FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

(Originally posted April 1, 2006) [Archive Table of Contents]

They shoulda been contenders: Funds that invest only in stocks are supposed to be riskier than balanced funds, which also hold fixed-income investments.....In exchange for this extra risk, stock funds are expected to generate better returns, but sometimes this trade-off doesn't hold.....The accompanying page lists 85 diversified U.S. stock funds that have returned less than the Vanguard Balanced Index fund over the past 12 months, three years, and five years.....Vanguard Balanced invests only about 60% in stocks, and the other 40% is allocated to fixed-income.....In other words, Vanguard Balanced competes against stock funds with one hand tied behind its back, yet it still sent 85 stock funds down for the count.....See the 85 diversified stock funds that couldn't even whup a one-armed balanced fund

A recent column by Jane Bryant Quinn ("Autopilot for Retirement") described lifecycle mutual funds as a "true buy-and-forget investment," as well as a "smart and sensible choice" for "do-it-yourselfers".....To which we respond: "Don't expect any help from Jane Bryant Quinn when you're 85 years old, and your lifecycle fund has run out of money".....As we've said before, a lifecycle fund can be a good choice for some investors, but it's emphatically not a "true buy-and-forget investment" (all together now: "Nothing ever is").

What's a lifecycle fund? A lifecycle fund (also called a "targeted retirement fund") is typically designed for people who plan to retire in or near a specific year, and that target year is often part of the fund's name -- for example, "XYZ Lifecycle 2020" would be designed for people who plan to retire in or near 2020. A lifecycle fund typically invests in several other mutual funds offered by the same fund family (for example, XYZ Lifecycle 2020 might invest in two stock funds and two fixed-income funds sponsored by the XYZ fund family). As the target year approaches, a lifecycle fund typically adjusts its allocation in the underlying funds, gradually becoming more "conservative" (i.e., periodically increasing its allocation to the underlying fixed-income funds, and decreasing its allocation to the underlying equity funds).
What's the problem with lifecycle funds? Certain lifecycle funds will perform worse than other lifecycle funds, and in some cases much worse. While this may seem like an obvious statement -- certain funds always perform worse than other funds -- lifecycle funds are unique because they're often marketed (or, in Quinn's case, touted) as one-decision solutions to retirement planning. Let's frame the problem another way: Given the choice today between (say) three 2020 lifecycle funds, from three different fund families, we can guarantee that one of those funds will be the best performer and one will be the worst performer. And why can we make that guarantee? Because lifecycle funds from different fund families start out, today, with vastly different allocations among stocks, bonds, and other assets. If you're unlucky, and you happen to "buy-and-forget" the worst lifecycle fund, you may wake up in 2020 and find that you haven't accumulated enough capital for the kind of retirement you were expecting. Even worse, had you invested in the lifecycle fund that turned out to be the best performer, you might easily have achieved your retirement goals.
Would you like to take another dig at Jane Bryant Quinn? I would. Towards the end of the column that we've been discussing, Quinn gives the following advice:

"You can decide, yourself, if you prefer low risk and income [in your lifecycle fund] or would rather own more stocks to grow your estate for you heirs."

Sure, just like you can decide, yourself, whether you want to walk or drive to an appointment 50 miles away. Both methods of locomotion will get you there, but one of them (walking) would be a really bad choice if your goal was to arrive at your destination within an hour. Retirement planning almost always starts with your goal (i.e., your income need), and works backwards to the portfolio that's most likely to achieve your goal with an acceptable level of risk. Choosing a lifecycle portfolio isn't the kind of six-of-one, half-dozen-of-another decision that Quinn suggests. The composition of a lifecycle portfolio is critical and, as we've discussed above, could very well mean the difference between a satisfactory and dismal retirement.
So what's FundAlarm's take on lifecycle funds?
- Never buy and forget any fund, including a lifecycle fund.
- If you are able to select your own funds, don't buy a lifecycle fund.
- If you must buy a lifecycle fund, consider investing in at least two lifecycle funds from different fund families, even if they have the same target date. One of your lifecycle funds should be relatively aggressive, and one should be relatively conservative -- in effect, a lifecycle barbell. This will keep you from betting all your retirement money on the loser fund. If you invest in a lifecycle fund through a 401(k), and you have access to only one fund family, consider investing in another lifecycle fund outside of your retirement plan.
- Periodically refine your retirement income goal, and compare it with the amount you have accumulated in your lifecycle funds, plus any other assets or income streams (such as Social Security) that will be available for your retirement. If it looks like you're going to come up short, you may need to adjust your fund holdings, invest more money each year, or both. If you aren't able to do this kind of analysis yourself, hire a competent financial planner.

