| Highlights and Commentary |
| By Roy Weitz |
| Federal regulators are investigating a $100,000 bachelor party for Fidelity stock trader Thomas H. Bruderman, Jr. The party was allegedly paid for by several major brokerage firms, who were either thanking Bruderman for sending them business, trying to generate future business, or both.
The all-weekend party began with private jet rides to Miami, and it ended up on a private yacht. The party involved at least one hired dwarf, bikini-clad women jumping off the boat, waiters arriving on Jet Skis, two women who may have been prostitutes and, we can assume, much, much more. Herewith, an exclusive FundAlarm Q&A, designed to help you put this important story in perspective. Was there any dwarf-tossing? Danny Black, the dwarf hired for the party, is refusing to compromise his professional ethics, so he isn't providing any details. But it appears that Mr. Black did go airborne at some time during the weekend. Fidelity's outside brokers apparently think it's worth spending $100,000 on a party for one Fidelity trader. Does this mean that Fidelity's trading business is profitable for these brokers? Yes, a $100,000 party for one Fidelity employee suggests that Fidelity's outside brokers earn a healthy profit. But doesn't Fidelity have a reputation for excellent trade execution, including low trading costs? Yes, but a $100,000 party suggests that Fidelity might be able to cut trading costs even more. If Fidelity has been overpaying commissions to its brokers, and those commissions came from Fidelity's mutual funds, didn't every owner of a Fidelity mutual fund, in effect, subsidize this bachelor party? Yes. Isn't that kind of repulsive? It depends on your attitude toward hired dwarves, waiters on Jet Skis, and drugs and prostitutes at bachelor parties. Wait a minute. You didn't say anything about drugs before. Sorry. The U.S. attorney in Boston is conducting a criminal investigation to determine whether brokers also furnished Fidelity traders with drugs. But not necessarily at the bachelor party, so let's just leave it at prostitutes. Thanks for the clarification. Glad to help. So what happens now? The SEC will investigate Fidelity. Fidelity will probably end up paying some meaningless fine, and it will tighten its gift and entertainment policies. You and I will continue to work hard and play by the rules, so that we can earn enough money to invest in mutual funds. Mutual fund traders will continue to overpay commissions to favored brokers, because it's not their money. Brokers will continue to get rich off commissions paid by fund shareholders. And the bachelor parties will continue, behind closed doors, dwarf optional. Is it true that some of the Fidelity stock traders were seen cavorting on the yacht in nothing but pink panties? I hadn't heard that one. "A Wall Street Affair: This Bachelor Party Gets Lots of Attention," Susanne Craig/John Hechinger, The Wall Street Journal, July 18, 2005; "Booze, babes & a dwarf," Dave Goldiner, nydailynews.com, July 18, 2005 |
When TIAA-CREF started its line of mutual funds back in 1997, the business opportunity was clear.....Low fees, plus historically good performance by TIAA-CREF's private money-management arm, gave TIAA-CREF a real shot at competing with Vanguard.....But the performance never materialized, marketing was non-existent, and the funds never created even the slightest buzz....Now, we learn that TIAA-CREF was supposedly losing money on its funds ever since they started, and the obliging Trustees of these funds recently approved dramatic increases in TIAA-CREF's management fees, in some cases by as much as 500% (the Trustees also voted to add a 0.25% 12b-1 fee).....If shareholders don't approve the fee increases, the Trustees have threatened to close the funds down, which raises an interesting question: Why didn't the Trustees step in sooner, before this alleged problem became a crisis?.....In any event, fund shareholders will almost certainly agree to saddle themselves with the higher fees (what a great business this is!), and TIAA-CREF will become just another average-cost third-quartile fund provider, with a funny name.....If you own a TIAA-CREF fund, and you can sell without taking a big tax hit, we can't think of any reason why you wouldn't want to get out.....TIAA-CREF was going to be the next Vanguard, and it failed miserably.....Vanguard is still Vanguard, so why not just put your money there?
Trustees of the TIAA-CREF mutual funds (above) receive annual compensation as follows: a retainer of
$45,000; a Board and committee meeting fee of $1,800; a committee chair fee of $10,000; a Board chair fee of $15,000; and an Audit Committee member fee of $5,000......Trustees also receive an annual retirement-plan contribution $75,000 (remember, this is all for a part-time job that perhaps requires 10 hours a week).....Do you think these Trustees might have a strong personal interest in keeping the TIAA-CREF funds alive?.....Do you think this personal interest might have made the Trustees more inclined to approve the huge fee increases discussed above?
