Highlights and Commentary

By Roy Weitz

(Originally posted June 1, 2002) [Archive Table of Contents]
Fund Director Update:

Most mutual fund directors like to pretend that they have a real job, so FundAlarm kudos go out to John Hill, a Putnam fund director, who readily admits that his duties consume only about 25% to 30% of his monthly work hours.....Hill's part-time job at Putnam paid him $403,500 last year, which is still considerably less than the $810,000 that top-dog Joseph DiMartino earned as a Dreyfus director.....DiMartino refused to speak with a reporter about his compensation, although he did say, through a Dreyfus spokesman, that "he has over 30 years of professional experience" (Tiny Tim, the famous falsetto singer, had even more).....Average pay for the 50 highest-paid fund directors amounted to just over $263,000 last year, up 12.3% from the two years ago.....Directors who oversee the swooning Putnam funds received the biggest pay increase, up an average of 17.2%, to $228,275.....Why are we not surprised?
"During bitter harvest, directors still feast," Frederick P. Gabriel Jr., Investment News, May 20, 2002


And what do directors do with the money that they skim from your funds?.....Well, they don't exactly throw it back in the pot.....Mutual fund companies are now required to disclose the amount that independent directors have invested in the funds they supervise, and the early numbers don't suggest an overwhelming vote of confidence.....In response to the new disclosure rules, the Frank Russell Company now requires each independent director to invest at least one year's compensation -- $67,000 -- in the company's funds.....At Fidelity, 10 independent fund directors have put an average of $119,745 into the collective funds they supervise, which is not even half of what the average Fidelity fund director earns in a year ($266,100).....At T. Rowe Price, the company says that "some investment" by fund directors is "advisable," but it "should be discretionary"......According to a Price spokesman, "we encourage [the directors] to do what they can," which makes fund investing sound like free admission day at the local museum.....As it turns out, one Price director is only able to "do" a $10,000 investment in the firm's funds, an insultingly low amount that Price shouldn't tolerate.
"Do Fund Directors Buy In? The Answers Are Mixed," Elizabeth Kelleher, The New York Times, April 28, 2002; article includes a particularly vacuous quote from Roy


In response to a suggestion for even more detailed disclosure of fund director holdings, a lawyer for Vanguard essentially responded that directors' privacy is a more important goal, adding "I don't know too many people who want to put their financial information out there in public"*.....To which we respond, "Shouldn't the fund company owned by its shareholders be the first one to try?"
From the Kelleher article, above


Last month, we noted that all Putnam funds will become "team-managed," and investors no longer will be notified when there's turnover among team personnel.....As Putnam begins to implement this new shareholder-be-damned policy, it's amusing to note that Putnam still hasn't quite gotten the knack of keeping its customers in the dark.....As one fund reporter observed, three Putnam publications recently provided three different descriptions of the management team for the same Putnam fund (Putnam Voyager II):

From the Voyager II shareholder report, June 2001

From the Voyager II shareholder report, December 2001

From the Putnam Web site, May 2002

"Some Mutual-Fund Firms Stop Identifying Managers By Name," Tom Lauricella, The Wall Street Journal, May 17, 2002

The new Van Kampen Shareholder Salute		Van Kampen is another fund family that can't be bothered telling investors who is managing their money.....Van Kampen recently began notifying its shareholders that management of some funds "may change without notice at any time".....A spokesperson for Van Kampen says that the firm will decide whether to report manager turnover on a case-by-case basis: "We will assess the importance of the change in the eyes of the shareholder [and we will divulge changes] when we think it is appropriate."
-- From the Lauricella article, above