In mid-January, an independent newsletter that follows Fidelity funds released its list of Fidelity's top-ten mutual fund managers.....Within days, Fidelity had proudly reproduced the list on its Web site:

And just a few weeks after the list appeared, Katherine Lieberman became the first top-ten manager to quit her fund (Small Cap Value) and leave the firm.....Given Fidelity's dismal record on manager continuity, we're predicting that at least half the managers on this list won't be in charge of their respective funds as of the April 2007 edition of FundAlarm.....We'll check back from time to time, to see how the attrition is progressing.

When your fund outperforms its benchmark, the company that runs your fund takes a percentage of your account as a management fee.....That seems fair, until your fund trails its benchmark, and the company that runs your fund takes exactly the same fee.....Even if your fund manager has agreed to a performance-based fee, the result isn't much better: The "base management fee" is typically set so high, or it's reduced so little, that your manager almost never feels your pain, no matter how poorly he or she performs.....But what if your fund manager had a bad year and received absolutely no management fee?.....Would that seem like a more equitable arrangement?.....TFS Capital certainly hopes so, because that's pretty much the performance fee structure for the new TFS Small Cap Fund.....The base management fee for TFS Small Cap is set at 1.25%, but that fee is payable only if the fund outperforms its benchmark (the Russell 2000 Index) by at least 250 basis points (2.50%).....For every two basis points that the fund underperforms the "Russell plus 2.50%," the management fee drops by one basis points, as follows:

Performance of Fund relative to Russell 2000 Index (prior 12 months)	Fund management fee (annual rate)
+2.50%	1.25%
+2.48%	1.24%
+2.46%	1.23%
......................................
+0.06%	0.03%
+0.04%	0.02%
+0.02%	0.01%
+0.00%	0.00%

If the performance of the fund just matches the benchmark -- the last line in the table above -- the managers are effectively working for free.....(Since the SEC requires that fund performance fees be symmetrical on the upside and the downside, the manager of TFS Small Cap also stands to double its fee, to 2.50%, if the fund outperforms the Russell 2000 by at least 500 basis points)......TFS Small Cap opened its doors on March 7 of this year, so it has no track record, and the performance fee doesn't kick in until the fund has been around at least 12 months (until then, the management fee is a flat 1.25%).....Of course, if the fund turns out to be a stinker, then even a 0% management fee is no bargain.....TFS Capital has made it clear that this fee structure is an experiment, and you can assume that the company will liquidate the fund after a few years if the performance (i.e., management fee income) isn't adequate* (there's also the possibility that performance will be decent, but the fund will be liquidated anyway, because it never gathers enough assets).....If you're truly cynical, you might even view the TFS performance-fee structure as a Hail Mary Publicity Stunt: If it works, TFS will get on a lot of radar screens very quickly, with little out-of-pocket expense.....If it doesn't work, well, what did it really cost them?.....In any event, if you're willing to take some risk with a small portion of your portfolio, TFS Small Cap might be an interesting opportunity.....As much as any fund manager, it would seem that TFS Capital has all the right incentives to make this work.
* Mutual fund fee alternative," Chuck Jaffe, MarketWatch.com, March 19, 2006

