Highlights and Commentary

By Roy Weitz

(Originally posted July 1, 2001) [Archive Table of Contents]
They shoulda been contenders: Funds that stay fully-invested in stocks are supposed to be riskier than balanced funds....In exchange for this extra risk, stock funds are expected to generate better returns..... Often, however, this trade-off doesn't hold.....The accompanying page lists 571 diversified U.S. stock funds that have returned less than the Vanguard Balanced Index fund over the past five years.....Vanguard Balanced invests only about 60% in stocks, and the other 40% goes to fixed-income.....In other words, Vanguard Balanced fought these stock funds with one hand tied behind its back, during perhaps the best bull market in history, yet 571 funds still went down for the count.....Call the boxing commissioner: We smell a scandal.

See the 571 diversified stock funds that couldn't beat a one-armed balanced fund

And now, a word from the Lindner Funds:

"I'm a man in a gorilla suit, and some of you may be wondering why I'm talking about the Lindner funds. Actually, it's quite simple. The Lindner funds are desperate. A couple of years ago, the dentist who owns the Lindner funds brought in some consultants to try to save them. The consultants quickly fired all of the fund managers, and took control of everything. The funds continued to perform miserably, and investor money continued to fly out the door. About six months ago, Lindner shuffled its managers again, and nobody seemed to care. In the past couple of months, Lindner fired about 80% of its non-investment staff, shut down an office, and brought in another consultant for another 'reorganization.' Now, with an 85-page proxy, Lindner is seeking to add 12b-1 fees, increase management fees, and farm out all the work of managing the funds to outside firms. It's a jungle out there, and the Lindner funds are doing everything they can to survive. Do they deserve to survive? Hey, I'm just a man in a gorilla suit, and I need the work. Please vote 'Yes' for the Lindner proposals."

FleetBoston has agreed to pay $1 billion for Liberty Financial Corp......For its money, Fleet gets an undercooked stew of mutual fund families, including Stein Roe, Acorn, Crabbe Huson, and Liberty.....Fleet plans to centralize the research departments of the various funds, which is bad news for fund shareholders on several fronts.....Even as you read this, the best analysts are polishing their resumes, and those analysts who stay (and get centralized) will inevitably produce a blander, more homogenized brand of research.....At the very least, you can say goodbye to the distinctive personality of the Acorn funds.....Fleet currently runs the Galaxy and Columbia families of mutual funds, and even Fleet's CEO doesn't know how he's going to integrate these existing funds with his new acquisitions (when you spend a billion dollars, you apparently worry about such issues after you make the purchase, kind of like buying a bunch of stuff at a garage sale and then figuring out where you're going to store it).....Although Fleet isn't talking, Investment News figures that the following funds, soon to be part of the Fleet family, are the most likely candidates to be merged:

Merger candidates (by category)*	3-year return (% annlz'd)
International:
Columbia International Stock	3.86
Liberty International	-8.44
Large-cap growth:
Columbia Growth	5.64
Stein Roe Young Investor	6.11
Liberty Growth Stock	6.30
Mid-cap growth:
Columbia Special	13.31
Liberty Tax-Mgd Aggressive Growth	NA
Multi-cap value:
Galaxy Growth & Inc Ret	5.15
Liberty Tax-Managed Value	NA
Small-cap core:
Galaxy II Small Company Index	5.81
Liberty Acorn	NA
Small-cap growth:
Columbia Small Cap	15.73
Liberty Small Company Growth	13.25

* Fund categories are assigned by Lipper, and don't
necessarily agree with the categories used in FundAlarm.
Source: "Fleet shakes hands, then eyes mutual fund shakeout,"
Frederick P. Gabriel, Jr., Investment News, June 11, 2001

FundAlarm is supposed to be a site about selling mutual funds, but there's one aspect of selling that we've never discussed: Identifying the mutual fund shares that you wish to sell.....It's an important subject, and a little bit of homework could save you hundreds, or even thousands, of dollars.....Here's some background, some strategy, and some practical tips for dealing with your mutual fund custodian.

• Background: Almost everyone who owns mutual funds holds shares that have been bought at different times and different prices.....If you sell all shares of XYZ Fund at the same time, calculating your gain or loss is relatively easy....But if you sell only some of your XYZ shares, you could find yourself in Calculation Hell.....Conceptually, it helps to think of your mutual fund purchases as layers of a cake (remember that these layers include all shares that you acquire through dividend reinvestment).....When you sell, the IRS assumes that you start with the first layer and sell all of the succeeding layers in order.....This is referred to as the first-in first-out method, or FIFO, and the IRS likes this method for one very simple reason: Over time, stock markets rise, so the FIFO method ensures that you sell your lowest-cost shares first.....Shares with the lowest cost trigger the largest capital gains, which means more tax money for the IRS, and less money for you.....There's got to be a better way, and there is.
  
