FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

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

	Former Iraqi Minister of Information Mohammed Saeed al-Sahhaf makes his first appearance as head of public relations for the Janus Funds:
"I can say, and I am responsible for what I am saying, that the retirement of Helen Young Hayes will have no effect on Janus."

Well, Janus can spin the news all it wants, and the company certainly has hired a pro in Mr. Sahhaf.....But the fact remains: The retirement of Helen Young Hayes, announced in mid-April, is a huge blow for Janus and its funds.....Here's what happened at Janus last month...where things stand now...what to look for...and our two cents worth on what it all means:

Hayes resigned as the firm's chief investment officer, and she also resigned as manager of Janus Worldwide and Janus Overseas (including the "Adviser" and "Aspen" versions of those funds). Hayes will step down on June 16, but she has promised to stay around until year-end as an "advisor" to the new management teams. And what happens after that? According to the official line, Hayes is "retiring from the asset management business."
Laurence Chang, who has co-managed Janus Worldwide since September 1999, will take over as lead manager, assisted by Doug Kirkpatrick. Brent Lynn, co-manager of Janus Overseas since January 2001, will take over the top spot at that fund, assisted by Garth Yettick.
What's that? You say you've never heard of these new managers? Well, we barely have, and that's the point. Hayes was the experienced manager, the public face of Janus, and even though the recent performance of her funds has been poor, there was some reason to believe that she could lead them back to their former glory. New managers Chang and Lynn seem almost interchangeable, the Rosencrantz and Guildenstern of the mutual fund industry, and there's nothing particular in their backgrounds that inspires confidence. If you own shares of these funds, now might be a good time to reevaluate your holdings.
According to a Janus spokesperson, Hayes is retiring for lifestyle reasons. She likes to read, but has barely had time to finish one book in the past year. Hayes also likes to compete in triathlons, but hasn't been able to do so for the past four years.* The problem with these explanations is that Hayes almost certainly could have adjusted her work load any way she wanted, and Janus would have gladly gone along. She could have dropped her fund responsibilities, given up her investment officer role, gone to a part-time schedule, asked for a larger support staff, taken several months off, or negotiated almost any concession that would have kept her on staff and in the public eye. Also, if Hayes thought that the market was going to turn in her favor, you'd think she would have held on out of professional pride, and the chance for her management skills to be vindicated. This looks like a case where Hayes didn't see a market turnaround any time soon, and was simply fed up with Janus. She wanted out, period.
Why was Hayes fed up with Janus? One possibility is new and inexperienced CEO Mark Whiston, who's under pressure from outside shareholders to cut manager salaries and fire underperformers. Hayes may have seen this coming, and didn't want to be a part of it. Or, perhaps Hayes and Whiston just didn't get along, or Hayes didn't have confidence in Whiston's ability to lead the company in this difficult time. Another issue is publicity. As a public company no longer under the Stilwell umbrella (remember, this is what the brain trust wanted), Janus is under intense financial scrutiny, and the largest Janus shareholder (Highfields Capital Management Group) has been loudly and publicly complaining about the lack of salary information provided by Janus in its recent SEC filings. In particular, Highfields noted that Janus failed to disclose the compensation of Helen Young Hayes. Exactly one week after Highfields put Janus (and Hayes) on the salary hot seat, Hayes resigned.
So, what's in store for Janus in the near future? We'd keep an eye on two people: Scott Schoelzel, and the replacement for Hayes. Schoelzel is the last senior manager at Janus, and a vocal I'm-not-going-anywhere kind of guy. If (when?) he bails, all bets are off. Also, Janus needs to find a suitable replacement for Hayes as chief investment officer, and here's where things could get messy. A big-name hire, with a commensurately large ego, is likely to have some fairly definite ideas about how Janus should be run, and that person runs the risk of further disrupting an already shaky Janus culture. A no-name hire probably won't have the clout or prestige to control this difficult firm, and an inside hire signals that Janus has given up on changing its culture, which means that you can probably kiss Janus goodbye as an independent fund company. Any way Janus turns, it's going to be a lot more difficult crawling out than sliding into the hole in the first place.

* "Top fund manager at Janus to retire," Aldo Svaldi, denverpost.com, April 18, 2003; Also: "More turmoil shakes Janus family," Jonathan Burton, cbs.marketwatch.com, April 21, 2003

"Even as I speak, Janus is lowering expense ratios
to zero, and Janus will pay all investors for their losses
these past three years. This I can say, because it is true."

