Highlights and Commentary

By Roy Weitz

(Originally posted July 1, 2003) [Archive Table of Contents]
Some months nothing happens, and some months a lot happens.....In that respect, the mutual fund industry is a lot like life.....June was a busy month for the fund industry, with some potentially important developments in Washington.....As you may recall, Richard Baker (R-La) heads a House subcommittee that's investigating the fund industry, specifically issues related to fund fees and competition.....At the end of March, after some brief public hearings, Baker wrote a cage-rattling letter to the SEC that posed 18 separate questions about the fund industry.....The SEC responded to Baker's letter on June 9, Baker introduced new mutual fund legislation on June 11, and the fund industry (through the Investment Company Institute) added its two-cents worth on June 18, during another round of Congressional hearings.....What does it all mean for fund shareholders, and where is it all going?.....If we really knew, we'd be selling subscriptions for $10,000 a year, and living on five acres in Malibu with a view of the ocean.....But here are some fairly educated comments and speculations:

• Since Baker introduced his bill just two days after the SEC response to his letter, we can assume that Baker: (a) writes legislation really fast, (b) didn't care what the SEC had to say, or, (c) knew all along what the SEC was going to say, because his staffers had been working with the SEC on its response. We're pretty sure the answer is "(c)," which means that Baker wrote his bill knowing that the SEC would basically be able to work with it.
  
  
• Sure enough, the SEC staff member who wrote the June 10 response to Baker's letter gave a glowing endorsement of Baker's bill at the June 18 House hearings.
  
  
• Baker hopes that the House will pass his mutual fund bill by the August recess, but Baker's counterpart in the Senate appears to have no interest in Baker's bill, or any other type of mutual fund legislation. In other words, it's doubtful that Baker's bill will become law any time soon, and maybe never.
  
  
• If anything does come of Baker's bill, it will probably be the result of unilateral SEC action. The SEC is likely to give the legislative process a little while to work (six months? a year?), but we think the SEC will eventually write new rules in those areas where it can.....Here are the four most likely SEC actions, in areas already staked out by Baker's bill:
  
  
  • More information about fund expenses. Baker's bill calls for a separate, personalized report of a fund shareholder's expenses, but the SEC is lukewarm to this idea, and the Investment Company Institute (ICI) is adamantly opposed. However, it seems as if everyone could support a requirement that funds disclose the dollar cost of a $10,000 investment, based on the fund's actual expenses, and we predict this will happen. For example, if your average account balance in XYZ Fund was $42,000 for the year, and the fund reported that shareholders paid $115 of expenses per $10,000 investment, you'd know that your share of expenses for the year was about $483 (that's 4.2 times $115). This is far less effective than a personalized statement, but it still could be a step forward if the disclosure is prominently featured in the year-end account statement, along with a standardized worksheet showing how to calculate an average account balance. Of course, the SEC could allow the disclosure to be buried in a fund report, or not require a worksheet, in which case the disclosure would become another useless bunch of words.
    
    
  • More information about manager compensation. Baker's bill calls for funds to disclose the "structure of, or method used to determine, the compensation of portfolio managers." Again, the SEC isn't thrilled with this idea, but it seems as if it's willing to go along, and (pinch us, we must be dreaming) the ICI also seems to support this type of disclosure, so it's probably not too far away from becoming a reality. This kind of disclosure could be a big step forward for fund investors, who will know for the first time if their manager's financial incentives are aligned with theirs. But if the SEC allows this disclosure to degenerate into boilerplate, or allows it to be buried in the Statement of Additional Information, then see above under "useless bunch of words."
    
    
  • More information about portfolio transaction costs: Ideally, fund investors would receive information about all transaction costs incurred by their fund, including stock commissions, market impact costs, and opportunity costs. But that doesn't look like it's going to happen any time soon. In its June 9 reply to Baker's letter, the SEC spent a lot of time whining about how haard it is to determine these costs (especially the latter two), and it seems highly unlikely that the SEC will require funds to come up with these numbers. However, the SEC did suggest that a fund's portfolio turnover ratio can be a good surrogate for total transaction costs, so expect the SEC to start pushing for better disclosure of turnover ratios.
    
    
  • More heat on soft-dollars: Baker's bill calls for more disclosure of soft-dollar deals [what's a soft-dollar deal?], more oversight of soft dollars by fund directors, and an SEC investigation of the whole "corrupt, stinking soft-dollar system" (those are our words, not Baker's). Interestingly, the SEC also seems to be fed up with soft dollars, and hints that it could be ready to "lance this infected boil" (those are our words, not the SEC's). Throw in some ICI criticism of the current soft-dollar system (pinch us again), and some significant soft-dollar changes seem almost inevitable. Our best guess: The SEC will require better documentation and disclosure of soft-dollar arrangements, and prohibit fund managers from purchasing common overhead items (like data feeds and subscriptions) with soft dollars.

