Highlights and Commentary

By Roy Weitz

(Originally posted June 1, 2004) [Archive Table of Contents]

PIGS FLY!

FUND MANAGER APOLOGIZES! "The regulatory investigations of me and my company have been resolved, and I now want to apologize to the many thousands of shareholders of Strong Funds. I created Strong and devoted most of all my business life to making Strong a safe, secure and prosperous investment vehicle. Mutual fund investing is core to the futures and needs of millions of American investors and its hallmark has always been and continues to be the safety and care of the monies entrusted to those who manage these funds. Throughout my career, I have considered it to be my sacred duty to protect my investors; and yet in a particular and persistent way I let them down. In previous years, I frequently traded the shares of the Strong funds, at the same time that the advice which we gave our investors was to do the opposite and to hold their shares for the long term. My personal behavior in this regard was wrong and at odds with the obligations I owed my shareholders, and for this I am deeply sorry." Richard S. Strong

In the end, Dick Strong turned out to be a bigger sleazebag than we thought, his penalty was less than we expected, but overall some sort of rough justice was probably done.....And, oh yes, somebody on Eliot Spitzer's staff probably wrote that nice apology above -- an exercise in "public humiliation," they call it -- which still hasn't found its way to the Strong funds Web site.....Some key points from Strong's recent settlement with the SEC and Spitzer's office:

The sleazebag factor: Contrary to earlier reports, which made Strong's market-timing trades seem almost casual, we learned that Strong made over 1,000 trades, in 10 funds and 40 accounts, over a period of five years (1998 to 2003), with a net profit of $1.6 to $1.8 million.

The penalties: Strong won't face criminal charges, which seemed like a sure thing just a couple of months ago. But Strong will personally cough up $60 million in fines and disgorgement, while his firm will pay $80 million (most of that $80 million comes out of Strong's pocket, too, since he owns 85% of the company). Fees on Strong funds will be reduced by 6 percent (a total of about $35 million) over the next five years, and Strong has been barred for life from the mutual fund industry.

The future: Several days after the settlement, Wells Fargo announced a deal to buy the Strong funds. It's unlikely that the funds will carry the Strong name for long, but Wells might give them a new name and keep them going under their current managers for a while. Ultimately, however, we expect to see the Strong funds merged with the Wells funds. Some of Strong's better managers might be kept on to run the new, merged funds, but otherwise Strong will cease to exist.

According to conventional wisdom, large mutual fund firms have huge advantages in the marketplace, and small fund firms are rapidly becoming an endangered species.....Unfortunately, someone forgot to share this industry wisdom with America's fund investors.....For all of 2003, small fund companies (i.e., those that started the year with less than $50 billion in assets) accounted for nine of the top 15 companies with the largest net cash inflows from investors (this trend continued during the first quarter of 2004, with small companies grabbing eight of the top 15 spots).....Dodge & Cox, which runs just four funds, showed the biggest dollar increase over these 15 months, growing from $25 billion to almost $58 billion in assets.....Other small fund groups with significant increases in assets include Calamos Asset Management ($5 billion to $15 billion), First Eagle Funds ($4 billion to $14 billion), Harris Associates, manager of the Oakmark funds ($14 billion to $25 billion), and Lord Abbett [not a typo], which grew from $27 billion to $44 billion*.....If you own a fund from one of these small, popular families -- and especially if you've been on board for more than a year or two -- you deserve credit for your prescience.....But a rapidly-growing fund company is not a cause for unalloyed joy.....A flood of new accounts can bury customer service departments and, more importantly, new cash can seriously disrupt fund-management strategies.....It's always tough to relate the performance of a fund to the growth of its asset base -- the performance of some funds seems immune to asset bloat, while others seem to suffer as they grow, but even then it's difficult to pin poor performance solely on a fund's increasing size.....In any event, with the companies discussed above, rapid growth should be one of the factors you consider when reviewing funds for a hold or fold decision.
* "Dodge & Cox, Calamos show fund growth isn't over," Chet Currier, bloomberg.com, May 11, 2004


When your bank tells you that you've had an overdraft, it means that you wrote a check for more than you had in your account.....But what does it mean when a mutual fund has a "bank overdraft"?......A sharp-eyed FundAlarm reader (who's also a financial planner) spotted the following line item in the balance sheet of the Oppenheimer Capital Income Fund, and he wanted to know what I thought of it:





Since this is a curious entry for a mutual fund, and it didn't seem like it was part of the fund's normal investment strategy, I decided to play journalist and investigate further......I sent an e-mail to Gregory Stitt, Oppenheimer's VP/Director of Media Relations, and asked him to explain how the overdraft occurred, and whether shareholders incurred any expense as a result.....Several days later, having heard nothing from Mr. Stitt, I gave him a call.....After explaining the purpose of my call, and noting that he hadn't responded to my e-mail, I again asked Mr. Stitt if he could explain the overdraft....At that point, our conversation went exactly like this:

Mr. Stitt: "There's nothing that we need to add to that." Mr. Weitz: "So you have no comment?" Mr. Stitt: "No comment."