Someday me talk smooth like this guy:

	"They're either rocking and rolling or getting the snot beat out of them."
--Paul Cook, Munder Capital Management, commenting on the current market for Internet stocks; Source: USA Today (Matt Krantz), March 31, 2003

Under the Sarbanes-Oxley Act, which passed last summer, public corporations -- including mutual funds -- are required to certify the contents of their shareholder reports.....Lawyers who advise mutual funds have apparently started to focus on the Act, and one of their major concerns is the fund manager's letter to shareholders, which often contains opinion, comments about individual stocks, and general market prognostications.....A hypothetical nightmare scenario, gleefully sketched by lawyers, concerns the mutual fund manager who writes a shareholder letter that's optimistic about (say) the retail sector, and then the retail sector tanks......Since market opinions aren't facts, and only facts can be certified, lawyers worry that a fund executive who certifies a shareholder letter with opinion could violate Sarbanes-Oxley, and potentially become a real good friend with cellmate Bubba in the federal pen.....This nightmare scenario seems like typical lawyer overreaction and overanalysis, but the result is predictable: Some funds (for example, Artisan) are already talking about "slimmed down" shareholder reports that would eliminate all opinion and outlook.....Other funds, with a tradition of being entrepreneurial and shareholder-friendly (for example, Longleaf), are basically treating Sarbanes-Oxley for what it is: A slightly increased risk to their business, which they plan to deal with rationally, just like any other business risk.....Here's our prediction: The big, bureaucratic fund companies, and those with lousy performance -- often one in the same -- will generally use Sarbanes-Oxley as an excuse to say even less than they currently do.....The smaller fund companies, especially those that still carry the stamp of a living, breathing human being, will make a few changes, but pretty much continue as usual with their shareholder reports.....Keep an eye on your shareholder letters, and you'll see which kind of fund you own.
"Funds pare loose talk," Frederick P. Gabriel Jr., InvestmentNews, April 14, 2003; "Mutual Fund Managers Say New Law May Mute Opinions," Karen Damato, The Wall Street Journal, April 18, 2003

Dan Geraci's career in three headlines:

	"*Pioneer Nabs Geraci from Fido*"
	--October 5, 2001

	"*Pioneer Gets Ambitious*"
	--March 7, 2002

	"*Geraci Resigns From Pioneer*"
	--April 23, 2003

All headlines from MutualFundWire.com

Until a few days ago, Dan Geraci was president and CEO of Pioneer Investment Management, the firm that runs the Pioneer mutual funds.....As we noted last month, Pioneer is rumored to be up for sale, a rumor that Geraci vehemently denied just before he consummated his own private sellout (Geraci is headed for the company that runs the Phoenix funds, in case you care).....In any event, Geraci appears to have accomplished little at Pioneer.....Given other recent changes in the executive suite, as well as considerable fund manager turnover, Pioneer isn't a company that inspires confidence, and there are no signs that things will get better any time soon.....If we had money invested in a Pioneer fund, we'd be looking for alternatives, now.

"Please discuss whether [Rule 12b-1] should be updated in light of the evolution of fund distribution since its adoption": That's one of the issues the House committee investigating the mutual fund industry recently asked the SEC to address.....While we await the SEC's written response (due June 11), here's what a senior executive at the Invesco funds had to say about 12b-1 fees:

"I would hope that the SEC staff would recognize that the industry has an extensive distribution system that relies on 12b-1 fees. And at this point, to require the system to be retooled would have a major impact on the industry."*

This Invesco executive was speaking at a fund industry conference, and he probably didn't expect his comments to be widely distributed.....So what he said is probably as close to the unvarnished truth as you're likely to hear from any highly-placed fund exec.....The industry relies on 12b-1 fees, the industry needs 12b-1 fees to ensure distribution of its funds, and the interests of individual fund investors don't even enter into the discussion.....12b-1 fees allow fund companies to dip into fund assets to pay fund distribution expenses, and there can be only one economic justification for 12b-1 fees (this was also the original justification): In the long run, 12b-1 fees should result in economies of scale, and economies of scale should result in lower overall expenses for fund investors.....Over the years, however, 12b-1 fees have taken on a life of their own.....Mutual fund supermarkets, like Schwab, are supported by 12b-1 fees, and alphabet-soup share classes ("A", "B" and "C") also wouldn't be possible without dipping into the 12b-1 till.....In other words, over the years, the fund industry has forgotten the purpose of 12b-1 fees, while making them central to the industry's existence.....As a practical matter, the SEC can't make significant changes, because the financial effects on the industry would be too severe.....The SEC might be able to tinker with the 12b-1 rules, but serious reform -- the kind that would save you money -- is almost certainly out of the question.
* "SEC Nears Overhaul of 12b-1 Fees, May Surface By June," institutioinalinvestor.com, April 10, 2003

