stamps to stick to the screen?.....When old style collides with new style, the results can be either funny or pathetic, depending on your perspective, and something either funny or pathetic is going on right now at the new Baron iOpportunity fund.....The old-style Baron firm has been entrusted with $200 million of investor money, and it's trying to find bargains among Internet stocks, while avoiding big risks.....The new-style Baron firm, represented by iOpportunity analysts Matthew Ervin and Mitchell Rubin, wants to buy, buy, buy.....Old-style Baron President Morty Schaja insists on five-year cash flow projections, even for Internet stocks, while the new-style Baron analysts prefer five-second analysis, such as this one: "There is no cycle. It's a paradigm shift".....Old-style Ron Baron probably remembers a time when new mutual funds were started to fill real needs, and when the firm that started a fund had some expertise in the area.....New-style analysts Ervin and Rubin have no institutional memory, no fear, and nothing to lose.....Old-style Baron would have been ashamed of this pandering and poorly-conceived fund.....New-style Baron cranks up the music, passes around the brewskis, and gets ready to party on.
  See, also, "Baron Managers Get Caught in the Net," Ken Brown, Wall Street Journal, March 22, 2000
  
  
  
• Merrill Lynch Phoenix is coming off its best year ever, with the Class A shares up 48.83% in 1999.....This is a classic deep-value fund, which has been staying reasonably close to its mission, and that makes its recent performance all the more remarkable.....In an apparent attempt to break what isn't broken, and weaken a tough discipline that finally seems to be working, Merrill Lynch recently sent out proxy materials that would allow the fund to use a more relative measure of value.....To recap: Shareholders have been patient through some bad years, it looks like the manager may have finally found his groove, and now the fund company decides that a change is necessary.....Is anyone else thinking "bad timing?"
  
  
  
• The new Allied Owners Action Fund plans to invest in smaller companies that have "sleepy, selfish or unfocused" management.....Once the fund takes a position in a stock, it will seek to prod company management to make changes and increase shareholder value.....Shareholders in the fund will be encouraged to invest independently in the same companies, and then become pains-in-the-neck by e-mailing company executives, posting messages on stock bulletin boards, and otherwise making life uncomfortable for managers who thought they didn't appear on anyone's radar screen.....A related Web site, eRaider.com, will help coordinate and direct the shareholder frenzy.
  
  
  
• In case you were wondering, the co-founder of the Allied Owners Action Fund (above) is no stranger to disappointment, broken promises, and revenge.....He made his first fortune developing matchmaking software, which formed the basis for several radio station "datelines."
  
  
  
• On January 27, Janus entered into a much-ballyhooed private equity ("PIPE") deal to purchase almost $1 billion worth of Healtheon/WebMD, at $62 per share.....As of March 28, Healtheon/WebMD was trading for about $31 per share, which means that Janus had a paper loss of almost $500 million on its investment.....As one reporter recently noted: "If Janus thinks the stock is worth $62 and investors think it's worth [$31], someone is wrong. Either the stock is a bargain at today's price or Janus overpaid for a company of which it now owns more than 10%."
  "Janus' Healtheon/WebMD Stake Turns Into Big Pain," Ian McDonald, TheStreet.com, March 8, 2000
  
  
  
• "What do we want?" MAXIMUM RISK!!
  "When do we want it?" NOW!!
  

  James McCall came over from PBHG in November, and Merrill Lynch has just launched two new funds with McCall at the helm: Merrill Lynch Focus Twenty and Merrill Lynch Premier Growth.....Premier Growth is likely to hold many of the same names as its more focused sibling, but it will also be more diversified, with perhaps an additional 30 stocks in its portfolio.....Premier Growth managed to raise about $160 million during its subscription period......Focus Twenty, virtually guaranteed to be more volatile, made its debut with just over $1 billion.....Merrill is also cloning these two funds under the Mercury name, where they will be called Mercury Focus Twenty and Mercury Premier Growth.....This is apparently a Chevrolet/Geo kind of thing.....For those investors who wouldn't be caught dead owning a fund with a broker's name, Merrill hopes that a fund named for a mythological figure will be more appealing......Hey, it works for Janus.