  
• Strategy: If you want to avoid FIFO, the IRS allows you to elect an average-cost method for identifying your mutual fund shares.....Since many fund companies provide average cost information on their account statements, many fund owners believe that average cost is the only method they're allowed to use when selling their shares.....That isn't true.....There's another method -- specific identification -- that generally produces the best result of all, and a particular type of specific identification -- highest-in first-out, or HIFO -- can be especially attractive.
  
  WSSAHIFO (What's-so-special-about-HIFO)?.....By identifying your highest-cost shares for sale, HIFO guarantees that you generate the smallest possible capital gain.....The difference compared with FIFO or average cost can be dramatic.....For example, let's say that you've been investing $1,000 in Dreyfus Small Company Value on the first day of every month this year (in other words, you've been dollar-cost-averaging).....On June 15th, you need to sell 100 shares....Here's your gain, using the different methods of identifying the shares sold:
  
  

  Method	Gain/Loss
  FIFO	$388
  Average-cost	$223
  Specific ID (HIFO)	-$45

  
  In this case, HIFO actually results in a loss on the sale, versus a gain using both of the other methods.....The HIFO savings are relatively small, because we've assumed a small investment, and we're only looking at six months.....If you've been investing in a fund for many years, and the dollar amounts are larger, the HIFO savings can be huge.
  
  
• Practical tips: If you're going to use the HIFO method, you need to keep a running record of every purchase and sale transaction, including shares bought with reinvested dividends.....You'll also want to follow the IRS rules for specific identification, which are spelled out in IRS Publication 564, as follows:
  
  

  "Specific share identification. If you adequately identify the shares you sold, you can use the adjusted basis of those particular shares to figure your gain or loss. You will adequately identify your mutual fund shares, even if you bought the shares in different lots at various prices and times, if you: 1) Specify to your broker or other agent the particular shares to be sold or transferred at the time of the sale or transfer, and 2) Receive confirmation of your specification from your broker in writing within a reasonable time."

  
  If you're planning to use the specific identification method, you should take a few minutes to become familiar with these relatively simple requirements.....Pay particular attention to the words in bold.....These words appear that way in the original, so you can assume that the IRS is serious about these two requirements: You must identify the shares that you wish to sell at the time of the sale, and your confirmation of the sale must be in writing.
  
  If a mutual fund company holds your fund shares, you shouldn't have any problem with a specific identification sale, since fund companies have been handling transactions like these for years.....But what if you want to sell your funds through an online broker or fund supermarket? Is it still possible to use the specific identification method?.....In mid-June, FundAlarm went undercover as a potential new-account customer.....We e-mailed 11 major online brokers and fund supermarkets, and asked about their specific identification procedures for mutual fund shares (specific identification sales are also called "versus purchase" sales, since you sell shares "versus" a particular purchase).....Two of 11 brokers we contacted (TD Waterhouse and Morgan Stanley Online) said flat out that they couldn't handle "versus purchase" sales of mutual funds.....Another two brokers (CSFBdirect and Fidelity) appear to comply with the IRS rules precisely.....The seven remaining brokers claim to have procedures in place for specific identification orders but, in every case, these procedures appear to fall short of the IRS requirements discussed above (for example, Datek allows specific identification, but not at the time of sale).....The accompanying page contains the e-mail responses of all 11 eleven online brokers, and our comments on each.
  
  Back to our question: Is it possible to use the specific identification method when selling through an online broker?.....If you have an account with one of the seven non-complying brokers, you face a difficult decision: You can either try using specific identification, and risk having the IRS disallow it, or you can fall back on one of the other methods (FIFO or average cost) that the IRS won't challenge.....If it were us, we'd try specific identification (of course, your tax advisor may disagree).....As long as you follow your broker's procedures exactly, you can always argue that you did the best you could.....Believe it or not, the IRS often buys that argument.....In the worst case, the IRS is likely to unwind your specific identification sale, and require you to use FIFO.....Although that's far from the best result, it's not a disaster, and you can always fall back on Mom's comforting words: "Nothing ventured, nothing gained".....Before we go, we'd also like to have a word with the brokers who don't do specific identification, or don't do it right: Two of your competitors do it. You can, too.