There's more to Baker's bill but, as we said, a lot of it will probably remain as a wish list.....For those who are interested, there's a readable summary of the entire bill on Baker's House Committee Web site (Adobe Acrobat reader required).


Yes, folks, this comes from a Democrat: Rep. Paul Kanjorski (D-Pa) is the top Democrat on Rep. Baker's House committee, and Kanjorski is apparently feeling just a little bit left out of the action.....So, while Republican Baker drives deep into Democratic territory (consumer activism and shareholder rights), Kanjorski makes a stand for free enterprise and limited government:

"If we keep questioning the integrity of every financial market and company in this country, we may improve some. But one thing we will have a tremendous impact [on], we're going to drive people out of the trust and faith of the capitalistic system."

"Advisers oppose fund cost plan," Sara Hansard, Investment News, June 23, 2003
What's this? A Democrat preaching hands-off capitalism?.....Why, the next thing you know, the largest mutual fund company in the U.S. will take a strong pro-Republican position on a sharply divisive national issue.....Oh, wait, that's already happened.....


Whatever you might think about President Bush's tax cut plan, which is now law, you can be absolutely certain that someone else thinks exactly the opposite.....In fact, the Bush tax plan was an intensely political piece of lelgislation, and the proof of that (if needed) was the final, tie vote in the Senate.....Mutual fund companies seldom go near political issues, but Fidelity plunged right in, and Fidelity's Web site strongly supported the Bush tax plan:



Especially surprising was Fidelity's willingness to antagonize those customers who didn't approve of the tax plan -- and there were many of them -- as well as the firm's highly partisan links, which served up the straight Republican party line without a hint at the other side of the argument.....Well, it turns out that Fidelity's forays into the world of politics have only just begun.....FundAlarm has obtained a copy of what appears to be a new Fidelity advertisement and, given Fidelity's position on the tax-cut bill, the ad seems like the logical next step.....Still, we suspect that many Fido customers won't be happy:

Recently, Fidelity took a strong, public position in support of President Bush's economic stimulus plan. While some shareholders saw this as an inappropriate venture into partisan politics, and we respect their opinions, Fidelity will not hesitate to act in a leadership role when we believe it is in the best interests of our shareholders and the national economy. Therefore, Fidelity is pleased to announce the creation of a new mutual fund class that will be open only to registered Republicans. In the next few days, Fidelity shareholders will receive a letter from Fidelity Chairman Edward C. Johnson 3d, explaining how they can determine their eligibility for the new Republican ("Class R") fund shares and, if eligible, how they can convert their existing Fidelity shares into this new class. Class R shares will carry a number of important benefits, including an additional return of 5% per year, which Fidelity will take from all other shareholders of the same fund and reallocate to Class R shareholders. For more information about this feature, and the other income redistribution provisions of Class R shares, please refer to the forthcoming letter. For Your Convenience We have provided the following link, which will allow you to change your affiliation to the Republican party from whatever pathetic shell of a political organization you currently belong to, including the Democratic party. Sign me up now!

If you own a fund with a star manager, you might want to spend a little extra time deciding whether it belongs in a taxable or tax-deferred account (this assumes, of course, that you have a choice).....That's because star funds carry "manager risk".....To see what we mean, consider Fidelity Low-Priced Stock.....Manager Joel Tillinghast has performed wonders with this bloated small-cap fund, and it's safe to say that a large number of fund shareholders either bought this offering, or continue to hold it, solely because of Tillinghast's magic.....But Tillinghast is 44 years old, and he works for the company that invented the managerial revolving door.....At some point, Joltin' Joel won't be in charge of this fund -- that's the "manager risk" -- and we suspect that many shareholders will want to head for the exit when he does.....Shareholders who hold this fund in a tax-deferred account will be able to make their hold or sell decision solely on the merits, while long-term shareholders with taxable accounts might decide to stay solely to avoid their capital-gains tax liability, and that's not a position that any fund shareholder wants to be in.....There's no universal definition of a star manager, but here's our (necessarily incomplete) list of funds that have significant manager risk:

• Ameristock (all) (Nicholas Gerber)
• Ariel (all) (John Rogers)
• CGM (all) (Ken Heebner)
• Excelsior Value and Restructuring (David Williams)
• Invesco Leisure (Mark Greenberg)
• Legg Mason Value (Bill Miller)
• Marsico (all) (Tom Marsico)
• Oakmark I & II, Oakmark Select I & II (Bill Nygren)
• Smith Barney Aggressive Growth (Richard Freeman)
• Torray (Robert Torray)
• Vanguard Health Care (Edward Owens)
• Weitz (all) (Wally Weitz)
• Yacktman, Yacktman Focus (Don Yacktman)

Morningstar FundInvestor, May 2003


Several months ago, we pointed out how the poorly-written proxy materials of one fund company (Julius Baer) managed to make an overall decrease in fund fees seem like an increase.....This month, we have pretty much the opposite situation: A million-dollar increase in fees, for two Van Wagoner funds, that's hidden behind a shareholder-friendly proposal.....According to proxy materials that will be mailed in early July, Van Wagoner is asking for changes in the advisory agreement for two of its funds (Emerging Growth and Small-Cap Growth).....The ostensibly friendly change would convert the fixed management fee at both funds to a performance-based fee, while the pocket-picking proposal would eliminate Van Wagoner's obligation to reimburse certain fund expenses (currently, fund expenses are capped at 2.0%, and Van Wagoner makes up the difference).....Here are numbers from Van Wagoner's own proxy materials, comparing its actual income for 2002 to what income would have been had the proposed new advisory agreement been in effect:

Van Wagoner Emerging Growth (year ended 12/31/02)
	If proposed advisory agreement had been in effect	Under current advisory agreement
Van Wagoner management fee	$1,688,883	$2,111,081
Van Wagoner out-of-pocket reimbursement	$0	<$524,651>
Net to Van Wagoner	$1,688,883	$1,586,430

Van Wagoner Small-Cap Growth (year ended 12/31/02)
	If proposed advisory agreement had been in effect	Under current advisory agreement
Van Wagoner management fee	$564,470	$846,691
Van Wagoner out-of-pocket reimbursement	$0	<$418,333>
Net to Van Wagoner	$564,470	$428,358

Total, both funds (year ended 12/31/02)
	If proposed advisory agreement had been in effect	Under current advisory agreement
Van Wagoner management fee	$2,253,353	$2,957,772
Van Wagoner out-of-pocket reimbursement	$0	<$942,984>
Net to Van Wagoner	$2,253,353	$2,014,788
Benefit to Van Wagoner	$238,565

In other words, even though the proposed advisory agreement would have cut Van Wagoner's total management fee income by about $704,000 (because Van Wagoner failed to meet its performance target), Van Wagoner would have been relived of almost $943,000 in reimbursements, for a net increase in Van Wagoner's income of almost $239,000.....Going forward, if these Van Wagoner funds can merely maintain their miserable performance, the new agreement means that Van Wagoner's management company will be at least a quarter-million dollars richer every year, and fund shareholders will be poorer by a corresponding amount.....Basically, the only way investors will benefit from the new advisory agreement is if Van Wagoner is able to cut expenses, and it's interesting to note Van Wagoner's plans in that area:

"In an effort to reduce net Fund expenses the Adviser [Van Wagoner] may utilize directed brokerage. Directed brokerage involves the Adviser allocating portfolio transactions for the Fund to brokers who provide payments to various parties (other than the Adviser) who provide services to the Fund. Additionally, the Fund's expense ratio may decrease as the Fund's net assets increase."

Yeah, and "additionally" Roy may win the Nobel Prize in Mutual Funds.....What Van Wagoner is saying here is that it plans to make more use of soft-dollar arrangements, which is merely a way of moving costs out of a fund's expense ratio by overpaying commissions to stock brokers, and then accepting rebates of those commissions.....Either way, fund shareholders end up with lower account balances.


Excuse us while we puke: Here's a spokesman for the Van Wagoner funds, commenting on its proposed performance-based fee:

	""We've had three years of performance that has been less than desirable, and now we feel we want to align ourselves the best way we can with shareholder interests. "
"Van Wagoner says fund fees should reflect returns," James Paton, Reuters, June 11, 2003

Not a word, of course, about the expense increase.


As you may recall, Van Wagoner is being sued by shareholders for improperly valuing several private placement stocks in his funds, and the SEC continues to investigate the same issue.....The recent Van Wagoner proxy materials (above) briefly allude to these legal problems, in language that might make some shareholders gasp:

"The [Van Wagoner] Funds, two present directors, a past director and a non-director officer...are also named as defendants in [a class action lawsuit]. The cost of defense of this lawsuit may be significant. Substantially all such costs to date have been borne by the Adviser or have been covered by available insurance. In the future, costs may be incurred directly by the Funds [emphasis added by FundAlarm]."