We had some spare time, and we felt like engaging in a futile activity, so here are five suggestions for significantly reforming the 12b-1 rules, from the least to most radical.....Each of these reforms would benefit investors, but each would also seriously upset the industry apple cart.....We're confident the SEC will never implement them:

Eliminate 12b-1 fees for funds that are closed to new investors -- by definition, they have no distribution expenses.
Require funds to provide an annual statement to each investor, indicating the pro-rata dollar amount of 12b-1 fees paid -- if investors knew what they were actually paying, some might even complain.
With the annual statement (above), require fund companies to itemize the services or value that shareholders received for the 12b-1 fees expended -- most funds won't be able to do this.
Require shareholders, rather than directors, to periodically renew their 12b-1 plan -- it's shareholder money, and shareholders should make the decision, every time.
Shut down every 12b-1 plan that can't demonstrate, after a reasonable period of time (say, five years), that it has generated overall cost savings for fund shareholders -- this is the only reason a 12b-1 plan should exist, and the vast majority of plans would fail the test.

"Monkeys will dance in Scott Schoelzel's pants
before Janus loses another dime of investor money.
I know this to be true, as sure as I stand here."

Briefly noted:

John Montgomery runs the Bridgeway funds, and his company has a rule: The salary of the highest-paid Bridgeway employee (who is Montgomery) cannot be more than seven times the salary of the lowest-paid Bridgeway employee.....Montgomery's salary in 2001 was just under $297,000,* which means that the lowest-paid employee earned about $42,000.....Over at Mario Gabelli's eponymous fund firm, it's clear that no similar rule is in place.....Gabelli's total compensation for running his firm was $37.7 million in 2002.....If we assume that Gabelli's lowest-paid employee also earned about $42,000, then Super Mario paid himself 898 times that amount.....Gabelli's income breaks down as follows: About $26.7 million for "creating" and managing several portfolios, about $9.5 million as an incentive-management fee (imagine the incentive he would need if this wasn't his own company!), and about $1.4 million for providing "other services".....Gabelli also received a contribution of $598 to his company's profit-sharing plan (which will apparently fund his post-retirement hair cuts), but he received no separate compensation for his incomprehensible television interviews.
* "Critics Seek Disclosure Of Mutual Fund Managers' Pay," Aaron Lucchetti, The Wall Street Journal, April 9, 2003
Rich guy gets lesson in debt management: Alberto Vilar runs the tech-oriented Amerindo funds, and he's also a generous arts and music philanthropist -- perhaps too generous.....Vilar's extravagant charitable gifts and pledges, made when the Nasdaq was at its peak, are now starting to crimp his multi-home, multi-country lifestyle......Vilar is apparently delinquent in his mortgage payments on three [!] of his four [!] vacation homes in Vail, Colorado, and three banks have begun foreclosure proceedings.....Vilar has made some large charitable gifts to several Vail organizations, but he doesn't seem to realize that when it comes to loans, bankers don't care about generosity, they just want their money.....Says Vilar, a bit peeved about the pending foreclosures: "I think this is unfortunate, having done as much as I have for the Vail Valley. This has unfortunately served to dampen a great deal of my enthusiasm for the Vail Valley -- it gives the impression that my relationship with the community is one-way and not two-way."
"Vail Valley patron faces foreclosures," Jason Blevins, denverpost.com, March 25, 2003
Last year, we reported that John Hill earned $403,500 during 2001 as a fund director for Putnam.....Hill also admitted to spending only about "25% to 30% of his monthly work hours" on his fund responsibilities (roughly six days per month).....This year, Mr. Hill is back in the news.....His 2002 pay as a Putnam fund director dropped to $388,250, but don't worry, he's still not working up a sweat.....Hill says that he spent 60 to 70 days a year on board issues, about the same as the year before, which means that he still managed to eke out about $700 per hour.
"In off year, these cats get fatter," Rick Miller, InvestmentNews, April 7, 2003
Mr. Hill's salary cut, above, was not typical.....At the 50 largest fund groups, compensation for fund directors rose 8.2% in 2002, to an average of $113,000 each.....Joseph DiMartino, a Dreyfus director who oversees 191 funds, again topped the list of overpaid directors, with annual compensation of almost $816,000......We'd be willing to kick in an extra $1,000 for Mr. DiMartino if he could even name the funds that he supervises, let alone tell us what he does to earn that kind of money.....As usual, and you can hardly blame him, DiMartino refuses to discuss his compensation with the press.