"What's going on with Fidelity High Income?" Here at FundAlarm, we don't follow bond funds very closely.....But a reader's question recently made us take a peek at this sector, especially the high-yield sector, and what we saw astonished us.....Although it's old news to some people, it turns out that a number of bond funds -- including Fidelity High-Income -- have been clobbered by the crash of the telecommunications industry.....In many cases -- as with Fidelity High-Income, again -- funds that concentrate on low-credit quality bonds have been hit especially hard, as investors with recession jitters fled low-quality bonds in favor of higher-quality issues.....The performance of Fidelity High-Income is bad enough, with a three-year return of -6.4%, versus -1.8% for the average high-yield fund.....But 29 other high-yield bond funds have actually returned less than the average growth-stock fund over the past three years.....Ordinarily, you'd expect a bond fund to underperform a growth-stock fund on the way up.....But in a severe down market for growth stocks, such as we've been having, it seems almost impossible that any bond fund could perform worse than a growth-stock fund.....Impossible, perhaps, but true: The average large-cap growth fund in our database returned -6.9% over the past three years, and the 29 high-yield bond funds on the accompanying page still managed to return less.


Does anyone understand this slogan?



The Turner funds are now the latest, proud owners of a multimanager voting exemption, and here's what that means.....In the typical fund structure, directors hire an investment advisory firm to run the fund's investment operation, and the individual who actually manages the fund is an employee of the investment advisor (for example, Turner Small Cap Growth is run by Bill McVail, who's an employee of Turner Investment Partners, Inc., the fund's investment advisor).....A multimanager fund (such as Turner Large Cap Value) is still technically run by an investment advisor (in this case, Turner Investment Partners, Inc.), but that advisor typically doesn't have any role in the day-to-day selection of investments.....Instead, the advisor farms out the investment work to one or more subadvisors, who actually run the fund (in the case of Turner Large Cap Value, the sole subadvisor is Clover Capital Management, Inc.).....When the typical mutual fund wants to fire its investment advisor and hire a new one, shareholders must approve.....When a fund with a multimanager exemption wants to fire or hire a subadvisor/manager, shareholders approval isn't required, and that's a big difference.

The multimanager exemption was originally designed for funds that anticipated frequent turnover of their subadvisors, and the exemption has always been granted by the SEC on a case-by-case basis.....In the past few years, however, the SEC has granted the multimanager exemption to funds (like Turner Large Cap Value) that will seldom, if ever, change subadvisors.....Here's the bottom line: If Turner Large Cap Value ever needs a new manager, Turner shareholders will have no say in the selection of that manager.....Turner says that the multimanager voting exemption is desirable because it could save a few thousand dollars in proxy costs, and the exemption "relieves" fund shareholders of the "burden" of picking managers......What a great idea!.....As long as we're going down that road, maybe we can all be "relieved" of the "burden" of electing government representatives, too.
"SEC 'Manager of Managers' Exemptions Draw Fire, Kathie O'Donnell, Bloomberg.com, May 16, 2002


Hedge funds are hot right now, and funds that invest in other hedge funds are the hottest of all.....But there's a problem with these so-called hedge "funds of funds: They haven't performed very well.....To add insult to injury, funds of funds are expensive: The underlying hedge fund managers typically charge 1% plus 20% of any profits, and the fund of funds manager tacks on an additional fee of about 1% plus 10% of the profits.....If you're thinking about investing in a hedge fund of funds (or any other kind of hedge fund), we encourage you to think again.....For most investors, including quite wealthy ones, a well-designed portfolio of garden-variety mutual funds is still a good way to go, even if it does lack the cocktail party glamour of a hedge fund.....But if you insist on something more exciting than a conventional mutual fund portfolio, you might want to consider a "mutual-fund fund of funds".....A mutual-fund fund of funds ("FOF") can give you exposure to some of the same strategies as a hedge fund (for example, the ability to sell short or go to cash when market conditions dictate) but with less cost, greater liquidity, and virtually zero chance of a dishonest (or fraudulent) fund operator...[item continues on the accompanying page...]


Another FundAlarm Discussion Board Profile: Discussion Board regular David Snowball is a polymath, but he's probably not going to punch us in the face for saying so.....First of all, he's a really nice guy.....Second, we're actually giving him a compliment: A polymath is a "person of great and varied learning," and David certainly fits the bill.....A Professor of Speech Communications at Augustana College, in Rock Island, Illinois, many of David's posts on the FundAlarm Discussion Board read like erudite essays on mutual fund investing.....David makes mutual funds simple without simplifying, and he never talks down to his Board audience......He's intellectually curious, has seemingly boundless energy, he's unfailingly civil, and he's even got a wry sense of humor.....What did the Board do to deserve this guy?

