Highlights and Commentary

By Roy Weitz

(Originally posted June 1, 1999) [Archive Table of Contents]

3-ALARM funds you can live with? Each month, FundAlarm publishes a list of the "Most Alarming 3-ALARM Funds".....These are the 50 funds in each benchmark category that have the worst performance records.....What FundAlarm readers never see is the bottom of the list -- in effect, the "best" 3-ALARM funds.....The accompanying page presents the 25 funds in each benchmark cateogry which bring up the bottom of the "most alarming" list.....Owning a 3-ALARM fund is never something to aspire to.....But if you must own a 3-ALARM fund, the funds on the accompanying page are probably ones you can live with, at least for now.


"I'm a financial idiot" "No, you're an overpaid ingrate."
We have simplified somewhat, but these are basically the legal arguments being made by fund manager Jim McCall (PBHG Large Cap 20, Large Cap Growth, Core Growth) and the executives who run PBHG.....McCall is suing PBHG for violating the terms of his employment contract, and the company is suing McCall to keep the contract in force.....McCall wants to join Merrill Lynch.....PBHG is up for sale, and company execs seem to feel that McCall's presence will add to the company's value.....In his lawsuit, McCall alleges that he received verbal permission to break his contract.....McCall also alleges that he was "tricked" into signing his employment contract, and that he never received a $250,000 signing bonus, apparently because he forgot to ask for it.....McCall has one more gripe: Christine Baxter, underperforming fund manager and daughter of CEO Harold Baxter, received $750,000 more in bonus money than he did in 1997.....For its part, PBHG alleges that McCall had "very limited experience in managing mutual funds" when he started with the firm in 1995.....In his first full year, PBHG paid this unqualifed rookie $425,000 and then, for good measure, they paid him even more: $1.2 million in 1997, and $1.5 million in 1998.....Even so, PBHG alleges that McCall began expressing "dissatisfaction" with his compensation late last year.

Update: As of May 28, PBHG announced that McCall had been fired from all of his funds. Gary Pilgrim has taken over Large Cap Growth and Large Cap 20, and Jeff Wrona now runs Core Growth. McCall is still with the firm, which is very strange. We can only assume that McCall is now being used to run errands, handle large photocopying jobs, and answer the phones during lunch hour.

Watch what they do, not what they say: When Scott Schoelzel took over the reins of Janus Twenty in August 1997, he went out of his way to keep investors calm .....Schoelzel told SmartMoney magazine (October 1997) that there was "a tremendous amount of commonality" between Janus Twenty and Janus Olympus, which Schoelzel had just left.....Schoelzel also assured the magazine that his methods "won't differ much from Marsico's".....In a recent interview with Bloomberg Online, Schoelzel apparently felt comfortable enough to finally tell the truth.....In his first 90 days at Janus Twenty, Schoelzel acknowledges that he eliminated or reduced about half of the fund's holdings.....In fact, at the same time Schoelzel was telling SmartMoney that little would change, he knew exactly what he planned to do: "Tom Marsico taught me, when you take over a fund, you clean house".

A Liberty Financial spokesman

Liberty Financial runs the Stein Roe Young Investor Fund, as well as the Stein Roe Young Investor Web site.....In one part of the Web site, children were asked to provide personal information, including financial gifts received, spending habits, and family finances.....Liberty also collected names and addresses, in return for a free newsletter and prize drawings.....According to Liberty, all answers were "totally anonymous".....As it turns out, Liberty did keep a list of children's names linked with survey responses....The company also failed to provide the newsletter, and didn't hold prize drawings as promised.....Liberty says this was all due to innocent mistakes and, in a recent consent decree with the Federal Trade Commission, the company agreed to take several corrective steps.....Liberty executives are relieved to be rid of this public relations nightmare, but they're not out of the woods yet.....We've heard that Liberty now faces charges of candy-stealing, brought by the Justice Department.

Speaking of obnoxious online behavior: Vanguard's new "Online Planning" feature gives users only two options: "plan and save data" or "plan without saving data".....If you choose the "save" option, Vanguard cheerfully admits that you may (i.e., will) receive "appropriate educational materials or mailings [targeted] to your particular needs".....If you would like to use Vanguard's planning software, and you don't want your personal information all over Vanguard's computers, your best bet is to download the program to your own hard drive.....You also might want to take advantage of Vanguard's handy e-mail link, and suggest that they add a third option: "Plan and save and don't bother me."