Most of us "know" certain things about the stock market, and one of the things almost everyone "knows" is that stocks have returned an average of about 10% - 12% per year over the past 75 years.....Unfortunately, as with so much conventional wisdom, it's not that simple.....A recent study by The Leuthold Group (Minneapolis, MN) looked at 20 stock market peaks since 1901, and the study asked a simple question: How many years would it have taken from each peak until an investor in a stock market index would have achieved a 10% or an 11% annual compound return?.....As it turns out, to achieve a 10% annual compound return (ACR), an investor would have waited an average of 7.8 years from each of the 20 market peaks.....An 11% ACR doesn't seem like much more than 10%, but an investor would have waited almost twice as long from each peak (an average of 14.8 years) for this extra 1% of annual return.

Even more interesting are some of the specific market peaks.....For example, it took until 1998, almost 69 years, for an investor who bought at the peak of the market in 1929 to achieve a 10% ACR.....Amazingly, that hapless 1929 investor is still waiting to achieve an 11% ACR.....In more recent history, an investor who bought at the peak of the market in 1961 waited about 25 years for a 10% ACR, and about 35 years for an 11% return.....The Leuthold study assumes that dividends were reinvested.....Over the past 100 years, the average dividend yield was 4.5%, while the current yield of the S&P 500 is only about 1.25%.....Excluding dividends from the calculation, an investor would have been able to achieve a 10% or 11% ACR in only seven of the 20 periods.

What conclusions can you draw from this study?.....Now that the market is considerably off its year 2000 peak, you should have a better chance of achieving those 10% or 11% returns if you invest now.....However, since the dividend yield of your portfolio is probably nowhere near the historical average of 4.5%, it may take longer than you expect for your portfolio to recover from last year's peak.....This is especially true if you made significant new stock or mutual fund investments in early 2000, just before the markets crashed.....If you've been counting on money invested in early 2000 money to compound at 10% or 11% over the next 10 or 20 years, you might need to rethink that part of your financial plan.
"As dividends dwindle, it'll take compounding longer to work its miracle," Steven Leuthold, Investment News, May 21, 2001

Will Bales, manager of Janus Venture

Since the stock markets hit their peak in March 2000, about 9% of the stocks in the Wilshire 5000 index have dropped in value by 90% or more.....As you might expect, different fund families have weathered the storm in different ways.....For example, 16% of the stocks held by Janus funds in March 2000 have dropped 90% or more, compared with only 3% of stocks at the American Funds.....Within fund families, results also varied, with an astonishing 30% of the stocks at Janus Venture losing 90% or more.....Results at other large fund families were no big surprise:

Fund family	Stocks dropping 90+% from 2000
Janus	16
MFS	11
Wilshire 5000 Index	9
Franklin	7
Putnam	6
Fidelity	5
TIAA-CREF	4
American Funds	3

Why do professional fund managers pile into loser stocks?.....Lack of talent is always a distinct possibility, but something else may be at work, too.....Many fund managers receive bonuses based not on their absolute performance, or even their performance versus a benchmark, but performance versus their peers*.....If peers are buying hot stocks, your manager may have a strong financial incentive to buy the same hot stocks, even though you have no idea what's going on, or why, and no way to find out.....If funds were required to disclose the structure of each manager's compensation package (Not the numbers! Heaven forbid!) , at least you'd know if your financial interest was aligned with your manager's.....The structure of a manager's compensation package creates a potential conflict of interest.....For more than 60 years, the SEC has required managers to disclose other conflicts of interest.....Why not this one?
"If Mutual-Fund Managers Are So Smart, Why Do They Put Money in Dog Stocks?", Aaron Lucchetti, The Wall Street Journal, June 3, 2001


Briefly noted:

• It's been that kind of market.....In May, the FundAlarm Discussion Board Model Portfolio clawed its way into positive territory for the first time this year.....In June, however, the portfolio was beaten back again:
  
  

  As of:	FundAlarm	Vanguard
  Feb 22	$95,900	$94,900
  Mar 22	86,161	84,480
  April 22	93,445	92,440
  May 22	103,670	100,070
  June 22	95,083	93,460

  
  Here's our prediction (remember, like all such predictions, we don't know what we're talking about): This back-and-forth pattern will continue for the rest of the year.
  
