Highlights and Commentary

By Roy Weitz

(Originally posted May 1, 2006) [Archive Table of Contents]
Age doesn't always beget wisdom: Specialty funds are often viewed as training grounds for young managers, and manager turnover is often high (see: Fidelity Select funds).....But a surprising number of Specialty funds are run by managers who've been on the job for at least five years.....Some of these seasoned Specialty fund managers (such as Edward Owens, of Vanguard Health Care) are truly experts in their field.....Other experienced Specialty fund managers might as well be rookies, given how little they've delivered for their shareholders.....The accompanying page lists 69 Specialty funds, each run by a manager with at least five years on the job, and each currently a 3-ALARM fund.....If you own one of these struggling funds, here's a good question to ask yourself: "Exactly what benefit am I getting from this manager's experience?"


A company that overpays its executives, or makes stock options too easy to obtain, or doesn't establish proper pay-for-performance standards, is guilty of wasting corporate assets, just as surely as if it poured money down the proverbial drain.....If you or I own shares of such a company, we have a right to complain, and if a mutual fund owns shares of such a company, that right to complain becomes an obligation.....Try telling that to the folks who run funds for AIM, AllianceBernstein, Dreyfus, Morgan Stanley, and OppenheimerFunds.....According to a recent study,* these fund firms are the chief enablers of executive-compensation excesses, based on their pattern of proxy voting.....Morgan Stanley was the most complacent fund manager of all, voting in favor of company pay proposals about 95% of the time, and opposing shareholder proposals 85% of the time.....Next on the "Who Cares?" list was AIM, which kowtowed to company proposals 90% of the time, and opposed shareholder resolutions by the same percentage.....American Century led the list of fund companies that were "most sensitive" overall to shareholder compensation concerns, followed by TIAA-CREF, Federated, Vanguard, and Janus.
* You can find the entire study online at The Corporate Library


Many mutual funds lend their securities, often to short sellers, and the goal is to earn a few extra basis points of return......It's all entirely legal, and almost always disclosed in the fund's prospectus, even if the majority of fund investors have no idea that it's going on.....But what happens if a fund has loaned out securities as of the record date for a proxy vote -- for example, a proxy vote on an executive compensation proposal (as discussed above)?.....Legally, the vote belongs to the borrower of the securities.....In other words, when XYX Fund Company reports that it voted against a management proposal on compensation, what it's really saying is that it voted all of its non-loaned shares against the proposal.....There's no way to tell how many shares weren't voted by XYZ because they were out on loan, or whether those shares might have made a difference in the overall voting result.....In the case of a "material" corporate event, SEC rules require mutual funds to recall loaned securities in order to cast their vote, but it's not clear how often (or how well) that rule is observed.....To further complicate matters, there's some evidence that loaned securities have been voted twice, both by borrower and lender.....In most cases, this double-voting appears to be the result of a communication failure on the part of the fund company, but it's also possible that some double-votes are intentional.
"Are Funds Loaning Shares Ahead of Proxies?," Hannah Glover (Money Management Executive), financial-planning.com, April 13, 2006

In the last two years, the American Funds have taken in just over $169 billion in assets. These asset flows, by themselves, would have made American Funds the sixth-largest fund company in the U.S. American Funds is the world's largest shareholder of Altria Group, AT&T, Target, Fannie Mae, and Bell South. Let's hope the home improvement market stays strong, because American Funds is also the world's largest shareholder of Lowe's, at 15.05% of the company, or almost 117 million shares. That represents just over a month's worth of normal trading volume. American has never closed a fund. No fund company in history has ever had to deal with the kind of growth experienced by the American Funds. To all current (and, especially, new) American shareholders: Thanks for funding this experiment. "American's funds stall as assets soar," Timothy Middleton, moneycentral.msn.com, April 25, 2006

