Highlights and Commentary

By Roy Weitz

(Originally posted July 1, 2002) [Archive Table of Contents]

(Almost) every dog has its day: In the world of FundAlarm, a fund can't do worse than a 3-ALARM rating, yet most 3-ALARM funds still have managed to outperform their benchmark for at least one calendar year out of the last five.....Notice that we said "most" 3-ALARM funds.....The accompanying page lists 64 large-cap, 3-ALARM funds that have trailed the large-cap benchmark (Vanguard 500 Index) for each of the five calendar years since 1997.....In roaring growth markets these funds came up short, and in strong value markets these funds also underperformed.....If you own one of these funds, here's a fair question to ask yourself: What are the chances that it will ever beat its benchmark?

This often happens after a really big swelling:




Actually, the headline above refers to the departure of Janus CEO Tom Bailey, who is quitting his job effective July 1, 2002.....Yes, when Bailey sold his remaining billion-dollar chunk of Janus stock late last year, he said that he was going to stick around.....Yes, Bailey was an important part of the Janus culture.....Yes, finding the right replacement will be essential in keeping the prima donna Janus managers in line.....Yes, there's been a history of ill-will between Janus fund managers and Stilwell Financial, the company that owns Janus.....Yes, according to a recent press release, everything is hunky-dory at Janus, and there won't be any further changes.....And no, you probably shouldn't believe it.


From the horse's mouth: Or, more accurately, from the 10-K report of Stilwell Financial Inc., which was filed with the SEC on March 20, 2002 (remember, Janus is owned by Stilwell):

"...a formal succession plan in the event of a departure from Janus by Mr. Bailey has not yet been fully developed. There can be no assurance that an adequate succession plan will be effected or that the loss of Mr. Bailey's services, or the services of senior portfolio managers, for any reason would not have an adverse effect on Janus and Stilwell. Furthermore, relations between Janus and Stilwell were strained primarily as a result of disagreements over the structure of the spin-off of Stilwell to KCSI's [Kansas City Southern Industries] common stockholders that was completed on July 12, 2000. Continuation of these strained relations could result in the loss of key Janus employees or other management personnel or impair the ability to attract new personnel."

And more:

"Relations between Stilwell and the management of Janus have been strained, primarily as the result of disagreements over the structure of the spin-off from KCSI. Prior to the spin-off, a number of minority stockholders and employees of Janus, including members of Janus' management, its chief executive officer, its former chief investment officer, five of the six directors of Janus and others proposed that KCSI consider a spin-off of Janus in addition to the spin-off of Stilwell. The KCSI board of directors ultimately rejected this proposal. Press reports have appeared in which certain Janus employees expressed objections to the Stilwell spin-off and other disagreements with the structure and direction. While Stilwell and Janus have attempted to resolve some of these disagreements, not all disagreements have been resolved. Continuation of these strained relations could result in the loss of key Janus employees and Janus management, which could have a material adverse effect on Stilwell. The portfolio managers and other key employees of Janus are not subject to any non-compete agreements that would preclude them from participating in a competing financial services business..."

Not necessarily unusual in the money management business:

	"I asked him about Janus' beginnings, and he...told me that he started the firm in a building full of whores."
--Tom Bailey, retiring Janus CEO, in an interview with Denver Post reporter Al Lewis; thanks to "Ted," Linkster of the FundAlarm Discussion Board, for pointing this out

The price/earnings (P/E) ratio of an individual stock can give you some idea about the riskiness of that stock, with higher P/E ratios generally indicating more volatile stocks*.....In a similar manner, it seems that the P/E ratio of a mutual fund should be able to give you some idea about the riskiness of that fund relative both to its benchmark and to other funds.....In reality, the P/E ratio of a mutual fund can hide as much information as it reveals, and if you rely on P/E ratios when you buy or sell funds you'll want to understand what's behind them.....To see what we mean, consider the following tables, which compare Liberty Acorn Twenty and Vanguard 500 Index:

Liberty Acorn Twenty A (LTFAX)* P/E ratio of fund = 29.1					Vanguard 500 Index (VFINX)* P/E ratio of fund = 29.9
Stock	Col. (b) P/E ratio of stock	Col. (c) % of fund assets	Contribution to P/E ratio of fund (Col. (b) x Col. (c))		Stock	Col. (b) P/E ratio of stock	Col. (c) % of fund assets	Contribution to P/E ratio of fund (Col. (b) x Col. (c))
H&R Block	23.76	7.85	1.87		General Electric	22.73	3.52	0.80
Synopsis	53.10	6.04	3.21		Microsoft	44.66	3.09	1.38
Liberty Media	NA	5.58	NA		ExxonMobil	22.18	2.84	0.63
Intl Game Tech	21.04	5.50	1.16		Wal-Mart Stores	36.31	2.59	0.94
Markel	NA	5.39	NA		Citigroup	14.54	2.41	0.35
First Health Grp	27.46	5.18	1.42		Pfizer	26.82	2.37	0.64
Assoc Banc-Corp	14.33	5.03	0.71		Intel	106.23	1.93	2.05
JD Edwards	NA	4.94	NA		Johnson & Johnson	31.79	1.89	0.60
Expeditors Intl of WA	33.39	4.85	1.62		Amer Intl Group	33.15	1.78	0.59
IMS Health	35.08	4.60	1.61		IBM	19.86	1.70	0.34
Total (top-ten stocks)			11.59		Total (top-ten stocks)			8.32
Percent of total P/E ratio			39.8%		Percent of total P/E ratio			27.8%

Based solely on the numbers, Liberty Acorn Twenty (with a P/E of 29.1) might seem slightly less risky than the Vanguard 500 Index fund, with a P/E of 29.9.....But when we dig a little deeper, it becomes clear that Liberty Acorn Twenty is a riskier fund.....Here's why:

• The P/E ratio tells us nothing about a fund's concentration, which can be an important contributor to volatility. Even though Acorn Twenty has a lower overall P/E than Vanguard 500 Index, the table (above) tells us that considerably more of Acorn's P/E is contributed by its top-ten holdings.
  
  
• P/E also tells us nothing about how many unprofitable stocks are in a fund's portfolio. That's because money-losing stocks have no earnings (the "E" in "P/E"), and stocks without a P/E are ignored when calculating a fund's overall P/E ratio (for example, in the Acorn portfolio, Liberty Media and JD Edwards are ignored). To the extent that unprofitable stocks make a fund more risky -- and they do -- the typical method of computing a fund's P/E ignores those unprofitable stocks entirely.

Is a fund's P/E ratio good for anything?.....If you're comparing funds within a given category (for example, large-cap growth to large-cap growth), P/E ratio might give you a pretty good indication of relative risk.....But for any other type of fund comparison, P/E is probably best ignored.
* All data, except P/E ratios, from Morningstar.com, as of June 16, 2002. P/E ratios are from Yahoo.com. The Price/Earnings ratio, or P/E, is calculated by dividing the price per share of stock by the earnings per share of stock (EPS). For example, a $40 stock with $5 of earnings per share has a P/E ratio of 8.0.


In 1980, the SEC first allowed mutual funds to charge 12(b)-1 fees, and it was potentially a win-win situation: Cash-strapped fund companies could temporarily pass their marketing expenses through to shareholders, fund assets would grow, and shareholders would be rewarded with lower expense ratios due to economies of scale.....Today, 12(b)-1 fees have become a grab-lose situation: Hugely profitable fund companies collect about $10 billion a year in 12(b)-1 fees,* investors receive virtually no tangible benefits for their money, and this money-sucking monster has become a permanent, growing fixture in the mutual fund industry.....At a recent meeting of the Investment Company Institute, the mutual fund trade association, SEC Chairman Harvey Pitt made some noises about investigating the uses and abuses of 12(b)-1 fees, but the chance for any meaningful reform in this area is virtually nil.....Simply put, most of the fund industry is propped up by 12(b)-1 fees.....Without these fees (for example) there wouldn't be any "B"-share load funds, and no-load fund companies wouldn't be able to cover the costs of selling their funds through mutual fund supermarkets like Schwab OneSource.....If 12(b)-1 fees are ever to be brought under control, pressure will probably have to come from the marketplace -- in other words, from individual fund investors.....And since few investors other than Vanguard shareholders seem to care about controlling fund expenses, we might as well learn to love throwing our money away on 12(b)-1 fees.....They're going to be here for a long, long time.
* "Funds reap trail-fee bonanza," Frederick P. Gabriel, Investment News, June 3, 2002