  View the latest results for the Discussion Board Model Portfolio
  ...and continued thanks to Karl for his performance reporting
  
  
• The Bear Stearns Focus List fund is based on recommendations of the firm's in-house analysts.....The Bear Stearns S&P STARS fund is based on recommendations of 50 stock analysts employed by Standard & Poor's.....Even though one of those in-house analysts probably earns as much as all 50 S&P analysts combined, the Bear Stearns Focus List fund has never been able to pull ahead of the Bear Stearns S&P STARS fund.....Focus List had an especially bad year in 2000 (-13.8%, compared with +2.9% for S&P STARS), and Barron's columnist Michael Santoli thinks he knows why: "In rough markets, when caution and skepticism pay their highest dividends, the blind spots of brokerage-firm stockpickers lead investors astray".....Makes sense to us.
  
  
  
• 
  AIM Select Growth Fund was created to hold the best growth stocks from all of AIM's funds.....Recently, that strategy has been a flop.....Instead of giving the strategy time to work, AIM has decided to "reposition the target allocation of assets".....Now the fund will become a go-anywhere, buy-anything, hope-we-get-it-right-this-time offering.....It will also get a new name: AIM Select Equity Fund.....If all of this seems familiar, it is, except it used to be "value" names fund that companies couldn't get rid of fast enough.
  
  
  
• Zurich Scudder, which runs the Scudder mutual funds, is the U.S. asset management arm of a Swiss company.....Apparently, the two companies have yet to perfect the art of transatlantic communication.....In May, the head of the Swiss parent said that sale of the asset management business was not an option.....In June, the head of the U.S. asset management firm admitted that the company was, indeed, "in discussions" to sell....."We want to get something done as quickly as possible," according to the U.S. side of the company.
  
  
  
• The IPS iFund is a new community-directed fund and, as we've said before, we think it's a dumb idea.....Consider, for example, the following excerpt from a "Shareholder Agreement" that all new investors are required to sign:
  
  

  Once 5% or more of the iFund’s outstanding shares vote for a Nominee, it may become a Candidate stock. (The 5% figure is set by the Advisor at its discretion and is subject to change.) Candidate stocks will appear on a Candidate List. The list will consist of no more than 10 stocks, which have graduated from the Nominee List by having the highest percentage (over 5%) of outstanding shares voted in their favor. The iFund’s Website will update the Candidate List continuously to reflect the ten stocks with the highest percentage of shares in their favor, and which have met the minimum 5% requirement (or other percentage determined by the Advisor) .

  
  The Agreement goes on and on, for a total of 12 mind-numbing pages.....Good investments are usually simple, and complex investments often spell trouble (remember tax shelters?).....When the contract for buying a mutual fund is longer than the contract for buying a house, something is wrong.....Did we mention that the IPS iFund is a bad idea?
  
  
  
• A. Michael Lipper, former head of fund-tracking firm Lipper Inc., has hooked up with FundWatchDog.com.....The idea behind this Web site is to provide industry news and education for outside mutual fund directors.....Fund companies can also customize the site to provide information about their particular fund group, as well as materials for board meetings*.....A separate, interactive section is reportedly being developed, which will allow fund directors to play Follow the Leader, and practice repeating management's words.
  * "Lipper chairs fund directors' info site," Craig Tolliver, CBS. MarketWatch.com, June 18, 2001
  
  
  
• The Putnam funds are famous for their style purity.....Unfortunately, while everyone was worrying about style, risk crept in through the back door.....Putnam CEO Lawrence Lasser now acknowledges that Putnam's growth funds got "too aggressive" over the past few years.....Lasser has already made some changes in the firm's investment process and personnel, and he's ordered an internal review of Putnam's procedures*.....As CEO, however, Lasser is ultimately responsible for Putnam's lapses.....Perhaps Lasser should take the next tough step, and order himself to return part of last year's $33-million bonus?
  "Putnam admits mistakes," Mike Garrity, InvestorForce.com, June 14, 2001
  
  
  
• From the rumor mill: Dreyfus is trying to grab a team of growth-stock managers from Transamerica, which would almost certainly trigger manager changes at several Transamerica funds.....Dreyfus confirms that it wants to expand its offering of growth funds, but otherwise declines to comment.
  Investment News, June 11, 2001
  
  
  
• You could see this one coming: Vanguard has fired the outside managers of its U.S. Growth fund -- David Fowler and J. Parker Hall -- and replaced them with a team from Alliance Capital Management.....Fowler and Hall have been off-track since 1999, when they missed much of that year's bull market.....In 2000, they committed the ultimate sin for a Vanguard manager by changing their investment discipline and jumping into high-priced, low-profit Internet stocks.....We all know how that move turned out.
  