An expensive lesson in how not to conduct a proxy vote: Last fall, Torray shareholders received proxy materials, asking them to approve a reorganization of the fund's investment adviser.....Basically, the management contract to run the Torray fund would have been assigned to a new company, controlled by Torray co-manager Douglas Eby......Founder/co-manager Robert Torray, who has a significant ownership interest in the current management company, would have owned a considerably smaller percentage of the new company (and, presumably, would have been handsomely compensated for giving up some of his stake).....Eby and Torray would have continued to manage the fund, and would have entered into "long term" employment contracts with the new management company, but many shareholders didn't feel comfortable with the proposed deal......A FundAlarm reader has directed our attention to Torray's most recent shareholder letter, in which Robert Torray announces that the restructuring has been called off, even though a majority of fund shareholders did vote to allow it.....Torray seems surprised that the proxy's combination of "legalese, length and complexity" made shareholders nervous, which makes us wonder if Torray even read the proxy before it went out.....Let's see: Your fund tells you that the founder is selling out, a new guy will be in charge, new entities will be brought in to invest in the management company and, by the way, nothing will change.....The underlying motivation for the transaction (Torray's personal estate planning) is barely mentioned, and the proposed deal is presented almost entirely without context or explanation.....Yeah, I guess I'd be nervous, too.


As a mutual fund investor, you're already comfortable sending your money off to be managed by someone else.....If you're also charitably inclined -- even slightly -- you might consider contributing to a "donor-advised fund".....A donor-advised fund isn't a mutual fund, but it has some of the same characteristics.....Technically, a donor-advised fund is an independent charitable organization that is formed to act as a conduit for charitable contributions.....Fidelity, Vanguard, Schwab and T. Rowe Price each currently sponsor one (others do, too) and here's how it works: You make an irrevocable contribution to a donor-advised fund, and you get an immediate charitable deduction for the full value of your contribution, subject to the usual tax rules.....Your contribution goes into a separate account within the fund, which you can then use to make contributions ("grants") to other U.S. charities.

Donor-advised funds aren't just for heavy-hitters.....For example, let's say you typically give about $1,000 per year to charity......Let's also assume that you make a one-time contribution of $20,000 to a donor-advised fund, and you informally decide to pay out 5% of your account value each year to charities of your choice.....In the first year of your donor-advised fund, your 5% payout would allow you to support your favorite charities to the tune of $1,000 -- exactly the same amount that you were paying out of your personal checkbook.....But if your underlying account grows (tax-free) by more than the annual payout percentage (plus expenses), next year's 5% payout will be larger than $1,000, and so on.....In 10 or 20 years, your 5% payout could amount to a significant annual contribution.....In 300 years or so, for those who are dynastically-minded, your charitable fund could be worth more than a billion dollars, since each of our four donor-advised charities allows its individual funds to have an unlimited life.

Assuming that you're in the 30% tax bracket, a $20,000 contribution to a donor-advised fund could generate immediate tax savings of as much as $6,000.....This compares to tax savings of just $300 per year if you continue to make your contributions in annual $1,000 installments.....Of course, you shouldn't establish a donor-advised fund merely for the tax savings.....But if you're otherwise interested, the tax saving is a nice bonus.....Where will you get the chunk of cash that you need to start a donor-advised fund?.....We can't answer that question, but here's a suggestion: Consider donating appreciated mutual funds (as a FundAlarm reader, you should have plenty of these).....You'll generally be able to take a charitable deduction for the full market value of your funds, without paying capital gains tax on the built-in appreciation.

Once you've established your donor-advised account, you need to invest it:

• Fidelity offers eight "individual investment pools," each with a stated goal (e.g., the "international pool"), and each is comprised of one or more underlying Fidelity mutual funds (to Fidelity's credit, a few non-Fido funds are also available). Fidelity also offers three asset allocation pools, which combine the various individual investment pools and roughly correspond to balanced portfolios that are "aggressive," "moderate" and "conservative" These asset allocation pools were established in October 2004, so they don't have much of a track record.
  