Well, perhaps there is a routine explanation of the overdraft.......But if you're a shareholder in this fund, and you feel that you're actually entitled to an explanation of what the fund is doing with your money, you might want to get in touch with Mr. Stitt and see if he'll at least talk to you.....His e-mail is gstitt@oppenheimer.com, and his direct phone line is 212.323.0483.....If he does deign to talk to you, please let us know what he said.

"We need to shine up the brand. It's been dented. We have some work to do." -- Steve Scheid (left), used-car salesman and newly-appointed Janus CEO, lays out the job ahead of him. Source: rockymountainnews.com

If you owned shares in a mutual fund with, say, $3 billion in assets under management, you might want to know if there was one big shareholder who owned 41% of your fund.....And why would you want to know that?.....Well, for one thing, that big investor could one day decide to bail out of your fund and, if that happened, you and all the other smaller investors would be left paying a considerably larger share of the fund's fixed expenses.....As you might have guessed by now, we're not describing a hypothetical situation here, since this is exactly what happened recently to shareholders of the Invesco Technology fund......A little background is in order.....Invesco Technology is a multi-class fund, which currently consists of A,B,C,K, Institutional, and Investor shares.....As of April 2004, about $3 billion was invested across all share classes.....The Institutional share class was created in 1998, and in April the Institutional class held about $1.2 billion in assets, or about 41% of the assets in all share classes.....So far, there's nothing particularly unusual about the structure of this fund, except for one thing: The 401(k) plan of the Boeing company was essentially the sole shareholder of the fund's Institutional class and, in fact, the Institutional class was almost certainly created solely to accommodate the Boeing retirement plan......On April 30, 2004, the Boeing retirement plan moved all of its money in the Institutional class to another fund (Dreyfus Premier Technology Growth, a distinctly uninspired choice).....Literally overnight, the remaining shareholders of Invesco Technology found themselves responsible for 100% of the fund's fixed expenses, even though they represented just 59% of the fund's previous-day assets.

Is there a lesson here for other fund shareholders?.....Why, yes there is......Although the Invesco situation was unusual, it's probably not unique in the fund world, and it may be worthwhile knowing if your fund has a large shareholder, like Boeing, who could potentially disrupt your fund's operations by deciding to leave.....(And remember, when thinking about "your" fund, all classes of each fund generally share fixed expenses pro rata, so you need to look at every class to see if there's one big shareholder in any of them who could affect you).....If you can locate your fund's Statement of Additional Information (SAI), you'll be able to find out if anyone owns 5 percent or more of your fund......Of course, the SAI is also one of the fund world's most obscure documents, and few investors even know that it exists, let alone how to obtain one*.....Which brings us back to Invesco Technology Institutional class......Invesco clearly followed the letter of the law by disclosing Boeing's huge ownership position:

[From: Invesco Technology Institutional, Statement of Additional Information]
And in March 2004, when Invesco learned that Boeing was planning to abandon the Institutional class, Invesco notified all Technology fund shareholders (via a prospectus supplement) that Boeing's move could have adverse financial consequences on the remaining shareholders......But if the prospectus was the appropriate place to notify fund shareholders of Boeing's imminent departure, shouldn't the prospectus (and not the SAI) also have been used to notify shareholders of Boeing's large ownership position in the first place?.....We can't say that Invesco was trying to hide Boeing's stake from its Technology fund investors.....But in retrospect, it's clear that Invesco didn't use the prospectus to disclose all foreseeable risks of owning this fund.
"Boeing Pulls Out of an Invesco Fund," Yuka Hayashi, Dow Jones Newswires, May 10, 2004
* The SAI is technically the second part of a fund's prospectus, and a few -- very few -- fund Web sites offer the SAI as a download. Otherwise, you must obtain a hard copy of the SAI directly from the fund company, or locate the SAI on the SEC's EDGAR electronic filing system.