This little piggy sent a proxy: Investors in Fidelity's Destiny I and Destiny II funds already pay a steep front-end load.....Now, if Fidelity has its way, investor pockets are going to be even lighter.....Buried deep in a recent proxy (which runs about 135 pages), Fidelity is seeking to amend its management contract....Currently, Fidelity charges the Destiny funds a "basic" management fee, and adds or subtracts a performance-based fee.....Recently, for Destiny I, the "basic" management fee has been running about .48% (48 basis points), reduced by a penalty of .15% because the fund has been underperforming the S&P 500.....Fidelity wants to eliminate this penalty provision, which means that Destiny I investors will have the opportunity to contribute about $10 million more per year to Fidelity's bank account.....Destiny II investors will be subject to slightly different fee schedule, enriching Fidelity to the tune of about $5.6 million.

FundAlarm reader Kurt Kuberek was distressed enough about Fidelity's fee grab to circulate an e-mail letter, urging a "No" vote on proxy proposals 6, 7 and 10.....With Kurt's permission, here's part of what he had to say:

Morningstar reports the Destiny plans as having an 8.67% front-end load. Obviously, it is difficult to capture the Destiny plans' complicated variable load in a single number, but this seems to be a reasonable estimate. Who buys these plans? They are often marketed to military professionals. The agents who sell these plans are typically retired and former military professionals. Their customers are typically junior military professionals. Most people entering the military do not have a background in financial matters. Most are recently out of school, just starting their career, and probably have limited, if any, experience investing their money. Generally, they have not yet been exposed to other investment alternatives. The agent selling the plan is perceived as a "brother-in-arms" who is interested in helping them achieve their financial goals. It is an effective marketing strategy as evidenced by the fact that almost 13 billion dollars are under management in the Destiny plans. Now, the true extent of Fidelity's boldness in asking for more of Destiny shareholders' money can be judged. When compared to the loads, fees, and expenses charged by competitors in the mutual fund industry (Vanguard leaps to mind), unbiased people would certainly conclude that participants in the Destiny plans have already paid their fair share and more to Fidelity and the agents selling the plans. To ask for more does not seem reasonable. Many people serving their country in the military are Destiny shareholders. Certainly, many of the people involved in the combat over Kosovo are Destiny shareholders as well. Surely they deserve a better deal than this.

This seems like a great time for Destiny shareholders to give Fidelity their special salute.....How about it, folks?


Roy's new license plate:


Wave if you see me, but please don't honk.....That just makes it worse.


Do they really want to hear from you? Mutual fund companies should love e-mail.....On the one hand, it gives them immediate contact with investors....On the other hand, e-mail is less demanding than the telephone, since e-mail doesn't have to be answered immediately.....So how are the fund companies doing?.....When you visit the Vanguard Home page, you immediately see a link for "Contacting Vanguard".....Click your mouse twice, and you're ready to compose and send your e-mail message.....Fidelity's Web site is more like an e-mail treasure hunt.....There's no e-mail link on the Home page.....But if you click on "Site Map," then click on seven more links and fill out two mini-questionnaires, you will finally arrive at Fidelity's e-mail form.

Here's how some of the other no-load fund companies handle e-mail:

• T. Rowe Price: There's no obvious e-mail link on the Home page, but there is something that says "Service Area/Forms".....With visions of steam pipes and furnaces dancing in our head, we click on this, and one click later we arrive at Price's e-mail form.....Verdict: Why can't the link on the Home page just say "e-mail"?
  
  
• Janus: Again, there's no obvious e-mail link on the Home page, so we click on "Visitors".....Still no obvious e-mail link....We click again, and down there at the bottom of the screen, real tiny, it says "Contact Us".....We give it a try, and up comes the Janus e-mail form.....Verdict: Would it have killed them to put an e-mail link on the Home page?
  
  
• Neuberger Berman: There's no e-mail link on the Home page, and nothing else that looks even close.....For the heck of it, we click on a link that says "NB Funds," which brings up a link for "Feedback," which brings up an e-mail form.....Verdict: Uninviting, illogical.
  