There are 282 funds on this month's list of "Most Alarming 3-ALARM Funds" and, surprisingly, 15 of these funds are closed to new investors:

15 "Most Alarming 3-ALARM Funds" -- all closed
CGM Capital Development (LOMCX)
Credit Suisse Inst Small Cap Gr (WISCX)
Dreyfus Founders Balanced F (FRINX)
Dreyfus Founders Intl Equity F (FOIEX)
Dreyfus Founders Worldwide F (FWWGX)
INVESCO Balanced Inv (IMABX)
INVESCO European Inv (FEURX)
INVESCO Growth Inv (FLRFX)
INVESCO Telecom Inv (ISWCX)
Lord Abbett Developing Growth A (LAGWX)
Lord Abbett Developing Growth B (LADBX)
Lord Abbett Developing Growth C (LADCX)
Lord Abbett Developing Growth P (LADPX)
Lord Abbett Developing Growth Y (LADYX)
Scudder 21st Century Growth S (SCTGX)

Why would a dismal 3-ALARM fund, which is presumably losing assets, remain closed to new investors?.....It's possible that these funds were closed in better days, and the fund companies haven't gotten around to reopening them.....More likely, however, the fund companies have simply given up on these losers, and aren't willing to expend marketing (or other resources) to revive them.....If you own one of these funds, maybe it's time for you to give up, too.

An interesting side note: All four of the closed Invesco funds listed above are being merged out of existence (see the following item). At least in this case, Invesco has had the decency to make the abandonment official.



Well, not really, but they might consider it.....Invesco and its sister firm, AIM, have announced a major reorganization: 12 Invesco funds are being merged into AIM funds, two Invesco funds are being merged into other Invesco funds, and four AIM sector funds are being merged into related Invesco sector funds......In other words, if shareholders approve, a total of 14 Invesco funds will be eliminated.....The motivation is mainly to cut costs but also, as usual, it's also an opportunity to get rid of a some embarrassing losers.....Invesco Balanced and Invesco Growth are the largest loser funds to be merged out of existence (you can read all of the details in a press release) .....Back in May 2001, Invesco entered into a multi-year, $120-million commitment to rename Denver's Mile High Stadium, which is now called Invesco Field at Mile High.....Even though Invesco is clearly in trouble, and the firm faces the prospect of additional downsizing and job cuts, the stadium naming is not in jeopardy.....According to an Invesco spokesperson, who appears to be bursting with pride at his employer's misplaced priorities, "We're as emphatically involved in that as the day the ink was dry on the contract"*
* "Parent confirms merger of funds, layoffs, asset shifts," David Milstead, rockymountainnews.com, June 13, 2003


Briefly noted:

• 
  

  "There is no distinctly American criminal class, except mutual fund directors."

  
  With apologies to Mark Twain (he was referring to Congress), here are some facts and figures about directors at the UBS funds, all of which came to light during a recent lawsuit:
  
  
  • UBS management draws up the agenda for fund board meetings. Fund directors aren't solicited for input and, presumably, none of them never offer it.
    
    
  • The 12-member UBS board of directors oversees 41 funds at each quarterly meeting, and lunch is never served since no meeting ever lasts more than four hours. The 10 independent directors typically meet in "executive session" for 15 minutes per meeting.
    
    
  • In recent years, UBS directors typically spent 10 to 15 minutes of each meeting reviewing the 12b-1 plans for all 41 funds. That works out to an average of 22 seconds per fund, best case, or just under 15 seconds per fund if they're in a hurry.
    
    
  • Two top UBS execs can't recall any independent director ever inquiring about fund economies of scale, or voting against an advisory agreement or 12b-1 plan.
    
    
  • Each independent director receives a minimum fee of $90,000 per year -- that's $10,000 per meeting, plus a $50,000 retainer, and it comes right out if investors' pockets.
  