Mutual fund supermarkets, such as Schwab and Fidelity, love to sell funds with no transaction fees.....What the supermarkets don't love is when fund companies try to pass along the costs of participating in the no-fee program only to investors who benefit from the program......In fact, fund supermarkets have been ruthlessly effective in forcing all fund shareholders, even those who buy directly, to pay the costs of maintaining no-fee supermarkets......Here's what's going on: Every time someone buys XYZ Fund through a no-fee supermarket, the supermarket expects to get paid an ongoing fee.....In some cases, XYZ Fund Company will pay the supermarket out of its own pocket, but in most cases the supermarket will be paid out of XYZ Fund assets (this is where a 12b-1 fee comes in handy).....The investor who buys XYZ Fund directly from XYZ Fund Company, or who chooses to pay a one-time transaction fee to a supermarket, effectively subsidizes all those investors who come in through the no-fee program.....In an effort to treat no-fee and direct-purchase investors fairly, some fund companies have attempted to create two different fund classes: A more expensive no-fee supermarket class, in which every investor takes a hit for the supermarket fee, and a less expensive, direct-purchase class, in which nobody pays the supermarket fee.....The problem is, fund supermarkets hate these multi-class fund structures, because they screw up their marketing programs: The supermarkets need to claim that buying through their no-fee program costs no more than buying directly from a fund company, but the supermarkets can't make that claim if there's a cheaper, direct-purchase class on the market.....No-fee supermarkets have put tremendous pressure on fund companies not to create two-tiered class structures, by refusing to carry any fund class when there's a less expensive class on the market.....In effect, fund companies that want to participate in no-fee programs are forced to pay the supermarket fee out of their own pocket, or they must make everyone pay the ongoing supermarket fee out of fund assets.....For example, consider the situation at Selected American Shares, which has a class for investors who prefer to pay a one-time transaction fee, as well as a no-fee supermarket class:
| Pay one-time transaction fee at purchase (Class "D") | Pay no fee at purchase (Class "S") | |
|---|---|---|
| Minimum investment | $10,000 | $2,500 |
| Transaction fee to buy | $75 | None |
| Additional annual fund fees | None | 0.27% of assets |
| Effective September 30, 2005, Vanguard will tighten the rules on moving in and out of the same fund within a 60-day period.....At the same time, Vanguard will waive the 2% short-term redemption fee on IRA distributions by shareholders who are age 70 1/2 or older, making it easier for retirees to pull off some quick trades......Do we spot an investment and social opportunity here? |  Members of the Vanguard Quick-Trading Group meet to discuss stale prices and fresh baked goods |
Everybody's getting rich on real estate. I've got to get some real estate......Everybody's getting rich on real estate. I've got to get some real estate.....Everybody's getting rich on real estate. I've got to get some real estate: Before you work yourself into a real-estate deprivation frenzy, consider that your portfolio may already have more real estate exposure than you think.....If you own shares of a real estate investment trust (REIT), your exposure to the real estate market is clear.....But many diversified mutual funds also own REIT shares, as well as other holdings that provide indirect exposure to the real estate market (for example, homebuilders, building-product makers, home-improvement retailers, engineering companies, even regional banks that do a significant amount of mortgage lending)......Including these indirect real estate plays, Lipper recently found that about 4 percent of the average large-cap "core" fund was tied to real estate (the real estate exposure rises to 13 and 17 percent for mid-cap and small-cap funds, respectively).....Some ostensibly diversified funds recently had even larger real-estate exposure: Hotchkis and Wiley All Cap Value (about 36 percent), Alpine Dynamic Balance (almost 33 percent), Markman Total Return Core (28.5 percent) , and Muhlenkamp (more than 18 percent).....Of course, when the real estate market tanks, these funds can quickly reduce their exposure to bricks and mortar, and their shareholders won't be left high and dry (at least, that's the way it's supposed to work).....A three-bedroom fixer-upper, located ten feet from the Interstate, could involve a more lasting financial commitment.
Many mutual fund executives continue to bitch and moan about all the new mutual fund rules and regulations.....But when you look at what fund companies are really doing, you have to wonder what all the fuss is about.....Over at the Diamond Hill Funds, a small family that (you might think) would have been devastated by all the recent changes, president James Laird figures that his company will end up absorbing about $100,000 of additional compliance costs......(To put that amount in perspective, Diamond Hill needs to add about $12 million to the $375 million it currently manages, or the market needs to go up about three percent, and all the additional costs related to the recent fund changes will be covered)...... Vanguard hasn't even bothered to quantify the additional cost of the new fund rules, and probably never will, while T. Rowe Price says that all the new rules probably won't add even a basis point (1/100%) to the typical fund's expense ratio.....As a company, T. Rowe Price estimates that it will spend about $2.5 million more per year to comply with all the new rules, or about 0.2% (yes, two-tenths of one percent) of last year's corporate revenue.