Can you name the top 10 mutual funds owned in 401(k) and other types of defined-contribution retirement plans?.....And, even if you can, why should you care?.....First, here are the 10 most popular funds for retirement plans as of year-end 2003, in descending order:*

Fidelity Magellan American Funds Growth Vanguard 500 Index Fidelity Contrafund American Funds Washington Mutual Fidelity Growth & Income Fidelity Growth Company Fidelity Spartan U.S. Equity Index Fidelity Equity-Income Fidelity Low-Priced Stock

And here's why you should care: If you didn't already know, this list makes it clear that Fidelity is a huge player in the defined contribution/401(k) market.....On the one hand, this is good, because these popular Fidelity funds are unlikely to do anything crazy, invested assets should be relatively stable during market downturns, and these funds are likely to be first in line when Fidelity allocates internal resources (i.e., brains and money).....On the other hand, these funds will always have bloated asset bases, and it's unlikely that any of them will ever post dazzling performance numbers over a sustained period of time.....Many people who own these funds through retirement plans have few (if any) other choices, which isn't necessarily bad, since all of these funds are at least decent.....But if you do have other choices in your plan, you might want to explore a less-traveled path....Outside of a retirement plan, if you own one of these funds, or if you're thinking about investing in one, you clearly have other choices.....You might want to investigate some.
*InvestmentNews, May 17, 2004


If you are subject to the Alternative Minimum Tax, you (a) probably know it and (b) probably have added a few choice, new words to your vocabulary.....If you aren't yet subject to the AMT, which was designed 30 years ago to snag a few high-rollers, you could be caught in the net soon: By 2005, it's estimated that you'll have about a 30% chance of being an AMT victim once your income hits $75,000, and your chances of being caught will rise to about 80% if you earn more than $200,000.....One of the perverse effects of the AMT is to convert a certain type of municipal-bond income from tax-exempt to taxable, and this nasty transformation will occur whether you own the underlying bonds directly or through a muni-bond fund.....As more and more investors fall into the AMT, some fund companies are getting savvier about dealing with this potentially tainted tax-exempt income, which comes from so-called private-purpose muni bonds.....For example, Oppenheimer and Scudder recently renamed a couple of muni bond funds to make clear that they were "AMT-free," and Fidelity announced that all five of its Spartan Municipal Money Market funds would avoid private-purpose bonds altogether.....(Fidelity has a good background discussion of the entire AMT issue, at http://personal.fidelity.com/global/search/resultsindex.shtml?quser=alternative+minimum+tax).....Bottom line: If you're not subject to the AMT, and won't be for the foreseeable future, you don't need to worry about private-purpose bonds in your muni fund, since all of the fund's income will continue to be tax-free.....But if you are subject to the AMT (or might be soon), and you're not clear where your muni-fund stands with private-purpose bonds, you should probably find out.
"Seeking shelter from alternative minimum tax," Ilana Polyak, InvestmentNews, May 17, 2004


Briefly noted:

• This month brings a couple of updates to Busted!, FundAlarm's Archive of Mutual Fund Malfeasance.....In early May, the SEC brought a civil fraud action against PIMCO, for allowing market timers to run rampant in its stock funds.....Also included in this month's Busted! is the SEC's settlement with Strong, discussed above.
  
  
  
• The current mutual fund scandal is eight months old, and the loose ends are starting to pile up.....Case in point: Back in February, the SEC initiated a civil fraud action against the advisor of the Columbia funds.....The SEC alleged, in part, that several Columbia fund managers allowed market-timers to exploit their funds.....Columbia quickly fired three of the managers referred to in the SEC complaint, and a few weeks later Columbia settled its legal problems with the feds.....Now, Columbia has reinstated two of the three managers who were allegedly involved in cutting deals with market timers*.....Here's our question: Did the fired-and-rehired managers actually approve of market timers within their funds, or not?.....The original SEC complaint leaves no doubt that the fund managers were involved.....If the SEC has evidence that these managers did, indeed, accommodate market timers, the feds owe it to fund shareholders not to allow the reinstatements.....And if the evidence isn't there, the SEC would seem to owe the managers a public apology, which would also clear up things for shareholders.
  * The managers are Kurt Havnaer, of Columbia High-Yield, and Kimberly Campbell, of Columbia Tax-Exempt.
  
  
  
• Mark Greenberg, manager of Invesco Leisure, is now also serving as Invesco's chief investment officer (CIO).....We don't ordinarily report on CIO promotions, but Greenberg's new job is worth a mention: If he takes his new responsibilities seriously, then Greenberg will almost certainly have less time to spend running his fund, which has compiled an excellent eight-year record.....If he doesn't take his CIO duties seriously, then the Invesco fund complex will have a part-time CIO, and Invesco funds overall could suffer.....When one person is divided between two roles, something has to give, and it will be interesting to see which ball gets dropped at Invesco.
  