Since early 2001, Merrill Lynch has dumped over a million customers into its Financial Advisory Center, which is Merrill's way of weaning small-balance account owners (under $100,000) from their individual brokers.....Now, it turns out that customers of Merrill's Financial Advisory Center (FAC) were treated like the corporate disposables that they were: Among other things, FACs were improperly supervised, phone reps recommended thousands of unnecessary fund switches, and undisclosed sales contests (in violation of industry rules) contributed to a "dramatic increase" in the volume of "proprietary" (i.e., Merrill Lynch) fund sales.....(In one case, tickets to the rock group Foreigner were awarded to the brokers who sold the most Merrill Lynch funds, meaning that both brokers and customers were screwed).....Merrill's fine for three years of sloppiness, deception, and incompetence was $5 million, or less than five dollars for each affected customer account.....Wow, what a tough lesson.
Sources: "NASD Fines Merrill Lynch $5 Million for Call Center Supervisory Failures, Sales Contest Violations" (NASD press release, March 15, 2006); "Merrill Is Fined For Call-Center Work," Susanne Craig, The Wall Street Journal, March 16, 2006

Cockroaches rarely travel alone: On the heels of the Merrill Lynch enforcement action and fine (above), the NASD issued a warning about all mutual fund "customer advisory centers".....("Customer advisory centers" are sales-oriented operations, usually designed to replace individual brokers at national financial services firms. The NASD warning generally doesn't apply to call centers run by no-load fund companies, since these centers are staffed by salaried and hourly staff, rather than commission-based sales people).....If your brokerage firm has shunted your existing account to a customer advisory center (CAC), or if your broker intends to service your new account only through a CAC, you might want to read the NASD warning.....Even better, you might want to close your account, and resolve never to do business with that broker again.....A customer advisory center is a dumping ground, usually for customers who have relatively small accounts, and it doesn't matter what shade of lipstick your broker tries to put on this pig.....It also shouldn't matter what size account you have: You should be able to find a competent advisor (perhaps at a smaller, local firm) who will give you personal attention.....If not, consider becoming a do-it-yourself investor.....With just a little bit of effort and study, most people should be able to run rings around any call-in center.

Readers of the FundAlarm Discussion Board know David Snowball as the Midwest college professor who regularly contributes those long, knowledgeable, and extremely patient posts.....David and I recently discovered that we share an interest in new mutual funds: David likes to follow new funds, and I've always wished there was more and better coverage of them.....David volunteered to don the hat of new-fund guru, I offered to make space available on FundAlarm, so here we are with the first-ever FundAlarm Annex, devoted to new mutual fund offerings.

What's so special about new mutual funds? Nothing, necessarily. Some new funds are the tenth generation of a principal-protected fund that wasn't worth anyone's attention in the first place. Other new funds are gimmicks, or creations of the marketing department, or obscure state municipal bond offerings. But a few new fund offerings truly have promise, usually because of the manager(s) who will run them, the fund company that created them, or the idea behind them.
How will this feature work? David will select new mutual funds that interest him, and write about them. Each write-up will have a similar format, but there will be enough variation to keep things interesting. Basically, this Annex will be run as David's own mini-Website. I could describe it as David's "monthly blog devoted to new mutual funds," except the word "blog" is so overused, and so debased, that I don't want to insult him. Initially, David's new-fund Annex will be accessible via a link from the Highlights and Commentary page. If FundAlarm readers show enough interest in this feature, David and I will consider spinning it off into its own site.

What do I need to do? Give us feedback. Creating this feature involves a lot of work, and potentially a major commitment, so we need to hear from FundAlarm readers. We'll keep the feature going for a few months, no matter what, but if we don't receive a significant amount of feedback we'll probably drop it. Send us two words or 2,000. Tell us what you love about the feature, tell us what you hate about it (really!), offer suggestions for improvement, or tell us it's the most fun you've had since you went skinny-dipping with veteran Janus manager Scott Schoelzel. But it's important that you tell us something: Our e-mail address is feedback@fundalarm.com.