  
• Schwab's investment menu consists of eight "pools" (e.g., "balanced," "equity income"). Each pool consists of one underlying mutual fund, which is managed either by Schwab or its U.S. Trust affiliate, under the "Excelsior" name. Curiously, Schwab's only actively-managed domestic all-stock pool ("equity value") is invested in Excelsior Institutional Mid Cap Value (EXVAX), which is neither a great fund nor a core equity holding.
  
  
• The investment choices at T. Rowe Price are probably the most logical of the four companies profiled here: Price offers five descriptively-named investment pools, comprised of Price mutual funds, and the pools gradually ramp-up from money market to all-stock. But T. Rowe Price also tends to practice the most extreme form of diversification within its investment pools, which is not always a good thing. For example, Price loads up its "moderate growth" pool with nine -- count 'em, nine -- underlying T. Rowe Price mutual funds. Hey, guys, nobody knows these funds better than you: Can't you pick just three or four that you think are the best?
  
  
• Vanguard offers six investment pools, which cover the spectrum from money market/short-term bond to all-stock, plus one balanced social-investment pool. Each pool is invested in two or three Vanguard mutual funds. (It's interesting to note that Vanguard's money market/short-term bond pool is referred to as its "Gift Preservation Pool", the "preservation" part of which is true only if one ignores the effects of inflation. Fidelity and Price also adopt this sloppy, and somewhat deceptive, "preservation" nomenclature for their money market funds). Vanguard makes it difficult to evaluate the performance of its investment pools in comparison to any benchmark, since it doesn't provide three-year or five-year return data.

Summary Information: Donor-Advised Funds

Name	Minimums:		Annual Expenses (1 bp = 1 basis point = 1/100%)	Web address
	For initial contribution	For a donor-advised grant
Fidelity Charitable Gift Fund	$10,000	$250	Investment account: 7 - 117 bp (est) Overall admin*: 60 bp	www.charitablegift.org
Schwab Fund for Charitable Giving	$10,000	$250	Investment account: 24 - 151 bp Overall admin*: 100 bp	www.schwabcharitable.org
The T. Rowe Price Program for Charitable Giving	$10,000	$250	Investment account: 35 - 74 bp Overall admin*: 50 bp	www.programforgiving.org/
Vanguard Charitable Endowment Program	$25,000	$500	Investment account: 19 - 26 bp Overall admin*: 57 bp	www.vanguardcharitable.org

* For a $100,000 account. Fidelity's administration fee is 100 bp through June 30, 2006. Admin free is lower for larger accounts, although specific breakpoints vary by fund company.
So, which donor-advised fund is the most attractive?.....If you have the $25,000 minimum, we'd say that Vanguard gets the nod, based on its low expenses (no surprise there).....If you're looking to commit less than $25,000, but at least $10,000, we'd go with T. Rowe Price.....Aside from Vanguard, you're likely to pay the lowest overall fees, and we like the design of Price's investment choices better than those at Fidelity, which finishes a close third.....Schwab seems to us pretty much out of the running, at least in this group.


David Snowball is back this month, as promised, with the second installment of his new-fund report, which we're referring to (for now) as The FundAlarm Annex......For this month's report, David scored some one-on-one time with the manager of Ariel's new Focus fund, he annoyed some PR people at the new AARP funds, and he generally dug up some good information on three additional "open for business" funds (as well as two new "stars in the shadows") .....If you've already taken the time to give us feedback on this new feature, we thank you.....David and I read every one of your e-mails, every comment was carefully considered, and a number of your suggestions have already been implemented, or will be soon (David has more to say, inside, about the feedback we received).