David's most recent academic publication is "Controlling Degenerate Music: Jazz in the Third Reich," which seems a long way from mutual funds, and it is.....But it's the academic world that gave David his exposure to the financial and investment world, first as an undergraduate philosophy/economics major (which didn't last long), and then about five years of service (in the early 1990s) on the Augustana College Faculty Welfare Committee, which has responsibilities in the areas of compensation and retirement benefits.....Like the good academic that he is, David quickly recognized that he didn't know enough about these subjects, so he started his own program of investment self-education.....Currently, David serves on an Augustana task force for retirement policy, and he continues his financial and investment education with about an hour of reading each day, both on and off the Web.....David says that he checks the FundAlarm Discussion Board about three times a day, which leaves plenty of time for his other interests, including reading, gardening, and learning from his toddler son Will.

David's personal portfolio is a mix of retirement and non-retirement accounts, with the balance tilted towards tax-sheltered retirement assets (not an unusual situation for college professors and other teachers).....His CREF portfolio ("College Retirement Equities Fund") is dominated by the CREF stock account, real estate fund, and inflation-protected fund.....David's other retirement accounts are designed to diversify in ways that aren't possible through his CREF account, with roughly 55% of the total in "smaller cap" funds, 35% in international funds, and about 10% in fixed income funds.....David's 403(b) retirement account is heavily invested in Fidelity and T. Rowe Price funds, which reflects the choices available to him.....David's 403(b) holdings include Fidelity Low-Priced Stock, Fidelity Small Cap Stock, T. Rowe Price Small-Cap Value, T. Rowe Price Mid-Cap Value, Fidelity Diversified International, Fidelity New Market Income, T. Rowe Price International Discovery, and T. Rowe Price Emerging Markets.....David's Roth IRA holds ICM/Isabelle Small Cap Stock, and his non-retirement accounts are designed to diversify further: Artisan International is balanced with Oakmark International, Artisan Small Cap Value is balanced with Artisan Mid Cap, Strong Ultra-Short provides some short-maturity fixed-income exposure, and Muhlenkamp is included "because they let me in for $300" (and, we might add, it's a pretty good fund).

We asked David if he had any fund insights, words of wisdom, or anything else that he wanted to get off his chest.....In typical David Snowball fashion, he hit us with an idea that is so good, so simple, and so logical that you have to wonder why every financial services firm and politician isn't already lined up behind it: A retirement savings account for infants.....Under current law, let's say that age 15 is the earliest that a child can realistically set aside $2,000 of earned income to fund an IRA.....Assuming a 12% annual return, and no further contributions, that IRA will grow to about $580,000 by age 65.....But if the relatives of that child had been able to fund an "infant retirement account" of $2,000, that account could grow to the astonishing sum of almost $3.2 million by age 65.....As David says, in typical cut-to-the-core fashion, "with compound interest, the infant account allows for two more 'doublings' by age 65, plus a bit more, and that makes all the difference in the world"......David's idea seems perfectly attuned to our times: It's family-friendly, and it would foster economic self-reliance, take pressure off the Social Security system, and have minimal impact on the budget deficit.....If any politicians are out there reading this, and if you're looking for an issue that will make you famous and beloved, how could you do better than this one?.....Just get in touch with us, and we'll put you in touch with David.....And David is such a modest guy, he won't even object if you name the account after yourself.