Dumb de dumb dumb: Mutuals.com, which has always presented itself as a serious investment firm, might be starting to show its true colors.....In the middle of last year, mutuals.com rolled out a series of "generation-wave" mutual funds, which would have been a really cool gimmick in 1999.....Unfortunately, last year wasn't 1999.....Now, mutuals.com is getting ready to roll out the Vice Fund, which automatically qualifies for entry in this year's Gimmick Fund Competition, and also becomes the first entrant in a new competition category, Most Offensive Mutual Fund Logo:



(In this age of terrorism and rampant gun violence, those crosshairs should be worth extra points).....The Vice Fund will be allowed to purchase stocks only if they "derive a significant portion of their revenues from products often considered socially irresponsible," such as alcohol, tobacco, gambling and defense/weapons.....In keeping with the socially irresponsible nature of the fund, we've learned that its managers will occasionally pile into a 6,000-pound Lincoln Navigator and, just for the heck of it, drive over a small imported car.


Gumption and fund directors: These words don't often appear together, so we're pleased to bring you the tale of mutual fund directors who actually defied a fund manager and made a tough, shareholder-friendly decision.....Here's the background, from the November 2001 issue of FundAlarm:

Ameristock Focused Value is just a small and ordinary fund right now, but manager Nicholas Gerber has big plans for it.....When the fund reaches between $30 and $60 million in assets (it's at $4 million right now), Gerber plans to convert it to a holding company, which would essentially mimic the structure of Warren Buffett's Berkshire Hathaway.....As a holding company, Focused Value would be able to establish much larger stock positions than a mutual fund, even to the point of owning (and operating) businesses outright.....Gerber reportedly views this mutual fund as a "smart and convenient" way of developing a holding company -- smart for him, maybe, but hardly convenient for those investors who don't share his grandiose plans.

Apparently unpersuaded by FundAlarm's skepticism, the directors of Ameristock Focused Value initially gave Gerber the OK to investigate the new fund structure, and Gerber started working on the fund's filings and proxy materials.....When Focused Value passed the $50 million mark last April, Gerber closed the fund to new money in anticipation of its conversion.....But just a month later, in May, the directors told Gerber that he couldn't proceed with his grand scheme.....The problem, it turns out, was that Gerber planned to resign as lead manager of the flagship Ameristock fund in order to free up time for the new fund.....The directors felt that this wasn't in the best interest of the Ameristock shareholders, and that's when they decided to nix the whole plan (why the directors didn't ask about Ameristock earlier, or figure out Gerber's intentions on their own, we don't know).....Gerber probably could have fought for his plan, but he decided not to, and the recent reopening of Focused Value probably signals the end of this saga.....Now the question is: Will Gerber get the Warren Buffett itch again and, if so, how will he attempt to scratch it?.....Ideas like this typically don't disappear overnight, and we're betting that Gerber is back with another version of his plan, quite soon.
"Fund board tables manager's plans--for investors' sake," Chuck Jaffe, sfgate.com, June 9, 2002


Gus Sauter, of Vanguard, probably manages more money in index funds than any other person in the U.S.....So when Sauter starts bad-mouthing the indexes that he tracks every day, it's a bit like Alan Greenspan railing against the evils of capitalism: It makes you pay attention......Sauter doesn't seem to have a problem with so-called "total market indexes," like the Wilshire 5000.....Instead, Sauter reserves most of his criticism for style- and capitalization-based indexes, such as "growth" or "small-cap".....Sauter contends that today's most popular indexes are essentially artificial worlds, and investors who attempt to track these indexes are demanding (or settling for) an artificial measure of performance.....According to Sauter, there's a better way to construct indexes.....Let's take a closer look at what he has to say:

• "An index must reflect the way that money managers actually invest": This is a fairly startling comment coming from Vanguard's index guru, but it's the heart of Sauter's argument: Value indexes, for example, should "incorporate the thought processes" of real-world value managers, who may occasionally own stocks that have some growth characteristics.
  