Every year, Steven Goldberg of Kiplinger's magazine produces a short, thoughtful list of favorite mutual funds, and you can view the entire list at the Kiplinger's Web site .....This being FundAlarm, however, we're more interested in the offerings that have fallen off Kiplinger's list since last year.....Five funds were dropped only because they have closed to new investors (they are Century Small Cap Select, Julius Baer International Equity A, Masters' Select Smaller Companies, Third Avenue International Value, and Third Avenue Real Estate Value).....Five other funds were dropped by Kiplinger's for more substantive reasons, as follows:

Fund name (on Kiplinger's "favorite" list last year, dropped this year)	Why it got the boot
American Century Equity Income	Three consecutive subpar years, and another bad start this year, means goodbye for now.
Clipper	This fund's long-time management team has bailed out, and the team that runs Selected American Shares has taken over. Going forward, Clipper is likely to be a bit more concentrated (i.e., volatile) than Selected American, but those who can handle the bumpier ride might still be interested.
Fidelity Capital Appreciation	Manager Harry Lange has left to run Fidelity Magellan.
Masters' Select Value	Dropped in favor of the newly-reopened, and slightly more attractive, Masters' Select Equity. But Goldberg still likes Select Value, and it's definitely not a "sell" in his book.
Meridian Growth	Dreadful performance in 2005, possible asset bloat, and loss of a key staffer all suggest that it's time to move on.

"Kiplinger 25: What's In, What's Out," Steven Goldberg, kiplinger.com, March 28, 2006

Roy's Excellent Market-Timing Adventure: Month Seven: Longing to go Short

Hey, aren't market-timing programs supposed to be exciting?.....April was the third full month that Intelli-Timer kept me in the long position (ProFunds OTC Inv, or OTPIX), and I'm starting to get itchy for some action......If the market would just take a nosedive, and Intelli-Timer would switch me over to the short position, I could finally start making some money in my timing account (of course, everything else that I own -- long -- would be in the tank, but I really do find myself thinking that way. The human mind is an extremely odd thing.).....On the positive side, April was the best of the three months that I've been long, and the value of my timing account increased 1.24% during the 30-day period.....Since the inception of my account, last October, Intelli-Timer has steered me to an overall gain of 5.16%, as follows:

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%
April, 2006	No new signal	Long still in effect	OTPIX	$5,193.62	$5,257.84	+1.24%	+5.16%
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.

For the first time in a while, my timing account outperformed a couple of the usual FundAlarm benchmarks for the month (VFINX and VBINX), but the other three FundAlarm benchmarks continued to pull away from my account, as follows:

	Current month (3/27 thru 4/26)	Since inception (10/17/05)
Schwab International Index Inv (SWINX)	4.82%	18.88%
Vanguard Small Cap Index (NAESX)	1.30%	18.47%
Dreyfus Mid Cap Index (PESPX)	1.71%	11.67%
Vanguard 500 Index (VFINX)	0.30%	9.68%
Vanguard Balanced Index (VBINX)	-0.15%	5.67%
Roy's market-timing account	1.24%	5.16%

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

Looking ahead to the end of our experiment, in six months or so, it's pretty clear that my timing account will never be able catch a couple of the FundAlarm benchmarks, unless there's a fairly sustained market decline, and Intelli-Timer makes the proper call to the short position.....Not a pleasant thought.....But, then again, at least there would be some action.

To be continued...


Briefly noted:

George Washington's Axe: All-original, except for the new head and handle

For about eight years, Vanguard Global Equity cruised along with a solid record and a single, outside manager (Jeremy Hosking, of Marathon Asset Management)......Weighed down by a ton of new money, the fund was closed in late 2003.....When Vanguard reopened the fund, in October 2004, the changes began: Long-time manager Hosking was joined by a new management firm, Acadian, which was initially allocated about 5% of the fund's portfolio, but has recently worked its way to running about 56% of the fund.....Last month, Vanguard added a third manager (a team from AllianceBernstein), although Vanguard refuses to say how much of the fund Alliance is running, or will run in the future.....Acadian and AllianceBernstein are decent managers, and this fund still has a respectable track record, but that isn't the point.....Investors who supported this fund for the first eight years, provided the cash that built its track record, and held on through all the changes, now own something that's almost unrecognizable from what they started with -- and what they started with was in very good shape.....Vanguard seems to have its own priorities for this fund, but "loyalty to long-term shareholders" apparently isn't high on Vanguard's list.