Last month, we ran a brief item about New York artist Jennie Schueler and her paintings of mutual fund managers.....Little did we know that Jennie reads FundAlarm.....Jennie got in touch with us, and she's provided two more examples of her recent work:



The painting on the left (27" x 31", oil on board with aqua resin) shows Kathleen Millard (formerly of Scudder Blue Chip) and Timothy Miller (Invesco Dynamics, Invesco Mid Cap Growth).....The work on the right (same dimensions and materials) shows Helen Young Hayes (Janus Worldwide) and Rudolph-Riad ("Gotta Love that Hair") Younes (Julius Baer International).....Schueler, who can be reached at her New York City studio, notes that she is available for commissions.....If there's a mutual fund manager in your life -- or if you'd like to have one in your life -- this could be the gift you've been waiting for.


Briefly noted:

• Valley Forge is an $8 million balanced fund that's run out of a split-level house in Wayne, Pennsylvania.....The recreation room off the garage is the fund's world headquarters, and 81-year old Bernard Klawans is fund manager, investment strategist, shareholder service representative, and amateur securities lawyer.....The fund pays Klawans a decent-sized management fee (1.0%, or about $67,000 last year), but the fund's overall expense ratio is just 1.26%, and item-by-item expenses look like rounding errors on a large fund's financial statements -- for example, $5,000 for professional fees, and $1,747 for "other" fund expenses.....Speaking of large funds, Klawans definitely has some cost-cutting advantages -- for example, he can (and does) hire neighbors to stuff his shareholder mailings......But unlike his behemoth competitors, Klawans has no economies of scale, which is an area where large funds are supposed to shine.....Just for fun, we took a look at the expense ratios of the 53 balanced funds in our database with over $1 billion in assets -- in other words, funds that are at least 128 times the size of Valley Forge -- and, sure enough, we found that nine of those 53 funds are more expensive than Mr. Klawans' baby:
  
  

  Balanced fund	Assets ($ billion)	Expense ratio (%)
  George Putnam of Boston B (PGEBX)	1.16	1.67
  INVESCO Total Return Inv (FSFLX)	1.11	1.27
  Merrill Lynch Balanced Cap B (MBCPX)	1.22	1.61
  MFS Total Return B (MTRBX)	2.39	1.53
  Morgan Stanley Strategist B (SRTBX)	1.54	1.63
  Oppenheimer Quest Bal Value A (QVGIX)	2.2	1.47
  Oppenheimer Quest Bal Value B (QGRBX)	2.33	2.07
  Oppenheimer Quest Bal Value C (QGRCX)	1.04	2.07
  Van Kampen Equity-Income B (ACEQX)	1.85	1.58
  Valley Forge (VAFGX)	0.008	1.26

  
  For additional entertainment, we noted that Valley Forge has outperformed all of these giant balanced funds for the past 12 months, and it has outperformed all but five of these funds over the past three years.
  
  
  
• Micro-cap funds tend to invest in micro-cap companies, and very small companies can make fund managers look either very smart or very stupid.....Suprema Specialties is the latest micro-cap company to make a manager look dumb, and in this case the victims are James and James Oberweis, the father-son team that manages Oberweis Micro-Cap Value.....Suprema, which manufactures and markets gourmet all-natural Italian cheeses, had been Micro-Cap's third-largest holding.....Unfortunately, upon closer examination, Suprema's business smelled worse than a pound of Gorgonzola cheese.....The company collapsed in December, declared bankruptcy shortly thereafter, and is now under a criminal investigation.....Suprema shares, which once traded as high as 17.90, were recently quoted at 1/10 of a cent.....The Oberweis team rode the stock all the way down, and here's the reaction of the senior Oberweis to that disastrous turn of events: "Who would expect a cheese company to be a fraud" ....."Uh, perhaps a money manager?"
  "3 flash-in-the-pan funds to avoid," Timothy Middleton, moneycentral.msn.com, May 21, 2002
  
  
  