  
  
  
• Not exactly a ringing endorsement: David Jellison, manager of the Columbia Real Estate Equity Fund, says that he has "more than 5%" of his own assets in the fund.....You can assume that also means "less than 6%."
  Investment News, March 20, 2000
  
  
  
• If your fund has a great year, the management company might take a fee of, say, 1% out of your account.....And if your fund has a truly dismal year, the management company might take a fee of, say, 1% out of your account.....Is there no justice?.....In fact, there seldom is, and only a handful of funds base their fees on performance (i.e., your return relative to an appropriate benchmark).....According to a recent article, Fidelity has a few performance-based funds (Diversified International, Dividend Growth, Small Cap Stock, Value), and Vanguard has a couple (Asset Allocation, Growth & Income).....Among the other funds that are willing to take a fee cut when they don't perform: Pioneer, Pioneer Mid-Cap, Kemper Aggressive Growth and Calvert Capital Accumulation.
  "Funds That Tie Fees to Results," John Kimmelman, CNBC.com, March 16, 2000. Please note: The funds listed above are those that appeared in this article. This is not a complete list of performance-based funds.
  
  
  
• Here's something we've never seen before: IAI has closed its Growth & Income fund, due solely to a lawsuit over an Internet IPO.....It seems that the fund bought shares of a company called MatrixOne in a private deal, and the fund entered into a contract to sell the shares, also in a private deal, last October.....According to IAI, the prospective buyer let the deal lapse.....The buyer says that the MatrixOne sale should have gone through at last fall's contract price -- which, not surprisingly, is now much lower than the stock's market price (the company went public on March 1).....IAI has long had a liking for private stock deals, especially in its Value and Emerging Growth funds, and this has resulted in other legal problems over the years.....IAI will reportedly stop making new investments in private stock deals, and the firm is in the process of unwinding its existing positions.
  "Stake in Hot IPO Forces IAI to Close Fund," Ilana Polyak, TheStreet.com, March 10, 2000
  
  
  
• ReliaStar Financial (Northstar/Pilgrim/Nicholas-Applegate funds) will buy the 13-fund Lexington family, and some of the weaker Lexington offerings will probably be merged out of existence.....Included in the Lexington lineup is one fund that has no equivalent anywhere, and will probably survive: The Corporate Leaders fund, which has held the same portfolio since 1935, except for occasional spin-offs, mergers, or dissolutions.....You'd think that Corporate Leaders would have an extremely low expense ratio, but it doesn't (0.65%), which suggests that the price of NO-DOZ must be creeping up, too.
  
  
  
• The Pioneer fund family is officially up for sale, and Robert Sanborn is officially the ex-manager of the Oakmark fund.....Sanborn resigned on March 21, and he was immediately replaced by Bill Nygren (of Oakmark Select), who will co-manage the fund with Kevin Grant......New manager Nygren says that he has "inherited a portfolio that is very attractive relative to the market. I expect and desire that Robert's thoughts will be reflected through me in the portfolio".....Company officials could not immediately explain how Sanborn will channel his thoughts through Nygren, but a full bodily possession has not been ruled out.
  
  
  
• There's a restaurant in my neighborhood that sells only chili and hot sauces, and they won't even let you touch a certain brand of hot sauce unless you sign a waiver of legal liability......For dangerous products in the financial world, there are no similar safeguards.....The ProFund family says that it's working on versions of technology, biotechnology, Internet, electronics, and telecom funds that will have double leverage -- that is, twice the action of the underlying sector.
  "No Experience Necessary," Lewis Braham, SmartMoney.com, March 10, 2000
  
  
  

• Andrews #1

  Andrews #2

  Andrews #3

  Andrews #4

  The Open Fund, "the world's first interactive mutual fund," recently announced an addition to its Think Tank of "technology and business visionaries".....The new member is Lori Andrews (#1 - #4), an internationally renowned expert on cloning..... Lori Andrews #1 said that she is "looking forward to sharing my expertise in the legal and ethical dimensions of biosciences and genetics".....Lori Andrews #2 wondered if all this stuff about the Open Fund Think Tank is just a lot of silly hype.....Lori Andrews #3 appeared to be sound asleep.....Lori Andrews #4, also known as Dolly, could only say "Baa."

FundAlarm © Roy Weitz, 2000