Roy's Excellent Market-Timing Adventure:
Month Six: Sideways

Intelli-Timer didn't issue any new signals during March -- there hasn't been a new signal since January 29 -- so I continued to hold the long position for the entire month (i.e., ProFunds OTC Inv, or OTPIX).....Overall, my account showed a gain of 0.14%, which reflects a month of random up-and-down movement, and a net asset value that ended up just about where it started:

Month	Date of signal (1)	Type of signal	Fund bought/held (2)	Acct value (beginning)	Acct value (ending) (3), (4)	Change in acct value for month	Change in acct value since inception
October, 2005	10/16	Long	OTPIX	$5,000.00	$5,080.09	+1.60%	+1.60%
November, 2005	No new signal	Long still in effect	OTPIX	$5,080.09	$5,484.89	+7.97%	+9.70%
December, 2005	11/29	Short	SOPIX	$5,484.89	$5,381.32	-1.89%	+7.63%
January, 2006	No new signal	Short still in effect	SOPIX	$5,381.32	$5,378.51	-0.05%	+7.57%
February, 2006	1/29	Long	OTPIX	$5,378.51	$5,186.30	-3.57%	+3.73%
March, 2006	No new signal	Long still in effect	OTPIX	$5,186.30	$5,193.62	+0.14%	+3.87%
Notes: (1) Signal was executed (i.e., fund bought) on the next business day. (2) OTPIX=ProFunds OTC Inv.; SOPIX=ProFunds Short OTC Inv. (3) Cut-off for valuation is 26th day of the respective month. (4) Account value includes value of fund shares only. Cash in the account, as well as interest earned on the cash, is ignored. Brokerage commissions are paid out of this free cash, and commissions are not included in return calculations. Dividends are reinvested.

Although OTPIX went sideways for the month, a couple of the usual FundAlarm benchmarks (Vanguard Small Cap Index and Schwab International Index) had an excellent month, and pulled away even further from my market-timing account:

	Current month (2/27 thru 3/26)	Since inception (10/17/05)
Vanguard Small Cap Index (NAESX)	2.03%	16.96%
Schwab International Index Inv (SWINX)	2.61%	13.41%
Dreyfus Mid Cap Index (PESPX)	0.81%	9.79%
Vanguard 500 Index (VFINX)	0.76%	9.35%
Vanguard Balanced Index (VBINX)	0.05%	5.83%
Roy's market-timing account	0.14%	3.87%

Sorted by return "Since inception"; benchmark returns assume that dividends are reinvested

As we come up on the halfway point of this experiment, the average of the five FundAlarm benchmarks, from inception, is 11.07%.....Even that number is starting to seem out of reach for my market-timing account.

Briefly noted:

Matthew Fink retired in 2004 as President of the Investment Company Institute, which is the mutual fund trade association and Washington lobbying group.....In 2005, Fink was elected director of 38 Oppenheimer mutual funds......Let's see: After a 33-year career advocating the financial (and other) interests of the fund industry, Fink is hired (at an estimated $200,000 a year) and he now represents fund shareholders......Fink's remarkable transformation inspired us to research some other famous career turnarounds.....Would you believe that after the fox finished guarding the henhouse, he became a vegetarian?.....OK, we didn't think you would.
Details, details, details: For years, the boards of the Reserve Funds and the Hallmark Funds approved numerous management contracts and agreements for 12b-1 distribution plans, all without incident.....Then, in early 2005, someone discovered that two of the funds' "independent" directors weren't "independent" after all, which effectively voided all of the contracts and agreements those directors had voted on......Almost a year later, in February 2006, Reserve Management Company (the firm that runs the Reserve and Hallmark funds) came up with a solution to the problem: A 39-page proxy document that seeks a shareholder vote, in order to fix all of its screwups......Needless to say, Reserve also wants to fix its biggest screwup: Because years of management contracts were technically invalid, Reserve wasn't legally entitled to any of the management fees that it earned from the funds in question, and Reserve needs the kindness of strangers (i.e., a shareholder vote) in order to keep the money.
"Reserve's Proxy Reveals Multiple Problems," Lori Pizzani, Money Management Executive, March 13, 2006
Oh, and the outside auditing firm for the Reserve and Hallmark funds (above) abruptly resigned last September, and some of the funds have apparently had problems with their internal accounting controls, and Hallmark Convertible Securities still hasn't filed its semi-annual shareholder report as of June 30, 2005.....Otherwise, everything at Reserve and Hallmark is just fine.
Source: Money Management Executive article, above
Governor, senator, perhaps even the proverbial dogcatcher: It doesn't seem to matter much to former fund manager Jim Oberweis, founder of the of the eponymous Oberweis mutual funds, who apparently just wants to get elected to some political office in his lifetime.....Alas, Oberweis recently failed at another electoral attempt, placing second in the Illinois Republican gubernatorial primary.
Fidelity offers a nice little fund screener on its Web site.....FundAlarm reader David Moran recently plugged several search criteria into Fido's screener, and got back a list of 75 potential investment opportunities, including one Fidelity fund (Fidelity Small Cap Stock).....Problem is, David knew that at least two funds not listed, including one additional Fidelity fund -- Low-Priced Stock -- also met his screening criteria (although Low-Priced Stock is closed, the screener was supposed to return both open and closed funds) .....Why would the folks at Fidelity omit their own fund from the screening results?.....Darned if they know: According to a rep at Fidelity, the mysterious glitch has been referred to the Web site's "developer".....Meanwhile, David notes that "we all rely" on various third-party fund screening tools to help us make investment decisions, and the experience at Fido's Web site "kinda makes you wonder....."
* The Fidelity fund screener can be accessed through the "Advanced Search" link on the Fidelity Web site.
Warren Buffett, fund manager? Berkshire Hathaway is Warren Buffett's company, and Berkshire owns publicly-traded common stocks worth about $47 billion.....In other words, viewed as a mutual fund, Berkshire's publicly-traded stock holdings would be the sixth-largest actively-managed stock fund in the U.S., just ahead of Dodge & Cox Stock, and just behind Fidelity Magellan..... As you might expect, Buffett runs the fund-like portion of Berkshire Hathaway in his own, unique style -- think of it as a super-focused mutual fund.....For example, at the end of 2005, Berkshire's stock portfolio consisted of 12 stocks that Buffett was willing to itemize, and several other stocks that Buffett chose not to itemize.....The non-itemized group of stocks is worth about $7 billion in total, and Buffett says that no individual holding in the group is worth than $700 million.....If we assume that the non-itemized holdings have an average value of $350 million each, that means Buffett owns another 20 stocks, and his total stock portfolio consists of just 32 names.....By way of comparison, among conventional funds with more than $20 billion in assets, Dodge & Cox Stock is the most concentrated offering, and it recently owned stock in 86 different companies.....In other words, there isn't a mutual fund manager around who dares to run a fund the way Buffett runs his.
A snow-capped mountain of sleaze? Mario Gabelli is in trouble with the Feds, although his troubles have nothing to do with his mutual funds.....The Justice Department has taken over a five-year old civil lawsuit, which alleges that Gabelli created a number of sham companies in order to obtain -- and hugely profit from -- cellular phone licenses.....If Gabelli was behind these sham companies, and he's found liable in this case, he'd be dead to us a fund manager: We would never knowingly turn our money over to a manager who's been involved in an illegal financial transaction.....But we suspect that we're in the minority here.....After all, Gabelli was just showing some good, money-grubbing aggressiveness, and for a lot of people, that exactly the kind of guy they want on their side.