  
  
• Speaking of Invesco, a lot of people seem to be interested in getting more information about the firm.....In a recent SEC filing, Invesco says that it has received inquiries related to the firm's improper fund-trading activities from the U.S. Attorney for the Southern District of New York, the SEC, the U.S. Department of Labor, the NASD, and state securities regulators from Florida, Georgia, and West Virginia.....Not yet heard from, but expected to issue a subpoena soon: McGruff, the crime-fighting dog.
  
  
  
• Last month, we reported on the departure of manager Robert Ammann from Dreyfus Founders Discovery.....What we didn't realize is that Ammann's departure also represents the end of an era: Ammann was the last remaining stock-fund manager from 1998, when Mellon Financial acquired Founders and slapped the Dreyfus name on its funds.....Inasmuch as the most valuable asset of a mutual fund company is its professional staff, and Mellon was unable to retain the Founders stock-picking staff, can we conclude that Mellon's acquisition of Founders has now officially fallen into the "failure" category?.....Oh, no, quite the contrary: According to a Dreyfus spokesperson, the Founders investment team is now "larger and deeper" than it was in the past.
  "Longtime exec exits Founders," James Paton, rockymountainnews.com, May 14, 2004
  
  
  
• Wellington Asset Management is being investigated by the SEC for improperly allocating shares of initial public offerings (IPOs) among its different types of clients*.....Wellington subadvises a large number of mutual funds, including 13 funds for Vanguard, and our guess is that Wellington will come out of this investigation fairly clean.....But if it turns out that Wellington's IPO policies weren't fair to its mutual funds -- for example, that Wellington allocated a disproportionate share of IPOs to its hedge funds -- we'll definitely have ourselves another little fund scandal.....Stay tuned.
  * "Fund Probe Broadens To IPO Allocations by Money Managers," Hechinger/Solomon/Lauricella, The Wall Street Journal, May 27, 2004
  
  
  
• And speaking of future fund scandals: Investment banks help bring companies to the stock market, through initial public offerings (IPOs).....Investment banks also run mutual fund companies, and therein lies a potential conflict.....Now, there's strong evidence that mutual fund companies run by investment banks have loaded up on IPO shares underwritten by those same banks (the fund companies in question are Citigroup, Credit Suisse, Goldman Sachs, Merrill Lynch and Morgan Stanley)......At this point, the evidence is mostly statistical and circumstantial -- for example, in 2002, Citigroup's investment banking clients made up almost 31 percent of the shares in its mutual funds, compared to much smaller percentages of the same stocks in funds with no investment-banking relationships*.....Richard Shelby, Chairman of the U.S. Senate Banking Committee, has pretty much washed his hands of the recent market-timing and late-trading scandals, but he recently expressed some interest in potential investment-bank conflicts of interest.....Shelby has promised to "discuss" investment-banking conflicts with SEC Chairman William Donaldson, "as soon as possible, perhaps in a letter"......Oh my, all that reforming zeal in one person!
  * "Citigroup Uses Mutual Funds as 'Dumping Grounds' for Clients," David Dietz, Bloomberg.com, April 29, 2004; "U.S. Panel Asks Probe of Bank Mutual 'Conflicts'," David Dietz and Adam Levy, bloomberg.com, May 11, 2004
  
  
  
• Here's an excerpt from a recent Q & A with Ed Haldeman, Putnam's new reform-minded CEO:
  
  

  	Q: Have you invested in Putnam funds?
  	A: I have some of my money in Putnam funds.

  
  Thanks, Ed, that's just about as useful as me saying that I have "some of my money" in cat litter.....Given that Haldeman's income is a matter of public record ($13 million 2003), it hardly would have compromised his privacy to provide the dollar amount of his Putnam investment, or at least the percentage of his investable assets represented by Putnam funds.....Considering the way Haldeman blew off this question, it's safe to assume that his personal Putnam investment doesn't represent a strong vote of confidence in the firm he now oversees.
  "Trying to fix Putnam," Amy Feldman, Money, June 2004
  
  
  
• Like Ed Haldeman (above), Martin Whitman also has "some" of his money invested in the fund that he manages (Third Avenue Value).....But unlike Haldeman, Whitman is willing to tell us how much: Whitman has a hefty $63 million of his own money riding on the fund, or about 2 percent of the fund's total assets.
  "Fund manager feasts on home cooking," Chris Graja, Bloomberg News, May 20, 2004
  
  
  
• 
  
  

