FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

(Originally posted August 1, 2003) [Archive Table of Contents]

Back in February, we reported on the formation of a task force that was supposed to deal with the breakpoint mess (for those of you who don't memorize every word of FundAlarm, securities regulators earlier this year found that almost all of the 43 brokerage firms they looked at had problems applying the proper breakpoint discounts [what's a breakpoint?].....Outright cheating wasn't a major issue, but brokers lacked systems to ensure that customers got all the breaks they were entitled to)......When dealing with an issue like breakpoints, it's easy to lose sight of the big picture, so let's get that in focus before we start: Breakpoints were created by the fund industry, and breakpoints are ultimately designed to help fund companies sell more product.....Breakpoints are a product feature, like the horsepower rating on a car, but there's one big difference between breakpoints and most other product features: Breakpoints are spelled out in a legal document (the fund's prospectus), and failure to provide a breakpoint is (or should be) a serious misrepresentation under federal securities law.....In mid-July, the breakpoint task force finally spoke, and the results were less than impressive.....Part of the problem may be that 25 of the 26 task force members came from the fund industry, and the only non-industry member was a college finance professor (they probably needed him to work the calculator).....In one key section of the its report, the task force acknowledges that the breakpoint mess could be solved, once and for all, by developing a national database for the holdings and transactions of every mutual fund investor.....But the task force immediately rejects this idea, primarily on the ground of cost:

"...developing the [breakpoint database] would be a time-consuming and costly effort. Task Force members representing broker/dealers and transfer agents projected annual costs of $10-$20 per account. Given that there are approximately 250 million mutual fund accounts, the costs associated with this [database] would be enormous. Likewise, there would be significant capital requirements in the ongoing operation of the [database]."

Note that the first instinct of these fund executives is to stick fund shareholders with the cost of a breakpoint database.....But wait a minute: Breakpoints were created by the fund industry, and fund companies use breakpoints to help sell their products, so shouldn't fund companies be required to spend their own money to fix a mess that they created?.....Of course they should, and the failure of the task force to face that issue makes the rest of the report just a bunch of half-measures.....If the SEC had the guts, it would zero in on this database recommendation, thank the task force for identifying the one, simple, all-encompassing solution to the breakpoint mess, and order the industry to dig into its own pockets to create the breakpoint database.....Of course, that won't happen.

Here's our favorite recommendation from the breakpoint task force (above):

"...a fund's prospectus [should] disclose that investors may need to provide their broker/dealer with the information necessary to take full advantage of breakpoint discounts...For example, the prospectus should inform investors that if they wish to count positions [in a retirement account] toward achieving a breakpoint discount, they should inform their broker about their retirement account holdings, and may need to provide an account statement to verify those holdings."

In other words, it's up to you to help your broker give you the discount that the fund company created, even though the fund company is legally obligated to deliver it.....Here's an idea: After you help your broker deliver your breakpoint discount, you can also run his commission check down to the bank.

The breakpoint task force, above, did make one (almost) good recommendation: The task force wants confirmation slips for mutual funds to reflect the "percentage sales load charged [for] each front-end load mutual fund purchase transaction" (the SEC hasn't required this information to appear on a confirm since 1979).....But notice how the task force carefully limits its recommendation to disclosing the "percentage" sales load.....Perhaps these industry titans are concerned that also disclosing the dollar amount of the sales load might give investors a bit too much information.

We think he might have PBHG confused with another firm:

	"I'm delighted to have the opportunity to work alongside some of the best investment minds in the business."
-- David Bullock, new CEO of the PBHG* funds*

A little more than two years ago, Abigail Johnson took over as head of investments at the Fidelity funds.....Since then, the performance of Fidelity's fund family has improved, especially in relation to other funds, but Fidelity offerings have fizzled in the marketplace: Through May of this year, none of the 20 best-selling funds has the Fidelity name in front of it, and Fidelity ranks only fourth in net fund sales*....It could be that Johnson is just snakebit, it could be (as she contends) that Fidelity needs to establish a better reputation among conservative, value-stock investors, or it could be that her problems are neatly summarized by the following two headlines:

The departing manager in question is David Glancy, who ran three top-performing Fido funds (Leveraged Company Stock, Advisor Leveraged Company Stock, and Capital & Income), and who bailed out of Fidelity to start his own hedge fund.....Glancy was Fido's hottest property and, one month after appearing on the cover of SmartMoney magazine (and days after his track record started appearing in Fidelity ads), Glancy's departure must have been a huge embarrassment.....Glancy is also one of about half a dozen important managers to leave Fidelity in the past 18 months.....Could Fidelity be faltering in the marketplace because investors (and their advisors) are finally getting tired of the managerial revolving door?.....That kind of connection is always difficult to make, but at some point (now?) it seems likely that Fidelity has to start paying a price for its highly-publicized inability to retain key employees.....Fidelity's mantra -- "We have a deep bench, we have a deep bench, we have a deep bench" -- can only work for so long, until investors and advisors figure out, "Hey, if I wanted a bench player, I would have invested with one in the first place".....We don't know how Johnson is going to solve this problem -- that's why she's worth several billion dollars, and we're not -- but solve it she must.
* "Fidelity's Sales Lag Performance," John Hechinger, The Wall Street Journal, July 15, 2003

Here's a quote from Suresh Bhirud, manager of Apex Mid-Cap Growth, whose fund is up 115% year-to-date, and down 86% for the preceding 10 years:

"I'm having a great year -- I haven't found enough words in the English language to describe it."
May we suggest "fluke"?

In last month's issue of FundAlarm, we reported on a mutual fund bill drafted by a House subcommittee under the leadership of Rep. Richard Baker (R-La).....During July, Baker's draft bill went through the mark-up, amendment, and God-knows-what-else process, and the bill that was finally submitted to the full House, on July 23, bore only a passing resemblance to Baker's draft.....The revised mutual fund bill still doesn't have a Senate sponsor, and it won't go anywhere without one, so we'll keep you posted as it starts working its way through the legislative process.....As we said last month, we doubt that the bill will ever become law.....We think the bill will be most useful as a framework for future SEC rulemaking.....One major addition to the revised bill: Fund companies would be required to disclose manager fund holdings, in addition to the structure of fund manager compensation.....One major deletion from the revised bill: Mutual funds would be required only to disclose their fees, in dollar amounts, on a hypothetical $1,000 investment, instead of the original requirement of a personalized fee statement.....One astonishing provision, which somehow made its way into the revised bill: Already overpaid and underworked mutual fund directors would no longer have to attend fund meetings in person if it was "impracticable" for them to do so.

For manager Mario Gabelli,
investment research never stops

You wouldn't necessarily know it, but fund managers are paid to think.....So what do they think about?.....One fund manager scrutinizes sales of frozen dinners, since he claims that increasing sales is a bearish indicator (i.e., fewer people eating out).....Another manager tracks sales data from Avery, a label-maker, since he figures that label sales is an early indicator of shipping volume and, indirectly, demand for goods.....Never one to be boxed-in by conventional thinking, fund manager Mario Gabelli recently looked at cat ownership and discovered that it's booming.....Gabelli followed this information to its logical end, and decided to scoop up shares of OilDry, a company that makes kitty litter.
"Predicting markets a wacky biz," Suzanne McGee, nypost.com, July 6, 2003

Briefly noted:

In March 2000, Alexander Cheung quit as manager of the Monument Internet fund (remember that concept?).....Cheung, who was the heart, soul, and brains of the fund, was replaced by a no-name manager, but that didn't stop Monument from putting a unique spin on Cheung's undistinguished replacement:

"Monument Funds Group Strengthens Top Team..."
For over three years, that comment has reigned as Most Laughable Fund Company Response to a Manager Change, but now its time to crown a new king.....In early July, star high-yield manager Sandy Rufenacht quit Janus to start his own firm, and a couple of weeks later Rufenacht's entire high-yield support team (two analysts and a trader) followed him out the door.....A Janus spokesman claimed that the departure of Rufenacht and his team was part of a "mutual agreement" and, anyhow, this devastating series of losses was really no big deal.....According to the Janus spokesman:

"We saw [these losses] as an opportunity to leverage our bench strength in building a new team"*
Oh, sure. We'll bet the Baath party in Iraq feels exactly the same way about its recent losses.
* Janus high-yield team members to join new firm," Martha Graybow, reuters.com, July 23, 2003
And before we let Sandy Rufenacht (above) slip away, who can forget these wonderful moments from the FundAlarm archives (August 2001):

Honest, boss. I was working: Sandy Rufenacht, manager of Janus High-Yield, "has been known to interview massage therapists about a casino's business while getting a back rub."