• T. Rowe Price New Horizons is a small-to-mid-cap growth fund, with a bloated asset base (about $5 billion) and decent, but not spectacular, performance.....For some reason, investors have decided to flee this fund, and over $600 million has been withdrawn during the first quarter of 2002, on top of about $770 million that was withdrawn over the past four years.....To make things worse, New Horizons has been closed to new investors since 1996, so there's relatively little fresh money to replace the cash that's been flowing out.....In an attempt to stabilize cash flows, Price recently reopened this fund to new investors,* which raises a couple of interesting questions: (1) Why would anyone want to go near this thing right now? and, (2) Should you sell this fund if you already own it?.....Funds that are bleeding assets can quickly enter a death spiral, in which shareholder redemptions force unwanted sales, which depresses performance, which spurs further redemptions, which further depresses performance......It's pretty clear that New Horizons has already started its spiral.....Maybe it will pull out, maybe it won't, but do you really want to have cash on the line while you wait to find out?.....By reopening the fund, Price is probably hoping to lure some new 401(k) money, so don't take the bait even if you have the opportunity.....If you already own this fund, we suggest that you keep a close eye on performance......If New Horizon's numbers start to deteriorate, especially relative to its peers, you're probably seeing the death spiral as it starts to accelerate.
  * "T. Rowe Price Horizons opens its doors," Craig Tolliver, CBS.MarkektWatch.com, May 2, 2002
  
  
  
• We spend more time sneezing: Half of all Americans spend less than six hours a year (about 30 minutes a month) managing their retirement accounts, according to a recent survey by John Hancock Financial Services.
  
  
  
• There's an old saying about military generals, to the effect that they're always planning to fight the last war.....The same can probably be said about government regulators, in this case the SEC, which recently issued some proposed new rules on mutual fund advertising.....These rules were inspired by the crazy markets of the late 1990s and, if the rules had been in effect then, those markets might have been slightly less crazy (maybe).....According to the current draft of the new SEC rules, fund ads that contain performance information would be required to:
  
  
  • Include a toll-free telephone number, which investors could use to obtain performance information that is current through the end of the previous month (ads currently contain performance data that is current only through the previous quarter);
    
    
  • Include a disclosure that past performance does not guarantee future results, and that current performance may be higher or lower than the performance quoted;
    
    
  • Contain language that directs attention to a fund's fees and expenses
  
  Ads also would be required to present the new narrative disclosures in a type size at least as large as the rest of the ad (the SEC finally figured this out!), and performance disclosures would have to be placed in close proximity to performance information.....Also, for the first time, fund companies would be allowed to include information in ads that is not in the fund prospectus, for example, information about current economic conditions and events.
  
  
  
• If the goal of the SEC (above) is to make performance information more meaningful, why doesn't the SEC also require funds to disclose if there's been a manager change during the advertised performance period?.....The required disclosure might go something like this:
  
  

  "This fund experienced a change in its portfolio manager during [insert month and year]. Therefore, the advertised performance numbers may be meaningless, since the person responsible for at least some of that performance is no longer running the fund. Those investors who believe that a manager has no impact on fund performance may wish to ignore this manager change, and treat the advertised performance numbers as if they really meant something."

  
  How refreshing, how true, how unlikely.
  
  
  
• Haven't we seen this before? (Hint: Tech funds, early 2000): In just the first three months of 2002, assets in small-cap value funds ballooned by 55%, from $45 billion to $70 billion.....About 90% of this increase was the result of new money flooding into this hot segment, with only about 10% due to market appreciation*....."Flow of funds" statistics are generally meaningless for individual investors, but this fund-flow statistic should be like a bright, red light (or, better still, an alarm bell).....Dear Reader: The small-cap value segment simply can't absorb this kind of money, and the party is all but over.....If small-cap value is part of your long-term asset allocation, then by all means you should continue to invest.....But if you're investing in this market segment simply because it's hot, well, it's time to move on and start distorting some other part of the mutual fund market.
  *Michael Santoli, Barron's, April 29, 2002
  
  
  
• Here's a surprise: Janus Capital, the firm that runs the Janus funds, is now the largest single owner of Berkshire Hathaway "B" shares.....Berkshire Hathaway is Warren Buffett's company, and Buffett is perhaps the most famous deep-value investor in the U.S......As you may recall, Janus was one of the most famous growth investors in the U.S., until that became inconvenient.
  "What's Keeping Berkshire Up?," Lisa Gibbs and Suzanne Woolley, Money, June 2002
  
  
  
• Adapted from last month:
  
  
  What it takes to make Jim Goff's hair stand on end:
  
  

  "My hair stands on end when people say our [investment] strategy has changed."