"Vanguard Global Equity's Not What It Used to Be," Gregg Wolper, morningstar.com, April 25, 2006





• First some BS, then some news: Fidelity claims that it doesn't consider the impact on fee income when deciding whether to close one of its funds (oh, come on guys, not even a little peek?)*.....And now the news: Fidelity has announced that it's closing four funds to new investors: Growth Company, Mid-Cap Stock, Advisor New Insights and, finally, Contrafund (finally).
  * "Fidelity Looks to Protect Performance, Will Close 2 More Big Mutual Funds," Jennifer Levitz, The Wall Street Journal, April 14, 2006
  
  
  
• Not subsisting on dog food: Retired Fidelity Magellan manager Peter Lynch was responsible for two of the 25 largest residential real estate transactions in the Greater Boston area last year.....Lynch, who apparently needs a place to store some of his stuff, purchased a condo next to his present Back Bay home for $6.175 million.....Lynch also purchased a Beacon Hill townhouse for his daughter and lucky son-in-law, for $5.125 million.
  "High-end buyers driving harder bargains," boston.bizjournals.com, April 10, 2006
  
  
  
• Like all annuities, Vanguard's "Lifetime Income Program" annuity is backed by insurance -- in this case, AIG Life Insurance Company*.....Vanguard describes AIG as "highly rated for insurer financial strength" by several independent insurance rating agencies, including A.M. Best Company, Standard & Poor's, Moody's, and Fitch.....But Weiss Ratings, another well-respected service (and, some would say, the most accurate of all), assigns an overall C+ rating to AIG (on a six-point scale from A to F).....(According to Weiss, C+ represents "fair financial security" and the company is "currently stable. But during an economic downturn or other financial pressure, we feel it may encounter difficulties in maintaining its financial stability.").....This is far from a crisis situation, and it's not clear if AIG carried a better Weiss rating when Vanguard first hooked up with them.....Still, annuities require long-term financial strength, and the underlying insurance company is likely to be on the hook for many years .....If we were buying an annuity, the presence of a C+ insurer probably would cause us to look somewhere else.
  * Except in New York, where the annuity is backed by another company; thanks to FundAlarm reader "AT," who spotted this item on andrewtobias.com (April 11)
  
  
  
• Sheep, slaughtered: For no good reason, shareholders of Schroder U.S. Opportunities have voted to approve a 33% increase in their management fee, and they've also agreed to give up the fund's fee breakpoints.....We wrote about this proposed money-grab back in February, we expressed incredulity that any shareholder would go along with it, and now a majority of Schroder's shareholders have apparently decided that they need an additional opportunity to waste their money.....Hey, folks, let's put this in terms everyone can understand: For each $10,000 that you have invested in Schroder U.S. Opportunities, you've just agreed to pay Schroder the equivalent of about eight additional gallons of gasoline, every year.....Now do you think your vote was such a good idea?
  
  
  
• According to a recent study, sponsored by Putnam, there are six key beliefs and habits for achieving financial security: (1) realistic expectations, (2) resisting the temptation for quick rewards and fads, (3) patience in the face of adversity, (4) greater satisfaction from saving rather than spending, (5) ability to tolerate above-average risk, and (6) receptivity to advice on how to save and invest.....With respect to item #3 ("Patience in the face of adversity"), FundAlarm suggests that you award yourself double points if you own Putnam OTC & Emerging Growth.
  You can find an automatically-scored version of this survey at www.putnam.com/survey
  
  
  

FundAlarm © Roy Weitz, 2006