Highlights and Commentary
By Roy Weitz
(Originally posted July 1, 1999)
[Archive Table of Contents]


How are they doing? Just over a year ago, FundAlarm started a monthly listing of the Most Alarming 3-ALARM Funds.....This has become a popular feature, and we thought it would be interesting to take a look back at the list of most alarming 3-ALARM funds from July 1998.....That list contained 233 funds.....Of these, 57% can still be found on this month's most-alarming list.....24% of the funds have moved off the most-alarming list, but are still 3-ALARM.....Only 19% of the funds have made it off both lists, and are now out of 3-ALARM territory entirely.....The accompanying page lists each of the most-alarming funds from July 1998, and indicates its current status.....Some of the more familiar names still on the most-alarming list from a year ago include:
  • American Century Giftrust (TWGTX)
  • American Century Vista (TWCVX)
  • CGM Mutual (LOMMX)
  • Dreyfus (DREVX)
  • Ivy Growth A (IVYFX)
  • PBHG Growth (PBHGX)
  • Strong Discovery (STDIX)

Grab a six-pack and pull up a chair. A new episode is just about to begin: In April, we reported that The Internet Fund (WWWFX) would be sold to money management firm Lepercq, de Neuflize & Co....In late June, the deal fell through, and several days later fund manager Ryan Jacob announced that he was resigning to start his own firm.....Here's what we think really happened: Jacob has always had close ties with Lepercq (he ran the fund out of their offices, and his analyst was a Lepercq employee).....We believe that Jacob was the one pushing this deal -- perhaps because he wanted the fund run more professionally, perhaps because he saw a future for himself at Lepercq.....When the owners of The Internet Fund refused to sell, probably because the price they originally negotiated was too low, Jacob no longer needed them, and vice versa.....The Internet Fund will now be run by a team, including Steven Tuen, Peter Doyle, and two or three analysts (also new, since the previous analyst left with Jacob).....Tuen has never run a fund before.....He was previously director of research for The IPO Value Monitor, the same job that Ryan Jacob held before he became fund manager.....Peter Doyle has never run a fund before.....He is the 37-year old son of Margaret Doyle, the retired school superintendent who co-founded The Internet Fund.....Tuen's official title is "executive advisor" (just like "fund manager," but more pretentious).....Doyle is described as the fund's "senior investment advisor with a focus on risk management".....To help clarify his new role at the fund, Doyle recently posted a 350-word "essay" on the fund's Web site ("Risk and Its Perception by Human Beings").....Most of Doyle's essay is devoted to a discussion of probability, specifically the probability that at least two out of ten people at a party will share the same birth date.....For readers who don't have the slightest idea how this relates to investing in Internet stocks, Doyle offers the following explanation (errors in spelling and spacing appear in the original):

...the salient point is that in uncertaian situations (and what situation isn't), the chance of success as opposed to failure are not predicatable through common sense analyses. In Internet investing,uncertain situationsare the norm. The manner in which one manages uncertainty, a process called risk control, can be practiced within a portfolio unnoticed by fund participants. Risk controlis of paramount importance and will be stressed in the coming months. This essay is merely offered to our investors as a means of introducing the nature of this important subject.

Doyle's future essay topics reportedly include "What is a Stock?", "Slim Jim as an Internet Play," and "Why Running Your Own Mutual Fund Is Way More Cool Than Winning the Lottery."

Update: On June 30, the company that runs The Internet Fund hired two former executives of Chase Manhattan. Both have mutual fund experience. One will be the company's new president and CEO, the other will become chief operating officer. To meet a need that is even more urgent, The Internet Fund has also hired a public relations firm to handle communications.


Taking AIM: After paying for college, plastic surgery, and relaxed-fit Dockers, aging baby boomers now have another place to send their money: the AIM Dent Demographic Trends Fund.....Dent, of course, is Harry Dent, who predicts that spending by aging BB's will drive the Dow to 40,000 by the end of the next decade.....Dent will be the fund's big-picture guy (technically, subadvisor), providing deep insights as needed..... AIM, not previously known for pandering, will be the fund's main advisor and marketer.


FundAlarm's panel of Aging Baby Boomers comments on the AIM Dent Demographic Trends Fund:

"I support the goals of Baby Boomers everywhere, and I'm working hard to earn their trust and respect.""I've allways been a strong suporter of U.S. Savings Bonds. If we don't buy them, the Chineese won't, either.""I've seen fire, I've seen rain, I've seen mutual funds that I'd never buy again.""As publisher of FundAlarm, I've been warning you about gimmick funds for three years...
continued below...