"Dreyfus fund director's pay raised eyebrows," James Paton, Reuters, April 11, 2003
Principal-protected funds are for suckers, and now even the NASD (almost) says so.....In an alert posted on the its Web site, the NASD warns that this too-good-be-true investment is, well, too good to be true.
Hope doesn't just spring eternal. Sometimes, it positively gushes: Paul Hoffmeister is owner and manager of the new Georgetowne Long/Short Fund.....According to the fund's prospectus, Mr. Hoffmeister's professional experience consists of a couple of years as "assistant trader" at an unknown securities firm, several stints as a White House intern, and "operations supervisor for the office of Dr. Jana Hoffmeister MD," who just might be his mother.....Long/short strategies are notoriously difficult to pull off successfully, but Mr. Hoffmeister isn't shy about making people pay for his experiment with their money.....The fund's management fee is 2.0%, with an overall expense ratio of 3.25%.
Righteous self-justification is a wonderful thing, because it allows us to engage in conduct that otherwise might be inconsistent with our beliefs and values.....Consider, for example, Burton Malkiel, professor of economics and author of a 1973 book that introduced the American public to index investing ( A Random Walk Down Wall Street).....In his book (recently revised), Malkiel argues that stock markets are "efficient," because thousands (even millions) of different buyers and sellers, with vast amounts of information, set stock prices every day.....Indexes (such as the Wilshire 5000) are essentially proxies for these efficient markets and, in the long run, very few active managers are able to outperform these huge, efficient index machines.....Many investors know Malkiel as a long-time director of the Vanguard funds, which makes sense, given his views on indexing.....Relatively few people know Malkiel as a director of BKF Capital Group, Inc., a publicly-owned financial firm that subadvises several mutual funds, but mainly runs hedge funds for wealthy investors.....Malkiel's involvement with hedge funds, the ultimate active investment, seems inconsistent with his belief in indexing, and that's where a little righteous self-justification comes in handy......In Malkiel's view, the market needs active traders in order to become efficient.....By serving on the BKF board, Malkiel suggests that he's helping create the efficient market, which then gives index fans something to invest in*.....Got that?.....OK, then, here's some self-justification à la Malkiel, to try on a spouse who doesn't approve of your gambling: "Honey, of course I don't like losing our money. But if I don't gamble and lose, there won't be a pot for me to win someday."
* "Mr. Random Walk," Erin E. Arvedlund, Barron's, April 14, 2003
To comply with new SEC rules, all mutual funds will soon be required to disclose their proxy votes.....As usual, these government rules won't apply to the government.....SEC employees participate in a 401(k)-like Thrift Savings Plan that has never disclosed its proxy votes, and won't be required to disclose them in the future.
"Parting the Curtain," Werner Renberg, Barron's, April 7, 2003
Speaking of the proxy-vote disclosure rules: While these provisions were being considered, mutual fund companies whined that the proposed rules weren't faaair, since pension plans weren't subject to similar disclosure requirements.....Well, there are also some occasions when mutual funds get off easy, and pension plans are required to do the heavy lifting.....If a pension plan is defrauded on one of its investments (for example, if it purchases bonds backed by phony assets), many pension fund managers believe that under ERISA, the basic federal pension law, they are required to sue the bond issuer in an attempt to recover the lost assets.....Mutual fund companies are under no similar obligation, and fund companies are often quite passive in the face of investment losses caused by fraud (two possible reasons: fund companies don't want to jeopardize existing trading relationships by suing brokerage firms, and fund companies don't want to antagonize potential outlets for distribution of their products).....Vanguard recently made news for suing Salomon Smith Barney over some bad Enron bonds, and the main reason anyone paid attention is that fund managers rarely even bother with such lawsuits.
"Vanguard Sues Citigroup Over Enron-Bond Deals," Jathon Sapsford and Aaron Lucchetti, The Wall Street Journal, April 14, 2003
