Highlights and Commentary
By Roy Weitz
(Originally posted July 1, 2004)
[Archive Table of Contents]

When all signs point to the manager: If you own a 3-ALARM fund, do you also own a 3-ALARM manager?.....It depends.....To understand the difference, consider two hypothetical funds.....ABC Fund is 3-ALARM, but its manager has been on the job for only one year.....XYZ Fund is also 3-ALARM, but it's run by a manager with a six-year tenure.....Since a 3-ALARM rating requires at least five years of underperformance, the one-year manager of ABC fund is responsible, at most, for one-fifth of ABC's poor performance (and, hope always springing eternal, there's at least a chance that a new manager will turn things around)......On the other hand, the six-year manager of XYZ bears full responsibility for that fund's 3-ALARM rating.....The accompanying page lists all 3-ALARM funds in this month's database where the current manager has been in charge for at least five years.....With these funds, it's fair to say that you own a 3-ALARM manager.....And, unless you know something we don't, do you have any reason to believe that performance over the next five years will be significantly better?


Craven capitulation?.....Pathetic pusillanimity?.....Spineless submission?.....Yes, it's all of this and more: Marsh & McLennan, the parent company of Putnam, has let Lawrence Lasser walk away with a severance package worth $78 million.....As you may recall, Lasser was CEO of Putnam at the time several Putnam managers were market-timing their own funds, and there's at least a case to be made that Lasser was aware of his managers' misdeeds and did nothing about them.....But instead of trying to make that case in court, Marsh & McLennan caved in to Lasser in a private arbitration, and the company has even agreed to cover all of Lasser's future legal costs related to his (in)activities at Putnam.....Some of Lasser's settlement may have been vested compensation, some may have been severance, some may have been a reward for being the most overrated mutual fund executive of the 1990s, but who cares?.....By refusing to stand up to Lasser in public and at least making him sweat for his money, by refusing to send a message that executive misdeeds will have serious consequences in the mutual fund industry, Marsh & McLennan and Putnam have shown that their recent reforms are still merely cosmetic.


For over a year, we've been accumulating material on targeted retirement funds, and for over a year we haven't been able to decide what we think about these things......TIAA-CREF recently joined the targeted-funds bandwagon, and our file folder is getting too fat, so this month we're going to come to some kind of conclusion about targeted retirement funds.....Maybe.



The FundAlarm Review of Books

Title:Worry-Free Investing
Author:Zvi Bodie and Michael J. Clowes
Publisher:Prentice Hall
Price:$16.97 (at Amazon.com)
If you've read the review below and still insist on buying this book, you can get it
from Amazon.com by clicking on the following link: Worry-free Investing. FundAlarm will
receive 15% of the purchase price if you use this link, instead of our usual 5%.


The official subtitle of Worry-Free Investing is "A safe approach to achieving your lifetime financial goals." A more descriptive subtitle might be "A magazine article that got padded to 230 pages." Bodie presents one big idea in this book, but it hardly justifies the death of so many trees. Here's the idea, which is also the title of Chapter 6:

Stocks are risky, even in the long run

Many of us are familiar with charts that show the long, inexorable rise of common stock indexes. Many of us are also familiar with studies that show the risk of losing money in the stock market declines as the holding period increases, and a diversified portfolio held for 20 or 30 years will almost always be worth more than what you started with. Bodie doesn't dispute this conventional wisdom, but he does take a magnifying glass to these charts, and insists that we look at these studies year by year. In any given year, Bodie says, the risk of losing money in stocks is still significant and, like a run of bad luck rolling dice, several down years in the stock market can unexpectedly follow one another. If these down years occur just before, or in the early years, of retirement, the financial results can be devastating.

Bodie's remedy for stock market risk is to relegate stocks to a small portion of each person's retirement portfolio, and to make inflation-protected U.S. government securities (I-Bonds and TIPS) the centerpiece of retirement planning. There are problems with this approach: Few retirement plans offer an inflation-protected investment option, and yields on inflation-protected securities are currently low (about 1% to 2%). When you plug these expected investment returns into the formulas that Bodie provides, you're likely to find that your annual retirement savings target is an unrealistic 20% to 30% of your salary, or more. Bodie allows readers to reduce these eye-popping savings targets by the amount of their projected Social Security benefits, but we suspect that many readers will be more worried about the long-term health of the Social Security system than the stock market. If Bodie is wrong, and Social Security fails to deliver fully on its promises, you'll have exactly the same kind of retirement shortfall as if that oh-so-scary stock market had crashed on you. A much more useful book would recognize the importance of stock funds in retirement planning, and explore strategies for reducing stock market exposure as retirement approaches. This is not that book.

Bodie makes one other good point, which is often forgotten in retirement planning: Your paid-off home can be a good source of retirement income, either through a reverse mortgage or a sale plan that allows you to continue living in your home until you depart the scene (i.e., die). Overall, however, Bodie's book is poorly organized, and shamelessly padded with useless information or dubious recommendations (for example, he suggests that you ask to see a financial advisor's "RIA credentials" which, the last time we checked, consist of a filled-in government form and a cancelled check). Even if you're intrigued by Bodie's core idea -- that inflation-protected securities make for "worry-free" investing -- we doubt that you'll be able to apply his book to your real-life situation. We also doubt that many financial planners will help you implement Bodie's advice, except for Bodie himself.