  
  
• Speaking of funds that desperately need help, how about Van Kampen Pace?.....A year ago, FundAlarm reported on new managers Mike Davis and Mary Jayne Maly, the sixth management team in 10 years, and we thought they might have a chance to turn this sad-sack fund around.....They haven't.....At this point, here's a fair question to ask yourself: "Why do I own this thing?".....Van Kampen Pace A (ACPAX) hasn't outperformed the S&P 500 since 1993 (the "B" and "C" shares never have), and nothing that Van Kampen has thrown at this fund has ever made any difference.....If you want to stay in the VK family, you don't have a lot of compelling alternatives, but you should at least try to avoid Van Kampen Enterprise.....It's run by three-quarters of the team that runs Pace, and its performance has been almost as feeble.
  
  
  

• Weather Wizard III will soon offer a "Market Watch" attachment

  According to a recent study, stock markets rise much more often on sunny days than on cloudy ones.....For all its supposed sophistication, the New York Stock Exchange is among the world markets most influenced by the weather, along with markets in Brussels, Paris, Vienna, and Helsinki.....For example, from 1982 through 1987, the New York Stock Exchange produced an annualized return of 25% on sunny days, compared with only 9% on gloomy days*...Before you rush off to consult that old barometer in your den, you should know that the practical value of this study is almost nil.....But the study does remind us, once again, that emotions have a powerful effect on investing.....Almost any reasonable investment strategy, applied consistently, will beat a brilliant investment strategy that's inconsistently applied.....Dollar cost averaging works because it's consistent, and index funds work largely because managers have no opportunity to be inconsistent. *Forget About Efficient Markets. Let the Sun Shine In," Mark Hulbert, The New York Times, June 17, 2001

  
  
  
• From the February, 2000 issue of FundAlarm:
  
  

  "A midwestern stock broker and a Harvard Business School Professor (uh-oh) have teamed up to offer a new mutual fund, based on the professor's 1997 book (uh-oh)....The book, called The Innovator's Dilemma, explores how market leaders can be toppled by smaller companies with "disruptive technologies" (ho-hum).....The Disruptive Growth fund will apparently invest in the handful of companies that actually fit the theory, and then buy lots of other stuff that kind of fits."

  
  The professor in question, Clayton Christensen, has been called "the most important business thinker in the world today," but it looks like he'll never be called "the world's most successful mutual fund manager".....The Disruptive Growth Fund opened in March 2000 and, 11 months later, it had lost 64% of its value.....Facing The Money Loser's Dilemma, Christensen decided that discretion was the better part of big, empty theories.....The fund is now gone.
  Business Week, June 25, 2001
  
  
  
• Socially-conscious funds typically use a two-step process for screening stocks.....First, researchers identify suitable companies based on social criteria.....Then, traditional equity analysts screen the approved list based on the usual financial measures.....Recently, the Citizens funds have been getting heat for trying to short-cut the social investing process.....Citizens has disbanded its nine-person social research team and, depending on who you believe, either two or four members of the social team have been reassigned to the traditional equity research group.....The goal at Citizens is for all equity analysts to eventually perform both social and financial analysis, a big no-no in the world of social investing.....Citizens claims that it's still committed to social investing, which is curious, since all references to social investing have been removed from the company's Home page.....In any event, if you're still committed to social investing, Citizens may no longer be a sympatico place for your money.
  "Course change raises ill wind at socially conscious fund," Sarah O'Brien, Investment News, June 11, 2001
  
  
  
• Mutual fund managers may have a hard time beating the market, but that doesn't mean individuals perform any better on their own.....Over the past year, an equally-weighted portfolio of the 20 most widely-held stocks in Merrill Lynch brokerage accounts was down 30.2%, compared with an 11.8% loss for the average large-cap blend fund.
  "Don't Give Up on Mutual Funds," Ian McDonald, June 8, 2001
  
  
  
• In May, we gave the struggling Monument funds a year to live.....In June, we reported that three Monument funds were being merged into the Orbitex family.....This month, the collapse is complete: Monument plans to sell its funds to Orbitex, and leave the mutual fund business entirely.....According to a proxy statement, "Stock market conditions have made it increasingly difficult for Monument Advisors to continue its operations at levels necessary to support adequately the investment activities of the Monument Funds".....Translation: "All of our managers have quit, and we're broke."
  
  
  

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FundAlarm © Roy Weitz, 2001