  
• Indexes should rely on objective, not subjective rules: In other words, a computer-driven, slice-and-dice approach (such as the Russell 2000) is preferable to the creation of indexes by committees of humans, which is how Standard & Poor's operates. But today's slice-and-dice indexes are still deficient, because they tend to create artificial boundaries, especially capitalization boundaries. Which brings us to Sauter's next suggestion.
  
  
• Define market capitalization as a band, not as a line in the sand: For example, the initial cutoff for the large-cap index might be the 700th-largest stock, with a band of 150 stocks above and below. A mid-cap stock would enter the large-cap index when it became the market's 549th-largest stock, and it would exit the large-cap index when it became the market's 851st largest stock.
  
  
• Determine style in two dimensions: According to Sauter, current style indexes are flat, and anything this isn't a growth stock must (by definition) be a value stock, and vice versa. Sauter proposes growth and value indexes that could have overlapping holdings, which reflects the fact that real-world growth and value managers often buy the same stock for different reasons.
  
  

Sauter's observations, above, appear in a publication called Journal of Indexes (online at journalofindexes.com), so you might think that he's merely engaged in some harmless, academic navel-gazing.....But coincidentally or not, the first "active indexes" have already hit the marketplace, and they are designed somewhat along the lines envisioned by Sauter.....Lipper, the fund research firm, has just introduced a line of "Holdings-Based Indices" that are "based on actual holdings of actual funds within a category," such as large-cap growth or small-cap value, and these indexes are adjusted monthly to reflect changes in the underlying fund portfolios.....In other words, as Sauter suggests, Lipper's new indexes are an attempt to reflect the way that actual managers think by tracking their real-world holdings.....Sauter's comments, and Lipper's new indexes, are interesting developments, and you'll probably be hearing more about this kind of active index in the months ahead.
Sauter's comments are from his article, "Index Rex: The Ideal Index Construction," journalofindexes.com, Second Quarter 2002


On the other hand: Gus Sauter is a smart guy, but all this stuff about designing better indexes may be missing the point that matters most to individual investors.....Indexing works as an investment strategy because it forces investors to own low-cost, diversified portfolios that are constructed with logic and long-term consistency.....It's still far better to own a fund based on a theoretically imperfect index, if the alternative is some haphazard stock or fund portfolio.


Jeffrey Provence runs a company called Premier Fund Solutions, which is designed to help brokers and financial planners start their own mutual funds.....Provence promises to guide would-be fund owners through all of the difficult first steps, including "Fund Startup," "Fund Administration," and "Fund Accounting"......You've probably never heard of Provence, but we've been following his career for several years.....When we first read about what he was trying to do, Provence seemed like exactly the wrong person to teach others how to run a mutual fund.....But the more we thought about, the more we realized that Provence brings a unique perspective to start-up mutual funds, and there's plenty that he should be able to teach a new fund owner.....For example:

• How to launch a gimmick fund: In January 1999, along with his dad, Provence started a golf-oriented mutual fund called Value Trend Links.
  
  
• What to do when your gimmick fund isn't working: In mid-2000, Provence changed the name of Value Trend Links to Value Trend Focus.
  
  
• What to do when a name change can't save your gimmick fund: In October 2001, Provence liquidated Value Trend Focus.
  
  
• How to launch a boring, me-too conventional fund: In January 1999, also with his dad, Provence started Value Trend Large Cap.
  
  
• What to do when investors don't care about your boring, me-too conventional fund: In October 2001, Provence liquidated Value Trend Large Cap.
  