[Roy's comments continued]...As gimmick funds go, AIM Dent Demographic Trends Fund isn't the worst. It is simply unnecessary. The managers of this fund acknowledge that Harry Dent won't be picking any stocks, and Dent's basic insights (whatever you think about them) aren't likely to change much over the next few months, or even the next few years. In other words, any fund manager could read Dent's books and pretty much know what he has to say. Without the Dent gimmick, this is basically a fund that is trying to buy stocks that will perform well. By my count, that makes it identical to 5,000 other stock funds. If you already own a diversified portfolio of mutual funds, all of the good stocks that end up in the AIM Dent Demographic Trends Fund should also end up in your funds. On the other hand, the new AIM Fund is likely to miss out on many good stocks because of its narrow focus. One final comment: The lead manager of AIM Dent Demographic is Lanny Sachnowitz. He has a mediocre record as manager of AIM Charter, and there's no reason to believe he will do any better with this new fund."


Buddy, can you spare 10,000 shares of Microsoft? As a shareholder in a mutual fund, you own a pro-rata piece of each stock, as well as a pro-rata piece of each loan.....Did we say "loan"?.....Yes, indeed: Many mutual funds lend their securities, and in most cases the borrower is someone who wishes to sell the stock short short.....It's all perfectly legal, and it's all fully disclosed in the fund prospectus.....Still, many investors aren't aware of this practice, and they're surprised when they hear about it.

For example, here's how securities lending is described in the current prospectus for T. Rowe Price Science and Technology Fund:
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers, other institutions, or other persons to earn additional income. The principal risk is the potential insolvency of the broker-dealer or other borrower. In this event, the fund could experience delays in recovering its securities and possible capital losses.
Fundamental policy: The value of loaned securities may not exceed 33.3% of total fund assets.

This is a fairly standard description.....When markets are working normally, securities lending isn't something that investors (other than the ultra-cautious) need to worry about.....In fact, it should generate slightly higher returns, as promised.....But one ugly day, in the near or distant future, borrowers will default on securities loans.....And that's when investors who don't read FundAlarm will first learn about this widespread practice.


The Old Way
The Kobrick Way
1. Successful manager leaves large mutual fund company to start his own funds. 1. Successful manager (Fred Kobrick) leaves large mutual fund company (State Street Research) to start his own funds (Kobrick Capital, Kobrick Growth, and Kobrick Emerging Growth).
2. Investors follow manager to new company, hoping that smaller asset base and manager's personal stake will translate into better returns. 2. Investors follow manager to new company, hoping that smaller asset base and manager's personal stake will translate into better returns.
3. Fund assets grow slowly but steadily. The manager could make more money elsewhere, but he enjoys running a small, quality firm. The manager is also grateful to his investors, and feels he owes them some loyalty. 3. After just 18 months, manager sells his fund company to Nvest (June 1999). Manager tells Dow Jones Newswires that he now intends to "maximize" his growth opportunities. Investors face prospect of bloated funds, and little or no attention from their star manager. Many investors feel cheated. Manager set for life.


Who's Nvest? Nvest is seeking to buy the Kobrick funds (above).....Nvest is one of those companies that nobody seems to have heard of, yet it already owns six mutual fund families: Oakmark, Reich & Tang, New England, Loomis Sayles, Jurika & Voyles, and CGM.


Did he clean house or trash it? In late January, Stephen Silverman took over as manager of Merrill Lynch Growth, and he proceeded to sell almost all of that fund's substantial energy holdings.....Days after Silverman finished selling these stocks at bargain-basement prices, the energy sector began a strong rebound.....Silverman now looks like a sure finalist for this year's Granville/Garzarelli Market Timing Award.....If Silverman had merely gone on an extended vacation, Merrill Lynch Growth would be up about 20% for the year.....Instead, it's down by about 4%.

Some observers contend that Silverman did exactly what he should have, by shaking up a tired and underperforming fund.....Others wonder why he was in such a hurry.....Investors had suffered with this fund for years, and Silverman had a good reputation among Merrill Lynch executives, so he probably could have taken his time.....Style purists say that Silverman was right to sell off value stocks, since the fund needed to gain some consistency and credibility as a "growth" fund.....Pragmatists say that he should have at least tried to sell his energy stocks into a rally, instead of dumping millions of shares all at once.

Merrill Lynch Growth has been a high-profile embarrassment for the company, and this is a high-profile assignment for Silverman.....With so much riding on one fund, it still astounds us that Silverman could be so utterly wrong.....Silverman's screw-up reminds us, once again, that blind luck plays a huge role in short-term investing.....When it comes to the short term, it's safe to assume that nobody knows what they are talking about.....If you read someone's prediction that a certain stock sector will remain "strong through the end of the year," you might as well ignore it.....Ditto for predictions that a certain sector or asset class is about to come into favor.....Even a broken watch tells the correct time twice a day.....If that thought gives you comfort, you might want to heed short-term prognostications and pursue short-term trading strategies.....Otherwise, the old, boring approach still makes sense: Own a well-diversified portfolio of funds, and hold them for a reasonable period of time.