  		According to a recent survey, 56% of Americans will rely on personal savings or a contributory pension plan (such as a 401(k)) as their primary source of retirement income.....Yet the average survey respondent had accumulated only $51,000 for retirement, even though he or she was already 46 years old and earned $55,000 a year.....Upon retirement, survey respondents expect to withdraw a stunning 21% of their savings each year, but not to worry.....Respondents expect their assets to grow by an average 22% per year, which would actually leave a surplus of 1% per year during retirement -- just enough to buy a continuing supply of hallucinogens.
  Source: Merrill Lynch "Retirement Preparedness Survey"

  
  
  
• Equilar Inc., a firm that does compensation research, recently turned its attention to mutual fund directors.....According to Equilar's analysis of 722 directors at the 82 largest fund families, 109 directors (or about 15% of the total) reported no personal investment -- zero -- in the fund family that they were charged with overseeing.....But aren't directors at the largest fund families generally the best-paid, and don't they have the widest assortment of funds to choose from?.....Couldn't they find something to invest in for a few dollars, and at least pretend to care?.....Yes, yes, and you would think so.
  
  
  
• Shlomo Eplboim's company runs the Blue & White Fund, which invests in Israeli stocks, and Eplboim is personally giving away shares of the fund.....Any American boy or girl who is celebrating a religious rite (communion, confirmation, bar or bat mitzvah) can apply for $18 worth of free shares at the fund's Web site (blueandwhitefund.com)*......Linkster Ted of the FundAlarm Discussion Board, who spotted this item, wonders if circumcisions also qualify for free shares.....Our advice: Write first, and ask.
  * "One Way To Get New Investors," Lauren Young, businessweek.com, May 31, 2004
  
  Ted's daily Discussion Board links continue to be the best mutual fund education on the Web. Check out Ted for a few days, and you just might get hooked.
  
  
  
• Back in December 2001, just after the September 11 attacks, FundAlarm made a prediction:
  
  

  "...you can bet that...gimmick funds will soon be torn from the headlines.....A "War on Terrorism Fund" is probably a bit crass, even for the fund industry, but a "New Realties Fund" (investing in defense contractors, security firms, selected biotech and pharmaceutical companies) is almost a sure thing."

  
  Last July, Rudy Giuliani and Bear Stearns announced the formation of a private equity fund to "pursue private equity investment opportunities in the security and public safety sectors".....It wasn't a mutual fund, but we knew that one was coming, especially since Giuliani himself had broken the sleaze barrier.....Sure enough, it's here: The Timothy Plan Patriot Fund debuted on May 1, and the prospectus says that it will invest "primarily in the stock of US domestic companies that are engaged in businesses servicing or manufacturing products supporting, defending, or promoting America and the values upon which our nation was founded".....The Patriot Fund will also exclude from its portfolio the same type of stocks that The Timothy Plan excludes from all of its other funds, including stock in any company that is involved in "alcohol production, tobacco production, or casino gambling, or which is involved...in abortion or pornography, or promoting anti-family entertainment or non-traditional married lifestyles."
  
  
  
• When it comes to companies that produce alcohol, as well as several other pariahs of the Patriot Fund, it seems that our nation's founding "values" might well be in the eye of the beholder.....In fact, one could argue that a true "patriot" fund should be swimming in alcohol, just like our Founding Fathers:
  
  

  "Alcohol has played a major role in our nation's history, and its use is a part of our heritage. In colonial times, Americans probably drank more alcohol that in any other era. Spirits were an integral part of daily life throughout the colonies no matter the geographic or economic differences. It was reported that the average American drank eight ounces of alcohol a day... Revolutionary War era persons drank a phenomenal amount. We have here an account of a gentleman's average consumption: 'Given cider and punch for lunch; rum and brandy before dinner; punch, Madeira, port and sherry at dinner; punch and liqueurs with the ladies; and wine, spirit and punch till bedtime, all in punchbowls big enough for a goose to swim in.'..." Tavern owners enjoyed higher social status than did the clergy during the colonial era. Taverns were the center of civic life. Because of this they were often required to be located near the church or meeting house. Religious services and court sessions were often held in taverns. Judges interrupted court to drink, and clergy were obligated to drink at every house call and were often seen reeling home... Among the founding fathers Adams stood pretty much alone [in his opposition to alcohol]. Washington, Franklin, and Jefferson all imbibed and enjoyed brewing or distilling their own alcoholic beverages... The sober picture we have of Washington is not correct if we are to believe anecdotes of his day. It was said that he could dance the night away with four bottles of wine under his belt...He was a devout lover of beer; in particular a dark porter was always in ample supply at Mount Vernon. A typical Washington hosted dinner "included several wines, beer, cider..."

  
  Source: "The Spirits of Our Forefathers," earlyamerica.com
  
  
  

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