More Stupid Manager Tricks: Rufenacht tries to "gauge the economy and check savings rates" by digging through trash bins at automatic teller machines to check the balances on discarded receipts.
Lehman Brothers has entered into a deal to purchase Neuberger Berman, and all of the Neuberger Berman mutual funds should now be considered on Manager Turnover Watch.....Oh, sure, the head of NB funds says that nothing is going to change, and about 5% of the purchase price has been reserved for restricted stock (essentially a manager retention pool).....But we think Neuberger Berman fund managers, many of whom also run private money, are likely to look at the deal differently.....Lehman will be able to justify the rich purchase price only if it can significantly grow NB's business, and there are two main ways it can do that: (1) By interfering with NB's day-to-day operations, and (2) by aggressively cross-selling Lehman products to NB customers.....Either strategy is likely to antagonize NB managers.....Also, a large block of Neuberger stock was owned by the firm's managers, who will receive cash and Lehman Brothers stock if the deal goes through.....For these managers, there's no longer any big financial upside to remaining a Neuberger employee.....When the upside is gone, managers start thinking about retirement, or they start looking for greener pastures.
Mutual fund columnist Chuck Jaffe has started a new feature, "Stupid investment of the week," and it didn't take long for one of our old buddies, the IPS iFund, to make it into Jaffe's dubious pantheon.....As you may recall, iFund was put on a FundAlarm death watch almost immediately after it was launched, in early 2001, and pretty much all of the original nonsense is still going strong: Management by mob (i.e., about 40 shareholders), a 12-page shareholder agreement written in Gibberese, pseudo-scientific bloviations about "complexity theory" and beehives, and an expense ratio (1.4%) that rivals the expense ratio of any non-joke mutual fund.....But we were wrong about the death watch, at least so far, and manager Robert Loest is still gung-ho, having fun, and making plans for the future....Loest sees the iFund Web site as becoming more technologically advanced, with shareholder meetings held in virtual chatrooms, and avatars -- little computer-generated people -- transacting fund business on behalf of their real-world counterparts.....You know, it might be fun to invest in iFund after all, but only if we could have our pick of avatars:

"IFund offers populist management by the masses," Chuck Jaffe, cbs.marketwatch.com, July 25, 2003
Events That Changed Mutual Fund History #679: Ralph Wanger, the recently retired manager of Liberty Acorn, used to work for Harris Associates (which runs the Oakmark funds).....One day, a Harris analyst named Joe Mansueto told Wanger that he was quitting to start a mutual fund newsletter.....Wanger says, "I think now that if I had offered him $10,000 more," Mansueto would have stayed -- which means that Mansueto's brainchild, Morningstar, might never have gotten off the ground.....If Wanger has any regrets, he's not talking.....Mansueto's replacement was Leah Zell, who went on to become Wanger's wife, and manager of Acorn International.
"What comes after 'bacle'?," Warren Boroson, dailyrecord.com, July 20, 2003
Starting later this year, E*Trade plans to rebate half of the 12b-1 and "shareholder service agreement" fees that it collects from mutual funds.....(For example, XYZ Fund Company might pay E*Trade 0.40% for distribution of its funds and administration of its client accounts, and E*Trade would rebate half of that fee, or 0.20%, to shareholders who hold XYZ Funds through E*Trade. On a $100,000 account, the rebate would amount to $200).....Every few dollars helps, and this is certainly a good move for shareholders, but here's our question: How enormously profitable is this business, when E*Trade can give up half of its fund-related fees and, presumably, still make a profit on the remaining half?.....It looks like Schwab, and all the other mutual fund supermarkets, might be in for a little scrutiny, as well as some well-deserved pressure to provide similar rebates (recall that Schwab recently raised the fees that it charges funds to participate in a similar program).
"We deeply regret our bald-faced lie, but what else can you say when you've been exposed as a bald-faced liar?" Acting on a tip from a Morgan Stanley broker in Boston, authorities in New York and Massachusetts are investigating whether Morgan Stanley improperly pressured its brokers and branch managers to sell the firm's in-house mutual funds, and also failed to disclose that practice to its customers.....In a written filing with Massachusetts regulators on May 8, a Morgan Stanley attorney denied that the firm's employees received additional compensation for selling in-house funds over rival offerings.....A couple of weeks later, after a Wall Street Journal article contradicted the attorney's filing, Morgan Stanley started frantically backtracking on its earlier statement and, by early July, the firm's in-house compensation expert had admitted under oath that Morgan Stanley does, indeed, compensate brokers and managers for pushing its own offerings, and clients aren't told what's happening.....Morgan Stanley now says that "it deeply regrets the errors made in one of our communications to state investigators. We have endeavored to correct the information and rectify any misunderstanding".....Morgan Stanley's talk about "communications" and "misunderstanding" makes it sound like the company put the wrong date on a party invitation, not that it lied to regulators in an official filing pursuant to a state securities investigation.....But not to worry: Morgan Stanley wants investors to know that the firm now "[supports] enhanced disclosure in the fund industry."
Associated Press, July 14, 2003
Based on the fallout from the Morgan Stanley investigation (above), it has become clear that Morgan Stanley uses two different "grids" to pay its brokers for mutual fund sales, with the higher pay grid including both in-house Morgan Stanley funds, as well as funds from 14 other fund companies (these outside companies presumably compensate Morgan Stanley for being on its preferred pay grid).....USA Today and the Boston Herald have been able to piece together a partial list of Morgan Stanley's favored outside funds, which include: AIM, American Funds, Eaton Vance, Evergreen, Fidelity Advisors, PIMCO, and MFS.
Source: mutualfundwire.com
If you're an employer who sponsors a 401(k) plan, you may be disappointed that more employees don't participate.....And if you're an employee who's eligible to participate in a 401(k), but you just can't bring yourself to sign up, you may not even understand why you're unable to act.....Here's an interesting insight for both employer and employee: One reason for low 401(k) participation may be that employees are given too much choice when it comes to investment options (an average of 15 choices per 401(k) plan last year, versus 4.2 choices just ten years ago).....According to some recent academic research, participation rates peak at 75% when 401(k) participants are offered only two fund choices, while participation declines to 60% when participants are faced with as many as 60 options.....As an employer, you might want to consider trimming your fund menu, as a counterintuitive way of boosting worker enrollment.....As an employee with a lot of 401(k) choices, you might want to consult a financial planner for help.....But you know that already, and you still haven't done it, so here's another suggestion for the decision-challenged: Randomly select three or four funds, and split your 401(k) contribution among them.....Chances are, even with this appallingly unscientific method of fund selection, you'll still be better off than a non-participant, especially if your employer matches any part of your contribution.....Once you get off the dime, and become familiar with your choices, you can fine-tune your allocation.
"Why Even a Rally Won't Save You--Host of Deep Problems Raise Doubts About Role of 401(k)s...," Ruth Simon, The Wall Street Journal, May 1, 2003
As we've said before, principal-protected funds are a dumb idea, and one of the main reasons they're so dumb is that an insurance company, not your money manager, ultimately controls how your money is invested.....If you need proof, consider the most recent version of Pioneer Protected Principal Plus Fund, which in early June was sitting on $160 million in cash.....Even though the stock market was roaring ahead, Pioneer couldn't invest any of the fund's cash in stocks, because Pioneer's primary obligation was to protect the insurance company that had written the fund's principal protection guarantee (if Pioneer did invest in stocks, the amount left over to buy bonds wouldn't have been enough to meet the fund's guarantee of a 14% return in seven years, and the insurance company would have been on the hook for the difference).....It was only after Pioneer renegotiated its agreement with the insurance company, and Pioneer agreed to a potentially lower management fee, that Pioneer was allowed to invest 17.5% of the fund's assets in stocks.
"Shielded Mutual Funds Held Down in Updraft," Christopher Oster, The Wall Street Journal, July 18, 2003
They're also dumb because they're expensive: Managers of the ING principal protection funds are now authorized to invest the stock portion of their funds in stock index futures and exchange-traded traded funds, in lieu of investing in individual stock issues (this authorization only kicks in when the value of a fund's stock portfolio drops below $5 million)......In effect, small stock portfolios within ING principal-protected funds can now be run like index funds, with one big difference: ING plans to continue charging the full active-management fee, even if the underlying stock portfolio is a dead-ringer for an index fund.....And where were the funds' directors when this decision was made?.....They were right there -- in fact they made the decision, calling the new fee arrangement "fair."
" 'Protection' Funds: Peace of Mind Get Pricey," Tom Lauricella, The Wall Street Journal, July 28, 2003
Déjà Vilar: Alberto Vilar, ringleader of the Amerindo funds, has vaporized billions of dollars of investor wealth over the past three years, but Vilar still hasn't lost his taste for putting other people's money at risk.....Recently, about 35% of Amerindo Technology was invested in just three stocks: Yahoo!, eBay, and Amazon.com.....These stocks have become the new must-have troika of the current technology bubble, and Vilar is more than willing (again) to play along.....The good thing about these companies is that they do have some "E" to plug into their P/E (price/earnings) ratio.....The bad thing about these companies is that their ratios are unsupportable: Yahoo! has a forward P/E of 93, eBay has a 76, and Amazon is at 80.....Even worse, institutions own a huge percentage of these companies (69%, 79% and 88% of their publicly-traded shares, respectively), so you can expect market values to collapse at the first hint of bad news*.....Way to go, Alberto: You've learned nothing!
* "Twice-Shy Funds Still Smitten With 'Net's Big Three," Stephen Schurr, thestreet.com, July 14, 2003