  
• Warburg Pincus: This one is easy to review, since there's no e-mail or feedback link anywhere on the entire site.....Seems like they're not interested in talking to anyone.....Verdict: Same to you.
  
  
• American Century, Berger, Strong: All three sites feature prominent e-mail links on the Home page.....Two clicks on each and you're ready to send your message.....Verdict: The way all fund company sites should be designed.

The two sides of

L. Roy Papp

"The link between the art world and mutual funds may not seem readily apparent. But if there's any doubt the link exists, you need only meet L. Roy Papp, founder of the Papp group of funds based in Phoenix." [This quote is from a recent article in The Christian Science Monitor.] "A tall, patrician, eagle-eyed individual, Mr. Papp has all the characteristics of an artist who just happens to be wearing a dark business suit." [OK, now we're starting to gag.]

Reading a bit further in the Monitor article, we discover that Papp's artistic credentials number exactly two: He collects Chinese paintings, and the "brochures accompanying his fund prospectuses have vibrant covers that are miniature works of art".....Not exactly life on the creative edge, but at least he has both ears.


A diagram of the recent fund changes at Stein Roe:




It's simple. Trust me.

• Stein Roe Capital Opportunities will be merged into Stein Roe Growth Investor, which is a clone of Stein Roe Young Investor.....Median market cap will move from about $3.5 billion to $35 billion.
  
  
• Stein Roe Special Venture will be liquidated.
  
  
• Stein Roe Growth Opportunities (which currently owns a little bit of everything) will become a mid-cap growth fund.....After an all-night brainstorming session, company executives decided to name the new mid-cap growth fund Stein Roe Midcap Growth, although Stein Roe Leftover Opportunities was the choice of several traditionalists.
  
  
• Stein Roe Special will remain a midcap fund, but it will shed its value approach for a mix of value and growth.....It will be renamed Stein Roe Disciplined Stock Fund.
  
  
• Oh, we almost forgot: Gloria Santella (formerly of Capital Opportunities) and Gerry Sandel (formerly of Special) were fired, and both have left the firm.

"I think this industry is incredibly short of talented people": That's the opinion of Oppenheimer CEO Bridget Macaskil, who spoke at a recent meeting of fund industry executives.....Why Macaskil would invite attention like this, we'll never understand ("Hey, everyone, look at my zits").....But Macaskil's observation is clearly correct, and the evidence is right there in her own backyard.....This month's FundAlarm database contains 22 Oppenheimer mutual funds, with a total of 57 measurement periods (this does not include multiple classes of the same fund).....In 74% of these measurement periods, Oppenheimer funds have underperformed their respective benchmarks.....Of the 16 Oppenheimer funds that have been in existence at least five years, 11 are 3-ALARM, and only two are NO-ALARM.


"We're from the securities industry, and we're here to help you": If you ran a brokerage firm, and you also owned a mutual fund, you might be tempted to occasionally dump some unwanted stocks on your fund.....Who are we kidding?.....Of course you'd be tempted, and that's why the prohibition against "affiliated transactions" has been a basic principle of U.S. securities law since at least 1940.....Earlier this year, the Securities Industry Association (SIA) submitted a wish list of proposals to Phil Gramm, Chairman of the Senate Banking Committee.....One of these proposals would eliminate the prohibition against "affiliated transactions" -- in other words, brokerage firms would be allowed to sell stocks to their own funds any time they wanted to.....Gramm reportedly likes the idea, but he may be the only one in Washington who does.....A top official at the SEC has come out solidly against it, and the Investment Company Institute finds the SIA proposal "entirely objectionable".....The securities industry is shocked by the strong negative reaction.....Brokerage firms say that they are only trying to find "new ways of helping investors," and they are confident that internal rules and policies can be written to protect investors.....FundAlarm was skeptical about the SIA proposals, so we called "Joey," our Wall Street contact.....Joey told us to relax: "Listen, Roy, brokers are used to rules. They got rules against churning. They got rules against selling unsuitable investments. They got rules against screwing people on breakpoints. See how well they've done with all of those? Besides, the world ain't gonna end if a broker sells some crummy stocks to a mutual fund. You gotta stop worrying so much. Get out more. Maybe play some golf."


Briefly noted:

• May 1999 was not a good month for big-name fund managers.....As we noted above, Gloria Santella and Gerry Sandel are now polishing-up their resumes.....Also, at the Berger funds, Patrick Adams is now a former fund manager.
  