  "Funds and Games," Neil Weinberg, Forbes, May 26, 2003
  
  
  
• Morningstar has announced that it's dropping two mutual funds from its corporate 401(k) menu.....Morgan Stanley Institutional Mid Cap Growth is being canned because Arden Armstrong left as manager (Turner Midcap Growth replaces it).....Templeton Developing Markets got the axe because of high expenses, and American Funds New World takes its place..... Fifteen funds in the Morningstar 401(k) are holdovers from last year, as follows:
  

  Brandywine Fidelity Low-Priced Stock Gabelli Asset Harbor Capital Appreciation Morgan Stanley Instl US Real Estate Oakmark Select I PIMCO High Yield PIMCO Total Return Selected American T. Rowe Price Small-Cap Stock Tweedy, Browne Global Value Vanguard 500 Index Vanguard Calvert Social Index Vanguard International Growth. Vanguard LifeStrategy Growth

  
  
  
  
• Another tough month for the rich guy: Alberto Vilar runs the tech-oriented Amerindo funds and, as we noted a couple of months ago, he's also a generous arts and music philanthropist -- perhaps too generous.....Vilar's extravagant charitable gifts and pledges, made when the Nasdaq was at its peak, recently came back to bite him in Vail, Colorado, where banks started foreclosure proceedings on three of his four vacation homes.....Last month, Vilar's considerable ego took another hit, as the folks who run New York's Metropolitan Opera removed his name from the prestigious "grand tier" of donors.....Vilar appears to be overdue (we assume way overdue) on his $25 million in opera pledges.
  New York Daily News, June 16, 2003
  
  
  
• Thanks to "Ted," of the FundAlarm Discussion Board, for bringing the Vilar item to our attention.....And how does Linkster Ted find all of this stuff?.....Only the Linkster knows for sure, and he ain't telling.....But you can reap the benefits of Ted's linking labors almost every day.....As we've said before, if you make a habit of reading Ted's links, you won't need any other source for mutual fund news except, of course, for FundAlarm's Highlights & Commentary.....Nah, you won't even need that.
  
  
  
• There's more on the FundAlarm Discussion Board than just good links.....There is also -- dare we say it -- good discussion.....David Snowball is a Discussion Board regular, and a thoughtful observer of the mutual fund scene.....Here's an intriguing item that David posted in mid-June, in which he speculates that the Sequoia fund may be a bellwether for the stock market in general:
  
  

  "One might plausibly argue that the best actively managed stock fund in existence is Sequoia, which has been closed to new investors for a quarter century and whose performance makes its peers look silly. Long-term, it beats its peer and the S&P by 4% per year with a beta of 38 and a portfolio turnover under 10%. Its tendency is to buy strong companies (on average, the portfolio's earnings growth is three times greater than the S&P's) selling at a discount (of 30-50% off the S&P) and then hold on. Hmmm . . . fat pitch investing, if I recall the phrase correctly. Yet Sequoia is currently among the poorest LCV [large-cap value] performers, YTD. A mere 5% gain (bottom percentile). The last time Sequoia trailed its peers was another bottom 1% performance in '99. Its percentile rankings from '97 to the present are: top 1%, top 1%, bottom 1%, top 10%, top 2%, top 1%, bottom 1%. Somehow this feels like both a warning and a measure of the size of the (mini?)bubble currently affecting the market.

  
  Is David onto something here?.....Maybe, but Discussion Board regulars "Greg" and Bendie Heroņez offer some important insights of their own.....For the entire conversation, please see the accompanying page.
  
  
  
• H Team Capital is getting ready to launch the ABC Fund.....In keeping with the letter theme, we're predicting this fund will be DOA.....ABC Fund intends to invest in companies with weak corporate governance, and then the fund will act as a catalyst (i.e., pain in the ***) in order to straighten those companies out.....A similar fund was launched in March 2000 (with a much better name: Allied Owners Action), and it died from lack of interest shortly thereafter.....The problem with corporate governance funds will be familiar to students of the chicken and the egg conundrum: Funds like this can never really become effective until they have some weight (i.e., a large asset base), and they will never get any weight until they become effective (i.e., perform well).....This is a gimmick fund with good intentions, but still a gimmick fund.
  
  
  
• Duh: After less than a year of existence, Invesco wants to kill its Basic Value fund.....The fund managers have apparently had a revelation, about a year too late, that the fund has "very limited foreseeable appeal to investors."
  
  
  
• They feel your pain: Vanguard employees have seen their annual bonuses cut by five percent.....This is the first time since the bonus program began in 1984 that a Vanguard bonus is smaller than the previous year's -- we think.....Vanguard is theoretically owned by its fund shareholders, but Vanguard refuses to disclose the firm's compensation structure to shareholders, or anyone else.
  "Vanguard reduces workers' bonuses," Too Mason, philly.com, June 12, 2003
  
  
  
• "It's none of your ****** business how much money I gave": Crusty mutual fund manager Martin Whitman, of the Third Avenue funds, also has a charitable side.....Whitman recently gave enough money to transform Syracuse University's School of Management into the Martin J. Whitman School of Management, but nobody is saying exactly how much Whitman ponied up.....It appears to the in the $15 to $20 million range.
  Source: ascribe.org newswire
  
  
  

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