Closing the loop, slamming the cell door: As we reported last November:

The Johnson family runs the Franklin Templeton funds, and one of the Johnsons has gotten himself into a huge legal mess.....Get out your Johnson scorecard: Charles E. Johnson, a director and co-president of the company, and son of CEO Charles B. Johnson, has been charged with felony domestic violence, and other related crimes, that could land him in jail for more than 10 years.....Charles E. has taken a leave of absence as a result of the charges (no word if the absence is with or without pay).....Charles E. had been responsible for spearheading Franklin's overseas operations, as well as its internal technology.....Those duties will be assumed by his fellow co-presidents, Martin Flanagan and brother Gregory Johnson.

On June 12, Charles E. pleaded no contest to one count of felony domestic violence, and Franklin fired him.....(The company still refuses to say whether Johnson was paid during his eight-month leave of absence, saying that it's a private matter, which will undoubtedly come as a surprise to Franklin's 25,000+ shareholders, including Roy).....On July 18, Johnson was sentenced to sixty days in the county jail, which is considerably less than the one-year sentence he could have received.

He's obviously made some good friends: Michael Price, best known for growing and then selling the Mutual Series funds, is reportedly offering "somewhere in the $10 million range" for a four-bedroom, six-bath, six-story townhouse on Manhattan's East Side.....The townhouse is reported to have "illegally high" 17 foot walls (10 feet is code), a card-key entry gate, and a ram-proof/bulletproof front door.....Inside, infrared detectors and cameras track all movements, and there's a panic room, without Jodie Foster, but with 12 security monitors, a refrigerator, food supplies, and "a door that could survive a major blast."
Source: mutualfundwire.com
American Century sponsors an annual celebrity golf tournament, and when you pay money for something like that, there's a strong corporate need to make the event seem like more than adolescent wish-fulfillment.....Therefore, in conjunction with the tournament, American Century also sponsored a survey of 400 Golf Digest subscribers, which tried to put investing concepts into golf terms.....Among the insights of the American Century survey:
- 63% of golfers state that they are "playing it safe with pars," while 35% say that they are "still shooting for birdies."
- Only 39% say they are "going for distance" in investing, while 57% are concentrating on "trying to perfect their short game."
- Forty-nine percent of golfers believe "it's not whether you win or lose, but how you play the game," while 47% feel "winning isn't everything, it's the only thing."
While the public portion of the American Century survey (above) is fascinating enough, the private portion of the survey is absolutely compelling.....Here's the part of the survey that American Century didn't want you to see:
- 87% of golfers who identified themselves as "market timers" said that they would only swing at certain times of the hour, based on what had worked for them in the past.
- Ninety-four percent of those who played golf with market timers (above) called them "annoying" or "very annoying."
- 91% of "Janus investors" overestimated their golfing skills.
- 87% of golfers who admitted to "chasing top-performing funds" also admitted to stealing the ball of someone who was playing better, and using it for their own game.
- 67% of "buy-and-hold investors" said that they "always" or "almost always" wore the same golf outfit. The vast majority of buy-and-hold investors (79%) "played with the same people they had been playing with since high school."
- 83% of "load-fund investors" felt that they "played better" when they overpaid their caddy, even when confronted with the total lack of evidence supporting their belief.
- (Interesting footnote: 51% of the overpaid caddies (see above) knew less about golf than the people who paid them.)
- 62% of "Vanguard investors" said that it wasn't worth playing at all, since golf scores tend to distribute evenly about each individual's mean, and scores could be assigned in advance by any properly programmed computer.
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