  
  
• As far as we know, Patrick Adams doesn't suffer from Multiple Manager Disorder, although he certainly has some of the symptoms....During his tenure at Berger 100, Adams turned in a truly dreadful performance.....At Berger Select, Adams was a star, at least for about 12 months.....Adams probably isn't as bad a manager as Berger 100 might suggest, and probably not as good as his numbers at Select would indicate.....And now that Adams has been fired, there isn't one in-house manager at Berger with any significant mutual fund track record.....In fact, the professional credentials of the remaining Berger managers are as thin as the Denver air in which they operate (see Recent Manager Changes for details).....On top of everything else, Berger has a new CEO who's been told to shake things up.....There's also talk that the Berger funds could be sold, or absorbed into the Janus family (Berger and Janus have the same corporate parent, Kansas City Southern Industries).....The locust and frog population in Denver is reported to be holding steady, but that may be the only good news for Berger investors.....FundAlarm readers often ask, "But how do you really know when a fund family is in trouble".....Let us spell it out:
  
  B-E-R-G-E-R
  
  
• On June 1, 1999 the small-cap Russell 2000 index undergoes its annual "reconstitution".....Among other changes, companies that have grown too large (in terms of market cap) will move out of the 2000 index and into the larger-cap Russell 1000.....Similar changes will occur in FundAlarm's small-cap benchmark, the Vanguard Small Cap Index Fund, which tracks the Russell 2000.....What do these changes mean for investors?.....As high-flyers move out of the Russell 2000, it should become easier for small-cap fund managers to beat their benchmark .....Improvements could appear quickly, and should be most apparent in the 12-month returns.
  
  
  
• By the time you read this, the SEC may already have voted on several new rules governing personal stock trades by mutual-fund managers.....Proposals for better disclosure and surveillance of manager trades have been bouncing around for years, and it looks like the SEC will finally do something in that area.....It also looks like the SEC will crack down on fund managers who invest in IPOs: There may be an outright ban on the practice, or (much weaker) managers may merely be required to get clearance for such trades from their employers.....The SEC has been talking tough recently, and it will be interesting to see if they go watchdog or weenie on the IPO issue.....In our opinion, any fund manager who personally invests in oversubscribed IPO shares is either (a) skimming an economic benefit from the fund, or (b) using the fund as leverage to obtain a financial reward not available to the general public.....Either way, IPO investments by fund managers should be banned.....We'll keep you posted.
  
  
  
• The Peter Young Fashion Scorecard:
  
  

  	-- Young's Court Appearances --
  	April, 1999	November, 1998
  Skirt	Red	Beige
  Handbag	Black	Pink
  High heels	Yes	Yes
  Jewelry	Tasteful	Tasteful

  
  As you may recall, Peter Young is a defendant in the U.K.'s biggest mutual fund scandal ever.....Young appears in court dressed as a woman he calls "Elizabeth".....According to British press reports, Young also "bought 30 jars of pickles on one shopping trip, kept condoms in his office, and spent a lot of time in dark rooms muttering to himself".....It isn't clear if these activities are related.....We're praying hard that they aren't.
  
  
  
• Charles Albers managed Guardian Park Avenue for 26 years, and he helped develop that fund's computerized stock-selection model.....Since May, 1998, Albers has been at the helm of Oppenheimer Main Street Growth and Income, which also relies heavily on a computer model to help select stocks.....Albers is the common denominator at both funds, and it seems reasonable to assume that the Guardian and Oppenheimer computer models now look very much alike.....With similar computer models, you might also expect both funds to perform about the same, but that hasn't been the case.....For the 12 months ended April 30, 1999, Main Street (with Albers) has outperformed Park Avenue (without Albers) by about 650 basis points (6.5%).....What's going on?.....According to one commentator,* "humans do make a difference, even when they're using a quant system"....."Quant managers use their models to spit out a group of reasonable-looking stocks, but part of the challenge is figuring out which to override".....Based on preliminary results, Albers seems to be better at implementing his computer model than the team he left behind at Guardian.....But before Albers gets too puffed-up, we need to remind him that he's still trailing the S&P 500 by a sizable margin since he started at Oppenheimer.
  * Christine Benz, morningstar.net
  