Kudos to FundAlarm reader Andrew Yeckel: In April, we published a lengthy letter from Yeckel, who is a long-time shareholder of Merrill Lynch Growth.....In retrospect, it turns out that Yeckel was one of the first to figure out what was going on with this fund --before FundAlarm (for sure), and before many professional fund-watchers.....This isn't surprising.....A serious individual investor with a personal stake in a fund almost always has an advantage over gurus who are trying to follow dozens (or even hundreds) of funds.....If a fund you own seems to be acting strangely, trust your instincts and investigate further.....There's a good chance that you're right.


No octopi were harmed in the making of this investment strategy:

"We have planted very deep tentacles in Europe."
-- Rob Friedman, Head Cipher at the Mutual Series funds


Ask Dick
(Wherein we imagine Dick Strong, of the Strong Funds, giving advice on proper business conduct):

As if

Dear Dick:
Like you, I own a mutual fund company. Yesterday, I called a special planning meeting of my company's top executives and fund managers. Some of them are asking for an ownership stake in my company, because they feel it will improve their motivation and performance. There's another meeting scheduled for today, and I'm supposed to attend. What should I do?
Signed: Mine, all mine
Dear Mine:
This is quite a coincidence. As The Wall Street Journal recently reported,* I faced exactly the same situation a couple of years ago at the Strong Funds. Here's the way I handled it, and I suggest you do the same: Barge into the meeting and scream "You greedy bastards." Shout some additional obscenities, and throw your chair and a suitcase against the wall. Then burst into tears.
Dear Dick:
A British insurance company wants to buy my funds for a billion dollars. Between you and me, that's a lot more than they're worth. Still, I don't feel right about the deal. I've got a pretty big ego, and without my company I'm afraid that I'll just be another rich guy with nobody to boss around. What should I do?
Signed: Can't Pull the Trigger
Dear Trigger:
Another amazing coincidence. As The Wall Street Journal also reported,* I faced exactly the same situation a couple of years ago at the Strong Funds. Here's the way I handled it, and I suggest you do the same: Attend the next big meeting with the buyers, and start off by telling them, "We make the crap, we sell the crap." A few days later, call the deal off. Spend the next two years whining about the future of your company, and devising business strategies that won't work.
* Source: Strong Funds' Woes Highlight Problems Facing Midsize Firms, Pui-Wing Tam, The Wall Street Journal, June 16, 1999


Amount that mutual fund investors will pay in 12b-1 fees during 1999:

$12 billion

How long the Securities and Exchange Commission could operate on $12 billion:

33 years

What investors actually get for their 12b-1 fees:



Harry would be proud: FundAlarm receives a lot of e-mail about American Century Giftrust, and the fund is a frequent topic of discussion (and anguish) on the FundAlarm Bulletin Board.....For example, consider this Bulletin Board posting about Giftrust, which appeared on June 1:
Rated as a three alarm by fundalarm! I bought for my grandchildren three years ago, has turned in a minus performance. Anyone with similiar experience. Anyone know how to get out of this "non revocable" fund? Thanks
One of the responses to this posting was blunt, but it also contained a good piece of information that readers may have overlooked:
I have been stung by these incompetent fools also. They will tell you that if you and your lawyer want to go to Kansas City and contest the trust you may have some success.....
According to a recent article in Barron's,* prospects for Giftrust relief are actually quite good.....Here's how: A lawyer admitted to practice in Missouri (home of American Century) must petition the appropriate court to dissolve the trust that holds the Giftrust shares.....The grantor, beneficiaries (and, presumably, the trustee) must consent to the dissolution.....Once the court approves, an order must be served on American Century, and the dissolving party must agree to indemnify the trustee against any future liability arising from the termination.....A California investor says that she recently dissolved a Giftrust account for her grandsons in a few days, and the total cost was $1,750.....That might seem like a lot of money for a $10,000 account, but it represents a 5% hit, or less, for accounts above $35,000.....Giftrust investors with relatively small accounts might be able to get together over the Internet and pool their "cases" (feel free to use the FundAlarm Bulletin Board to make your initial contacts).....This group of investors might then be able to approach a qualified attorney, and receive discounted individual rates for the services described above.....No guarantees from FundAlarm.....But if you feel strongly about Giftrust (and we know that many readers do), it might be worth a try.
*"Breakout!", Sandra Ward, June 21, 1999


Briefly noted:
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FundAlarm © Roy Weitz, 1999