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

N.Y. Times Reporter Uncovers Earth's Lowest Life Form



This is an old story, which has never gained much traction, but a recent series of articles in the New York Times might finally make a difference: There are people in this country who make a ton of money selling garbage financial products to the men and women in America's armed forces.....Even worse, these lower-than-bacteria salespeople (1) have been granted official access to our military personnel, (2) the military brass doesn't have the tools (or the will) to rein them in, and (3) key members of Congress have been bought and paid for by the companies that sell these products.....The articles in the Times focus mostly on sales of unnecessary and expensive life insurance, but at least one company mentioned in the articles -- First Command -- also sells outrageously expensive mutual funds to the military.....As we've noted before in FundAlarm (September 2003), First Command is probably this country's biggest purveyor of mutual funds with 50% front-end loads, also called "systematic" or "contractual" plan funds.....And while First Command probably has one of the cleanest legal and disciplinary records of any company working this niche market, that doesn't mean it occupies the moral high ground.....For example, one of the Times articles profiled a First Command "financial plan" that called for a single Coast Guard officer to take his $600 monthly raise (which is a lot of money on a $3,300 salary) and allocate it as follows:

  • $300 a month into a contractual mutual fund plan;
  • $150 a month into a money market fund at First Command's online bank;
  • $143 a month to buy $250,000 of life insurance, which duplicates the $250,000 of military coverage he's already buying for $16.25 a month.

The article doesn't say if this officer was advised about no-load alternatives to the contractual plans (almost certainly not), if he was advised about inexpensive investment options available through the Coast Guard's own retirement plan (ditto), or if a young, single officer even needs $250,000 of expensive life insurance on top of his military coverage (we doubt it).....But the article does say that this officer has $51,000 of personal debt, including $16,000 of credit card debt at interest rates of up to 25 percent, which First Command didn't deal with at all in its "financial plan" (Hint: Pay off expensive debt first).....Ultimately, First Command is troubling because it operates under a false (or at least untested) assumption: That military personnel need systematic plans to impose investment discipline.....But aren't our service men and women some of the most disciplined people in the world?.....Shouldn't the military brass at least try to expose our service people to professionals who can advocate less expensive investment options with the same zeal as commissioned salespeople?.....As "Dick" recently suggested on the FundAlarm Discussion Board:

"Why not have seminars put on by disinterested parties with nothing to sell, possibly Insurance and Finance professors from nearby colleges? Provide course materials that at least try to be balanced, articles from Consumer Reports for example."

Amen, and Roy hereby volunteers to teach such a course if he's ever allowed to.....Unfortunately, even if the Pentagon wanted to change the current system of insurance and investment advice, it's not clear that it could easily do so.....Under current law, the Pentagon must give Congress at least 90 days notice before changing the rules on military insurance sales, presumably so that Senators and Representatives on the take from the insurance industry could rally their forces.....Congress is also considering a new defense appropriations bill which, if passed, could tie the Pentagon's hands for an even longer period of time.....But there's also some hope: Rep. Michael Oxley (more about him below) is planning to hold hearings this fall, which will focus on the sales practices of First Command.
"Basic Training Doesn't Guard Against Insurance Pitch to G.I.'s," "Insurers Rely on Congress to Keep Access to G.I.'s," Diana B. Henriques, The New York Times, July 20 and 21, 2004


Many fund investors have come to expect -- and even demand -- that fund managers show some "skin in the game" by having a significant investment in the funds they manage......But should we also expect members of Congress to have some skin in the mutual fund game, especially since they have the power to write or influence mutual fund legislation?.....Based on recent personal financial disclosures filed with the U.S. Senate and the House of Representatives, four key legislators, who are in a position to affect every fund investor in the country, have remarkably little personal involvement with mutual funds:

There's nothing in Senator Fitzgerald's background, or portfolio, to suggest that he would be a friend of mutual fund investors, yet he was recently responsible for drafting a brilliant piece of fund-reform legislation.....Over in the House, Oxley and Baker present an even more interesting situation: One of them (Oxley) is a mutual fund junkie, while the other doesn't appear to have any interest in funds, yet the pair teamed up for some early, and very useful, fund hearings and fund-reform legislation.....Senator Shelby is the easiest one of the group to pigeonhole: This is a rich real-estate guy, who has little experience with mutual funds, and therefore little sympathy for fund-reform efforts.....Senator Shelby was also the one individual who was most responsible for keeping mutual fund legislation off the Senate floor during the recent mutual fund scandals.....Senator Fitzgerald stands for the proposition that you can't necessarily tell a legislator's mutual fund sympathies from his portfolio.....But if Senator Shelby had an Oxley-like interest in funds, we can't help believing that some kind of mutual fund legislation would have passed Congress by now, and we might all be a little bit better off because of it.

Net worth information comes from respective Senate and House financial disclosure forms for calendar year 2003, and FundAlarm has rounded all dollar amounts. Government retirement plans, including the Thrift Savings Plan, are not reported on these disclosure forms, so it's possible that one or more of these legislators has mutual fund or fund-like investments through the TSP. For purposes of this analysis, money-market funds are not categorized as mutual funds.

Vanguard knew best then....

[From the November 2002 Highlights and Commentary]

According to a Vanguard spokesman, mutual fund investors definitely have the right to know what their mutual funds own, but that right is somewhat limited....."Twice a year and that should be sufficient," said Brian Mattes, when queried how often fund companies should be required to disclose their holdings..... Mr. Mattes, who apparently knows your needs better than you do, might also be willing to tell you how much income, how many cars, and how many children "should be sufficient."


And Vanguard still knows best....According to Michael Miller, a current Vanguard spokesman, mutual fund investors don't need to know if their manager also runs hedge funds, and therefore has potential conflicts of interest.....Mr. Miller believes that disclosure of hedge fund responsibilities "has the potential to be a red herring that could distract investors. It takes investors' attention away from the ways conflicts of interest could be dealt with"......While we appreciate Mr. Miller's solicitude for our limited attention span, we'd like to suggest, once again, that it's not Vanguard's role to decide how much information our tiny brain can process.....Vanguard should be the leader in disclosing all potentially relevant information about its funds and fund managers, and Vanguard's shareholders -- some of them actually quite bright, we hear -- can decide what information they want to use, and how.
"Do Mutual Funds Take a Back Seat to Hedge Funds," Riva D. Atlas, The New York Times, July 11, 2004


Now that the Federal Reserve has started raising interest rates, it seems that the amount of income you receive from your money-market fund should start climbing as well.....But not so fast: Even though your fund may start receiving more income soon, thanks to higher-yielding short-term investments, little or none of that income may filter down to you, the fund shareholder.....Instead, that additional income may be sucked up by your money-fund manager, and it's all perfectly legal.....Here's what happening: For the past couple of years, as money-market funds were forced into lower-yielding investments, many fund managers found that fund expenses (including management fees) were greater than fund income....In order to keep fund yields from falling to zero, or even dipping below zero (i.e., incurring a loss), a number of money-fund managers started waiving management fees and absorbing some out-of-pocket expenses.....Now that more income is about to start flowing into money funds, managers are likely to ease-up on their fee waivers and stop absorbing expenses.....Bottom line: Even though your money fund is receiving more cash, you won't see it (at least for a while), because it will be eaten up by operating expenses.....Money funds with relatively low operating expenses will get back to normal sooner than anyone else, which is another good argument for low-cost funds.
"Some Money Funds May Miss Benefit of Rising Rates," Karen Damato, The Wall Street Journal, June 25, 2004


Bill Nygren, a manager at the Oakmark funds in Chicago, recently offered one of the least-convincing reasons we've heard for not wanting to disclose the dollar amount of his Oakmark fund holdings:

"...that's the kind of stuff I don't want my kids reading in the newspaper."*

Come on, Bill, it's not like you're going to be photographed wearing pink panties on Michigan Avenue.....If your kids are old enough to read about your fund holdings in the newspaper, we'll bet they've also figured out that you're not a pauper.....And we're guessing that you live in a pretty nice house, and you don't blindfold your kids to keep them from seeing where they live.....Call us naive, but mandatory disclosure of your fund holdings might even give you an opportunity to teach your kids an important life lesson: Positions of public trust frequently require individual sacrifice (in this case, a bit of your privacy), but the benefits to society, and the rewards of a job well-done, make the sacrifice worthwhile.
*"Running a fund? Then don't be shy," Susan Tompor, freep.com (Detroit Free Press), July 7, 2004


Working hard, but for whom? "SEC scrutinizes trustees of mutual funds," Beth Healy, boston.com, June 21, 2004



A Fidelity director,
before learning of
his $25,000 raise		 Fidelity fund directors, who already make an average of more than $262,000 a year, are giving themselves a raise of at least $25,000.....According to Marvin Mann, chairman of Fidelity's independent directors, it's been a long time since Fido directors receive a raise and "we've been working very hard".....Mr. Mann hasn't said whether Fidelity directors will return some of their compensation from the years when they didn't work hard, but presumably the answer is "no."
"Fidelity Board Gives Itself A Raise," institutionalinvestor.com, July 8, 2004
A Fidelity director,
after learning of
his $25,000 raise



Pity poor Primecap (well, not really, but play along with us for a while): On the one hand, Vanguard pays Primecap $40 million a year for managing two top-performing mutual funds (Vanguard Primecap and Vanguard Capital Opportunity).....On the other hand, Vanguard could pull the plug on Primecap with basically a moment's notice, and Primecap would lose 90% of its business....Looking to step out of Vanguard's shadow, Primecap has decided to offer three mutual funds of its own under the Odyssey label: Growth, Aggressive Growth, and Stock, all of which should be available this fall.....It's not clear why Primecap picked a meaningless name like Odyssey, when Primecap is a brand that at least some people know.....But the new funds should be fairly popular, if and when investors learn to make the Odyssey/Primecap connection (Primecap's Vanguard offerings are closed, so there should also be some pent-up demand for Primecap products).....The new Odyssey funds are projecting an overall expense ratio of about 125 basis points (1.25%), which is more than double what it costs to hire Primecap through Vanguard.....It's not surprising that the Odyssey/Primecap funds will cost more overall than the Vanguard/Primecap funds, since the fixed expenses of the new funds (for example, legal and auditing fees) will be spread over a much smaller asset base.....But take a look at the management fee for Primecap's new in-house funds, and compare it to the fee that Primecap earns for managing Vanguard's Primecap fund:

Fund assetsPrimecap's management fee (in basis points):
For running its
in-house (Odyssey) fund 		For running Vanguard's
Primecap fund
First $50 million6050
Next $50 million6045
Next $150 million5545
Next $250 million5537.5
Next $1,750 million5525
Next $2,750 million5520
Next $5,000 million5517.5
Next $10,000 million6015


From the first dollar of assets, Primecap is willing to work for Vanguard for a lower fee than it plans to charge its own Odyssey investors (50 versus 60 basis points).....At $5 billion of assets, Primecap provides its expertise to Vanguard investors for only 17.5 basis points on the next dollar under management, while it plans to demand 55 basis points from its own, in-house fund investors.....What accounts for this dramatic difference in fee structures?.....Whose answer do you want?.....Primecap would undoubtedly say that it costs more to manage a small Odyssey fund, compared to a huge Vanguard fund, while FundAlarm would say that Vanguard has simply negotiated a better fee deal than the Odyssey fund directors.....Under new SEC rules, the Odyssey fund directors will eventually have to explain, in writing, how and why they agreed to this fee schedule..... It will be interesting to see if they acknowledge Vanguard's better fee deal with Primecap, and try to explain it away -- but we doubt the issue will even come up.


Briefly noted:
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FundAlarm © Roy Weitz, 2004