  
• How to get caught up in an investment mania at the worst possible time: Again with his dad, Provence started the Wireless Fund in April 2000, just as tech stocks began their long, painful descent.
  
  
• How to pick one of the worst possible subadvisors for your new fund: Provence selected Malcolm Fobes as day-to-day manager of the Wireless Fund, and Fobes has proceeded to run up one of the worst records in the mutual fund industry (in case you're not familiar with Fobes, he also runs two disastrous funds of his own, Berkshire Technology and Berkshire Focus).

If you'd like Provence to advise your new fund, he can be contacted through his firm's Web site, www.pfsfunds.com.


Briefly noted:

• How would you feel about a company that charged an employee $65 every time that employee tried to do the right thing for a customer?.....Would "disgust," perhaps, be the appropriate word?.....Well, then, it may be time to direct a little disgust towards American Express Financial Advisors.....Currently, American Express imposes a "ticket charge" of $15 to $20 every time one of its financial advisors sells a mutual fund, and this ticket charge comes directly out of the broker's pocket (the only exception: American Express in-house funds incur no ticket charge).....Starting next month, AmEx plans to increase the ticket charge by $65, to a total of $85, every time one of its advisors sells a fund from the American Funds family.....Since the new $85 ticket charge would effectively wipe out an advisor's commission on small sales of American funds, and eat up a big chunk of that commission on larger sales, many advisors will probably stop recommending American funds to their clients, even if they believe those funds are otherwise the best way to go.....American funds are apparently being singled out because, unlike other families, American refuses to pay for a slot on the AmEx "preferred" fund list.....AmEx clearly hopes that its financial advisors will lose interest in the popular American funds family, and start diverting client money to the American Express in-house funds which -- surprise! -- continue to carry no ticket charge.
  "Fee Bitten: American Express Targets Outsider," Tom Lauricella, The Wall Street Journal, June 7, 2002
  
  
  
• Oh, and one more thing: Amex reportedly fines its financial advisors $1,000 every time they move a client out of AmEx funds and into the company's mutual fund wrap program, where the client's money might actually end up in a decent fund.
  "AmEx push poses adviser conflict," Jeff Benjamin, Investment News, June 17, 2002
  
  
  
• There's a perennial question in the mutual fund world (or, at least, there should be): Since Fidelity Magellan is so large, and the fund so consistently replicates its S&P 500 benchmark, why doesn't Fidelity stop pretending that Magellan is an actively-managed fund and just convert it to an index fund?.....The answer is: "Money, stupid".....For the fiscal year ended March 2002, Fidelity earned $556 million in management fees from Magellan.....As an index fund, it's been estimated that Magellan might bring in about $150 million.....The $400 million premium that Fidelity earns from Magellan, for essentially matching the market, has been called "the very epitome of nice work if you can get it."*
  * Michael Santoli, Barron's, May 27, 2002
  
  
  
• Lawrence Lasser, CEO of the Putnam funds, has recently been telling anyone who will listen about the reforms under way at his fund family: Cutting useless funds, adding a significant number of quantitative analysts, increasing the emphasis on staying true to investment style, introducing risk-management procedures that will keep funds from becoming overweighted in a single sector (such as technology), and changing the management compensation structure to emphasize long-term results*.....Ultimately, however, these reforms will fail unless investors regain confidence in Putnam funds and Putnam leadership.....Lasser is famous for his big annual bonuses ($17 million last year, $33 million the year before), so let's see him waive all of his future bonuses until the three-year performance of every Putnam growth fund lands in the top half of its respective peer group.....Now that's a commitment shareholders might believe.
  * "Putnam works feverishly to chase the clouds away," Charles Jaffe, boston.com, June 23, 2002
  
  
  