  --Jim Goff, director of research for the Janus funds, as quoted in The New York Times

  
  We make Jim Goff's hair stand on end:
  
  

  "Your investment strategy has changed, and Berskire Hathaway proves it."

  
  
  
• During the first five trading days of January 2002, the Nasdaq 100 index jumped 5.67%.....Several Van Wagoner funds rose about the same percentage as the Nasdaq, which led us to conclude, at the time, that the Van Wagoner funds were still "hell-bent-for-growth" funds that closely tracked that tech-heavy Nasdaq index.....Fast-forward to May 8, when the Nasdaq 100 jumped 10.7% in a single day, and the same Van Wagoner funds rose only an average of 0.9%.....If these funds were still heavily invested in tech, you'd expect that their returns once again would have closely tracked the Nasdaq, so clearly something has changed since early January.....The Van Wagoner situation is especially puzzling since the firm's 10 biggest holdings on March 31, 2002 (the latest date available) represented 30% of its assets under management, and these holdings rose an average of 12% on May 8*.....If these stocks were still in the Van Wagoner portfolios on May 8, in roughly the same percentages as March 31, then the remaining 70% of the Van Wagoner holdings must have dropped about 3.9% on that day.....Short sales, perhaps?.....Incredibly poor stock picking?......When questioned by a reporter, a Van Wagoner spokesman was unresponsive, and Mr. Van Wagoner himself apparently no longer deigns to speak with reporters......All in all, some very strange stuff, which investors must figure out without any help from their manager.
  "In a Odd Twist, Van Wagoner Missed Wednesday's Big Move," Ian McDonald, The Wall Street Journal Online, May 12, 2002
  
  
  
• Martin Whitman, 77-year-old head of the Third Avenue Funds, has sold 60% of his firm to AMG (i.e., Affiliated Managers Group Inc.), the fund-eating company that also owns Tweedy, Brown and the Brandywine funds.....The blunt and prickly Mr. Whitman has signed a five-year employment contract, while the firm's "senior principals" have signed 10-year contracts.....Will AMG keep its hands off Whitman and company, and let them continue doing their thing?.....Let's put it this way: If I were the AMG employee assigned to boss Whitman around, I'd want to be wearing one of those Hannibal Lechter masks, just in case he tried to bite my nose off.
  
  
  
• Soon, he'll be running an investment club for guys named Bubba: Back in July 1999, we ran a brief item about Steven Adler, who allegedly stole money from the fund he managed and used the money to cover personal and business expenses.....Well, the wheels of justice grind slowly, but you can now remove the word "allegedly" from our description: In early May, a federal-court jury convicted Adler on 20 counts of mail fraud and wire fraud for stealing almost $2 million of investor money.....The 64-year old Adler faces up to 100 years in prison when he is sentenced on August 9.
  
  
  
• According to a recent research report, the definition of "affluent" at financial services firms has shifted once again.....Where $1 million was once a lot of money, now you're only considered to be "mass affluent" with a net worth between $500,000 and $5 million.....From $5 to $50 million, you're "high net worth," and above $50 million you're "ultra high net worth"*.....In practical terms, here's what those definitions mean:
  
  

  In this wealth category...	You have access to...	And service that is...
  Mass affluent	A Vice President who wants to be Senior Vice President	Well-intentioned, but inadequate
  High net worth	A Senior Vice President who wants to be Executive Vice President	More well-intentioned, but inadequate
  Ultra high net worth	An Executive Vice President who wants to be a money manager	Extremely well-intentioned, but still inadequate.

  * "Strivers and Savers Risk Exposure to ABC Disorder," Chet Currier, Bloomberg.com, May 17, 2002

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FundAlarm © Roy Weitz, 2002