  
  
• The following table shows sales of in-house mutual funds as a percentage of total mutual fund sales:
  
  

  Morgan Stanley Dean Witter (MSDW)	75%
  Merrill Lynch	~ 40%
  Citigroup	35%
  Prudential	35%
  PaineWebber	20%

  
  Most brokerage firms and banks try to keep a 50-50 split between in-house and outside mutual funds.....That way, the split is likely to seem "fair on its face, and won't attract scrutiny of regulators concerned that firms are flogging their own products too hard"*.....MSDW has one of the worst-performing fund families, and we'd love to hear Morgan Stanley execs explain how these dismal funds could possibly account for 75% of sales if brokers weren't pushing them.....One possible explanation: A large percentage of Morgan Stanley customers play golf, so they actually prefer low performance numbers.
  * "House Funds Pose Challenge for Citigroup," Paul Beckett and Patrick McGeehan, The Wall Street Journal, May 13, 1999
  
  
  
• What happens when focused mutual funds meet simple arithmetic and a soaring stock market?.....You have the potential for some seriously skewed performance numbers.....Consider this: AmericaOnline stock returned 586% in 1998.....If a fund had invested just 10% of its assets in AOL for the entire year, the AOL stake alone would have contributed 58.6% to the fund's return (5.86 x .10).....If the return on all other stocks in the fund's portfolio had netted out to zero, this fund still would have been one of the 50 best-performing funds of 1998.
  
  
  
• Does our example above seem too theoretical?.....It isn't.....According to Mutual Funds magazine (June 1999), the Amerindo Technology fund held about 12% of its assets in Yahoo! stock for the first six months of 1998.....During that six-month period, Yahoo! gained 120%, which means that the Yahoo! stake alone added about 14% to the value of the Amerindo fund (1.20 x .12).....Since the total return for the Amerindo fund during that six-month period was 28%, all of Amerindo's other stocks returned just 14%.....In the second half of 1998, Amerindo's manager (Alberto Vilar) sold some of his Yahoo! shares.....Depending on exactly when Vilar sold them, all of the other stocks in Amerindo's portfolio gained somewhere between -3% and +12% -- hardly a stellar performance in a year that was generally favorable to tech stocks.....For all of 1998, Amerindo was up almost 86%.....Without Yahoo!, the fund's return for the year would have been somewhere between 11% and 26%.
  
  
  
• Alberto Vilar, manager of Amerindo Technology, contemplating his life without Yahoo!
  
  
  
  
• Money magazine recently published its annual list of the 100-best mutual funds*.....While it is possible to quibble with some of Money's choices (and we do), we were most interested in the funds that have dropped off the list since last year.....Money has dropped four funds due to manager changes: Founders Growth, n/i Numeric Investors Growth & Value, PBHG Technology and Communications, UAM FMA Small Company.....Another seven funds were dropped for poor performance: Barr Rosenberg Market Neutral, Colonial Small Cap Value A, CRM Small Cap Value, Papp America-Abroad, Smith Breeden U.S. Equity Market Plus, Sogen International, and Yacktman.
  * June 1999
  
  
  
• George Slutchuk [real name] is a Canadian financial planner, who was impressed by the track record of Michael Price.....In early 1997, Slutchuk put several of his clients in the Canadian version of Mutual Beacon, run by Templeton Management Ltd.....Now that Michael Price is gone, Slutchuk wants out, but there's one big problem: His clients must pay a deferred sales charge.....Slutchuk has asked Templeton to waive the sales charge, but they have refused.....Slutchuk simply plans to pay the redemption charges himself.....We've never heard of this particular issue turning into a lawsuit, but it wouldn't surprise us to see one.....Any fund with "B" shares and a well-advertised manager could be vulnerable.
  The Globe and Mail, April 29, 1999
  
  
  
• John Bogle Jr., who left the n/i (Numeric Investors) funds in February, plans to open his own firm in September.....Bogle Investment Management will manage private accounts, as well as two or three mutual funds similar to the ones Bogle ran at n/i.....Asked why he wasn't joining an established firm, Bogle said there are "too many interpersonal risks getting involved with existing enterprises".....In other words, he's an ornery s.o.b. who doesn't play well with others.....It should be a great place to work.

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FundAlarm © Roy Weitz, 1999