And speaking of Vanguard: As we reported back in September, but much more quickly than we expected, Vanguard has started to shift six index funds from mostly Standard & Poor's benchmarks to their new Morgan Stanley bogeys**.....The official reason for this switch is almost entirely theoretical: Vanguard index guru Gus Sauter has formulated several criteria for how good indexes should be constructed, and the Morgan Stanley indexes come closer to Sauter's ideal than the S&P versions.....So what happens if the new indexes generate lower returns than the old ones would have?.....Sauter says that he's more concerned with style purity than absolute return, so relatively poor performance apparently wouldn't bother him*.....The new Vanguard benchmarks are also untested in terms of their volatility and tax-efficiency.....Chances are, these new indexes will work out just fine, and most shareholders won't even notice the difference.....Still, about $20 billion in assets are affected by Sauter's experiment, which makes him the odds-on favorite for this year's coveted "Index Manager/Cojones Award."
* "Can index funds be new, improved?", Chuck Jaffe, cbs.marketwatch.com, April 13, 2003
** The affected Vanguard index funds are Growth, Mid-Cap, Small-Cap, Small-Cap Growth, Small-Cap Value, and Value.
Ron Baron, of the Baron funds, has been fined for blatantly manipulating the price of a stock -- in this case, the SEC even has Baron on audio tape, telling his people to break the law.....So, what does someone pay these days for a willful violation of the securities law, caught on tape?.....Baron himself was fined pocket change ($500,000), and his firm was fined a few hours worth of income ($2,000,000).....Oooh, that'll teach him.
Lawsuits filed against mutual funds have increased about 25% since 1998, but the insurance company that covers many fund firms (ICI Mutual) isn't worried, because ICI Mutual has never been on the losing end of a lawsuit (settlement payouts are another matter, but ICI Mutual would prefer not to go there).....Currently, one popular litigation strategy tries to nail mutual fund firms for being too cozy with their investment banking arms, and several large cases are pending against Merrill Lynch and Morgan Stanley, alleging that they packed their funds with in-house IPOs in order to manipulate the price of those stocks.....Once again, ICI Mutual isn't worried.....Says the insurance company's president: "Think about this for a minute. How does a portfolio manager get paid? He gets points for his fund doing well. Do you think for a minute he would invest in something [i.e., IPOs] that would feather [the investment banking] nest?".....To which we reply: Maybe.....If the compensation of a Merrill Lynch fund manager is based (even in part) on the financial performance of the investment banking group, it's entirely possible that he would compromise his fund in favor of the investment bankers..... The point is, we just don't know, which is another strong argument for disclosing the compensation structure and financial incentives of every fund manager.....Lawsuits alleging fund manager conflict of interest won't go away until all potential conflicts are aired, or all fears of conflict are allayed.
"Pristine mutual fund firms feel investor wrath in court," David Hoffman, Investment News, April 14, 2003
According to The Wall Street Journal, Morgan Stanley is under investigation by both the SEC and the NASD for what seems to be an extreme fondness for "B"-share mutual funds (perhaps 90% of all Morgan Stanley fund shares sold by Morgan brokers).....As we've noted in the past, "B" shares can be an easy sell for brokers, because they don't carry front-end loads.....But in the long run, "B" shares can cost considerably more than "A" or "C" shares, due to the "B"-share double whammy of back-end loads (redemption fees) and high 12b-1 fees.....The A/B/C share analysis is different for almost every fund company.....If you have recently purchased Morgan Stanley funds, "B" shares may have been the wrong choice if you had more than $50,000 in any combination of Morgan Stanley funds at the time of your purchase, or if your broker knew you as a long-term investor.
Norman Fosback, editor of Fosback's Fund Forecaster, says that a calendar-based market timing can be a successful investment strategy.....In April, for example, the first four trading sessions (April 1-4) are among the most promising of the month, April 29-30 can also be rewarding, and the two days that precede Good Friday are historically winners, as well.....Coincidentally, FundAlarm has been working on its own calendar-based timing strategy.....While much work remains to be done, our preliminary data suggest that it is best to buy one day before the market goes up, and best to sell one day before the market goes down.
"Trading by the date can make money," Norman G. Fosback, cbs.marketwatch.com, April 1, 2003