• A mutual fund "split" is always a cynical marketing move, but the recent split of fund shares at Bjurman, Barry Micro-Cap Growth also seems to include a healthy dose of hypocrisy and nonsense.....Here's the cynical part: By splitting the shares from $46.83 to $23.42, Bjurman only made Micro-Cap Growth seem cheaper, which confuses unsophisticated investors and helps create a phony marketing buzz......Here's the hypocritical part: The fund has closed several times before, and Bjurman previously announced that it plans to close the fund again when it reaches $400 million in assets (it's currently at $300 million).....Why, then, would Bjurman want to encourage a surge of new money by lowering the share price?.....Finally, the nonsense: Bjurman's only official explanation for the split is that it makes the fund more attractive to "smaller, long-term investors".....Since the minimum fund investment was $5,000 before the split, and it's still $5,000, where exactly is the break for "smaller" investors?.....While we're on the subject of nonsense, here's another question: How does lowering the share price of a fund help attract "long-term investors".....This is an area of academic research that we seem to have overlooked.....Perhaps Bjurman could post the relevant citations on its Web site.
  
  
  
• About 200 funds currently provide for performance-based management fees.....In-house fund accountants typically work with complex formulas to calculate those fees, and the in-house calculations are supposed to be verified by outside accountants during each fund's annual audit.....Are the accountants getting it right?.....Ordinarily, we'd think that was a silly question.....But with everything else that accountants are screwing up these days, it's certainly possible that the accountants are also screwing up performance fee calculations.....Well, good luck trying to find out.....With a little work, you could probably decipher most performance formulas (which are buried deep within the Statement of Additional Information), but then you would run up against a wall: There's no way to obtain the performance numbers that were used in the calculation, because the funds never disclose that information, and without the underlying performance numbers it's impossible to check the accountants' work.....But don't worry, you're not alone in your frustration.....Recently, a Vanguard spokesman was asked to recreate the performance fee calculation for one of his own funds, Vanguard Windsor.....He couldn't do it.
  "Performance Fees Become More Common, Murky," Eric Baum, institutionalinvestor. com, June 27, 2002
  
  
  
• "When you come to a fork in the road, take it".....Bill Miller, manager of Legg Mason Value, has probably come to many forks in the road during his long and successful career, but none has been as big, bad, and public as the Tyco Fork.....When Tyco was selling in the mid-$20 range, in the first quarter of this year, Legg Mason Value was buying, and Miller was defending Tyco in a shareholder letter.....As the stock crashed through $20, Miller could have taken another path, but he kept buying.....At about $10 per share, in early June, Miller publicly proclaimed that there was no stock he wouldn't sell to buy more Tyco, and he felt that Tyco had the potential to increase 200% or 300% in the next year.....To many people, Tyco seems to be retracing the Enron arc, and bankruptcy or massive restructuring seems inevitable.....To Miller, Tyco is one of the unique buying opportunities of a lifetime.....Chances are, Miller won't be partially right or partially wrong, and his decision at the Tyco Fork will either make him a full-fledged seer or a full-fledged laughingstock.....We'll keep you posted.....Many of you probably recognized the fork-in-the-road quote as a Yogi-ism.....While we're waiting for Bill Miller's Tyco drama to play out, you might want to chew on this other piece of wisdom from Mr. Berra: "If the world were perfect, it wouldn't be."
  
  
  
• USAA is getting out of the stock fund business.....Disappointed in the performance of its equity funds -- for good reason -- USAA has hired eight different subadvisors (outside managers) to handle the day-to-day stock picking.....In addition to the obligatory Wellington Capital Management, the new USAA stock fund managers include Dresdner RCM Global Investors, Marsico Capital Management, and MFS Investment Management.....Only USAA Precious Metals and Minerals (USAGX) and the "science" portion of USAA Science & Technology (USSCX) will remain in-house.
  
  
  
• James Cramer, the financial journalist, former hedge fund manager, and blowhard, is offering a new service that will allow investors to "look over his shoulder" as he makes stock trades.....An annual subscription, including Cramer's commentary, costs $400.....If you ask really nicely, you might be able to get a subscription without his commentary for a slightly higher fee.
  
  
  

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That's it for now.....See you August 1....In the meantime, visit the FundAlarm Discussion Board.

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FundAlarm © Roy Weitz, 2002