FundAlarm's rating of Worry-Free Investing,
by Zvi Bodie and Michael Clowes(five stars is best)

For fund investors in general

For readers who have been waiting for the opportunity to tell their spouse "See, I told you we shouldn't be investing in stock funds"

For readers who like one interesting idea, beaten to death


A couple of years ago, we ran an item about the "individual 401(k) plan," which was a new and relatively obscure retirement-planning tool......The "Indy-K" plan is somewhat less new today, but it's still quite obscure, and such plans only hold a few billion in assets overall*.....But there's a new, big player in the Indy-K field, which could make such plans considerably more attractive for many more people.

For the right person, the benefits of an individual 401(k) plan can be substantial.....Basically, an individual 401(k) plan is designed for the sole business owner and spouse who operate through any kind of business structure (corporation, sole proprietorship, or partnership).....Administrative requirements are minimal, contribution rules are flexible, and contribution limits are considerably higher than other low-hassle retirement plans (such as the SEP and SIMPLE) currently available to owner-run businesses.....The advantages of an individual 401(k) can be especially dramatic for relatively low-grossing, sideline, or part-time businesses -- for example, if you earn $20,000 from your business, you can contribute up to $16,000 to an individual 401(k) (up to $18,000 if you are age 50 or older).....You can establish an Indy-K plan through several fund companies (including AIM, Evergreen, Pioneer, Putnam, John Hancock, and Scudder) but, as far as we know, all of these companies require that you invest your 401(k) in their load funds (or in a limited number of outside funds) bought through a "financial adviser".....Fidelity has also moved into this area, and Fido is the big player we alluded to above.....With a Fido Indy-K, you can access the firm's entire no-load mutual fund supermarket, including thousands of non-Fidelity funds, and you can do it all yourself.....If you want to learn more about the individual 401(k), the Fidelity Web site has some good information (http://personal.fidelity.com/products/retirement/getstart/newacc/keogh.shtml#whocan).
* "Assets in Individual 401(k) Plans Grow Despite Detractors," Laurie Kulikowski, financial-planning.com, June 16, 2004


It looks like Congress isn't going to take any action on mutual fund reform, and one of the reasons may be that our Senators and Representatives simply don't feel our pain.....Elected officials, like other U.S. government employees, participate in the federal Thrift Savings Plan (TSP), which is a dream of a low-cost, index-based retirement plan.....Last year, for example, the TSP's large-cap index fund had an expense ratio of only seven basis points (i.e., seven-hundredths of one percent), which is lower even than all but one large-cap index fund from Vanguard (Institutional Index, at five basis points, but that fund has a $10 million minimum).....TSP funds are represented by an aggressively independent board, which is prohibited by law from having any conflicts of interest.....The TSP board also puts management contracts out for competitive bid, which is one reason they are able to out-Vanguard Vanguard.....According to Sen. Peter Fitzgerald, who's put forward a terrific (and dead-in-the-water) mutual fund reform bill: "[Congress] has created one mutual fund world for ourselves that is great and fair and we've created another for the rest of America that stinks".....In other words:

WGOSWSWCAY?
(We've got ours, so why should we care about you?)


Source: "A Great Fund (For Them, Not You)," Gretchen Morgenson, The New York Times, May 23, 2004


Public companies are subject to pressures that don't affect privately-held companies.....Public companies also have their own, unique opportunities for ethical compromise, and some of these opportunities will undoubtedly confront fund-rating firm Morningstar, which has filed to go public later this year.....Among the potential conflicts of interest facing Morningstar:

Source: "Mutual Assured Destruction," Daniel Gross, slate.msn.com, June 17, 2004


And this just in: From our mostly-unreliable sources, here's a new communication that allegedly comes from Fidelity's head honcho, Edward C. Johnson 3d:


An Open Letter on Lost Causes

I would like to update you on my pursuit of lost causes, and inform you of my future plans in this area.

As many of you are aware, in 2003 I took the lead in opposing efforts by the Securities and Exchange Commission (SEC) to require mutual funds to disclose their proxy votes. This year, I took the lead in opposing efforts by the SEC to require each mutual fund to have an independent chairman. I lost the proxy-disclosure fight, and last month I lost my other fight, when the SEC voted to require independent chairs for mutual funds. These battles are now over, and there is nothing I can do to prevent these progressive measures from taking effect. However, there will be other progressive proposals for the mutual fund industry, and I will continue to seek out proposals that I can unsuccessfully oppose.

From Harold Stassen's presidential ambitions to Ben Affleck's acting career, America has a rich tradition of individuals who have been committed to lost causes. I'm proud to uphold this tradition in the mutual fund industry, and I look forward to many more years of futile opposition to progressive fund-reform measures.

Sincerely,

Edward C. Johnson 3d


Briefly noted:
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