Thomas Faust Jr. will be taking over as CEO of Eaton Vance next year, and Faust has bold plans to turn Eaton Vance from a niche player, known mainly for tax-managed and bank loan funds, into a diversified investment shop.....Faust will succeed James Hawkes, who's hitting mandatory retirement age, and Faust says that "other members of senior management who are of similar vintage" to Hawkes will be retiring over the next couple of years*.....For the record, soon-to-be-ex CEO Hawkes (pictured on the right) is Vintage 1942.....Hawkes is noted for fresh and juicy fruit flavors that follow the nose, backed by snappy acidity, with light, smooth tannins in the background.
* "With Thomas E. Faust Jr. of Eaton Vance Corp.," Frederick P. Gabriel, InvestmentNews, March 13, 2006
If you're interested in becoming a shareholder of T. Rowe Price Mid Cap Growth, it might seem like you're out of luck, since the fund has been closed since December 2003.....But the door just opened a crack: In mid-June, T. Rowe Price Mid Cap Growth will take over the assets (and shareholders) of Preferred Mid Cap Growth (Preferred is getting out of the fund business, and T. Rowe Price will be taking over all of Preferred's other funds as well).....If you invest in Preferred Mid Cap Growth by May 31, you'll get a free ride into the T. Rowe Price mid-cap offering.
"A Side Door to a Great Fund," Katy Marquardt, kiplinger.com
The Jacob Internet Fund may be on a tear (up 31.77% for the 12 months through February 28, 2006), but manager Ryan Jacob apparently has better uses for his money.....According to a recent SEC filing, Jacob has less than $50,000 invested in his own fund.....Also, with very little fanfare, Ryan Jacob's investment firm (Jacob Asset Management of New York LLC) has relocated to Southern California (Redondo Beach, to be exact)......Do we detect a lifestyle change here, or did Mr. Jacob just want to be closer to the FundAlarm offices?.....Hey, Ryan, welcome to paradise.....Give me a call, and we'll do lunch.
Conventional wisdom holds that you can never lose all your money in a mutual fund, but for a couple of years it looked like Berkshire Focus was going to give it a try: From September 2000 through September 2002, Berkshire Focus lost just over 95% of its value, and it appears that manager Malcolm Fobes might have scared even himself.....As of last May (the date of the most recent SEC filing), Fobes didn't own even $10,000 worth of his own fund.
Fidelity New Markets Income is a decent emerging markets bond fund and, over the ten-year-plus tenure of manager John Carlson, we're guessing that Fidelity has paid Carlson at least $5 million for his services.....A recent SEC filing reveals that Carlson hasn't invested even a penny of that money in his own fund.
On the other hand: Foster Friess, founder of the Brandywine fund family, recently had over $160 million invested in Brandywine Advisors....Friess' stake works out to about 81 percent of the fund's total assets -- and Friess doesn't even manage the fund (he's retired from management, and Bill D'Alonzo is now in charge).
"Keeping it in the Family," Todd Mason, philly.com, March 19, 2006
As of December 31, 2005, the flagship Yacktman Fund held 34 stocks in its portfolio, while Yacktman Focused held just 20 stocks......The more concentrated fund (i.e., Focused) didn't own a single stock that wasn't also owned by its more diversified sibling, so its clear that the two funds share their research (in fact, they're run by the same father/son team).....Maybe, just maybe, the managers of Focused dig a little deeper, but you'd still expect these funds to charge pretty much the same management fee.....Unfortunately, you'd be wrong: For some reason, perhaps known only to the fund's directors, the management fee for Focused is almost 42% higher than its sister fund (0.92% per year versus 0.65%)*
* This is the Focused management fee after a voluntary expense waiver; the stated management fee is 1.00%. Thanks to "Patrick," of the FundAlarm Discussion Board, for bringing this item to our attention

Dear Yacktman fund directors: We were feeling generous, so we did some of the work you should have done for your shareholders.....We looked at several other small fund companies that run both diversified and focused funds, and here's how they charge for their services:

Bramwell: Same management fee for its diversified and focused funds

CGM: Management fee for its focused fund is 8% higher than its diversified fund

Cohen & Steers: Management fee for its focused fund is 8% higher than its diversified fund

Hennessy: Same management fee for its diversified and focused funds

Hillman: Same management fee for its diversified and focused funds

Marsico: Same management fee for its diversified and focused funds

Now, Yacktman directors, it might be time to fix your fee structure.

The most irresponsible item FundAlarm has ever published: According to MIT Professor Andrew Lo, $1 invested in the S&P 500 Index on January 1, 1926 would have grown to about $4,000 by the end of 2005 ($1 invested in the Lehman Brothers Aggregate Bond Index would have grown to about $18).....Over the same period of time, an investor who moved $1 between the indices at the precise time one was up and the other was down -- in other words, a market timer with perfect foresight -- would have accumulated a little more than $23 billion (yes, that's "billion" with a "b").....Now do we all understand why market timers will never give up their quest?
Pensions & Investments, March 6, 2006