The SEC has rules against misleading fund names, but there's probably not much the SEC can do about misleading fund slogans, even slogans like this one for the Reynolds funds:
Many socially-responsible investment managers screen out entire industries (e.g., energy and defense).....But there's also a trend among
socially-responsible managers to identify and invest in the best players from suspect industries, which is usually referred to as a "best in class" strategy.....Without "best in class" flexibility, socially responsible (SR) managers would often miss out on entire hot sectors, such as energy, and without those hot sectors it would be virtually impossible for SR managers to keep up with many traditional stock benchmarks (such as the S&P 500 Index).....So far, institutional managers have been the biggest fans of "best in class" investing, and it's too early to declare a "best in class" trend among retail mutual funds.....That's not to say that many funds haven't been quietly practicing a "best in class" strategy for years -- just don't bother trying to find out by reading your fund's prospectus.....Few, if any, socially-responsible funds will acknowledge in writing that they subscribe to a "best in class" strategy.....For example, if you press the managers of Neuberger Berman Socially Responsive, they'll admit to "best in class" proclivities.....But when you read the fund's prospectus, that term is never used, or even hinted at.
Here's a sampling of managers who have invested $1 million or more in the funds they run, which is a good thing:
| Manager name | Fund worthy of the manager's $1 million-plus investment |
|---|---|
| Edward Bousa | Vanguard Wellington Hartford Dividend & Growth |
| Gordon Crawford | American Funds Fundamental Investors |
| Bill Miller | Legg Mason Value Legg Mason Opportunity Legg Mason Special Investment |
| Stephen Petersen | Fidelity Equity-Income |
| Andrew Pilara | RS Partners RS Global Natural Resources |
| Brian Rogers | T. Rowe Price Equity Income |
FundAlarm readers get excited by nepotism: Last month, we ran a brief item on parent-offspring mutual fund management teams, and it generated more e-mails than any other item in the past nine years of FundAlarm (this is our anniversary issue, by the way, one year short of a decade).....As a reminder, here's last month's list of fathers and sons who are currently managing mutual funds:
| Fund family | Management family (father/son) |
|---|---|
| Nicholas | Ab/David Nicholas |
| James Advantage | Frank/Barry/David James |
| Alpine | Stephen/Sam Lieber |
| Hodges | Don/Craig Hodges |
| Oak Associates | James/Mark Oelschlager |
| Oberweis | James D./James W. Oberweis |
| Fund family | Management family (father/son) |
|---|---|
| Northeast Investors | Ernest/Bruce Monrad |
| Schwartz/Ave Maria | George/Timothy Schwartz |
| Yacktman | Donald/Stephen Yacktman |
| Royyyyyyyyyyy, am I dreaming? Nepotism in mutual fund companies and NO father daughter examples?? Am I wrong? Johnson, as in Abigail and Edward (?) of Fidelity? Or did Edward resign or something? Maybe I'm off, but I thought they were still there. |
Not much of a lifetime, and not much achievement, either: "Whakamole," a regular poster on the FundAlarm Discussion Board, recently awarded "bad fund of the day" to the Lifetime Achievement Fund.....A look under the hood reveals that this fund-of-funds invests in an uninspiring assortment of mostly Alger, Franklin, and Templeton mutual funds, plus a smattering of individual stocks.....Lifetime Achievement has apparently never found a benchmark that it doesn't like, so it has selected no fewer than four benchmarks to measure itself against (MSCI World Index, MSCI U.S. Index, S&P 500 Index, NASDAQ Composite Index).....Performance has been mediocre against each of these indices, except NASDAQ, yet access to this dubious investment expertise doesn't come cheap: Investors in Lifetime Achievement are hit with an expense ratio of 1.46%, which includes a management fee of 0.75% -- and all this on top of the expenses charged by the underlying funds.
At the end of his winning Senate campaign in 2000, now-Majority Leader Bill Frist still had about $1 million on hand.....Frist's campaign committee decided to invest that $1 million in mutual funds, and subsequent investment performance suggests that Dr. Frist and his staff might want to start reading FundAlarm.....According to the most recent financial report filed by the Frist campaign, the original $1 million mutual fund investment is now down to about $290,000.....It gets worse: Frist's campaign committee still has operating expenses, but the cash to pay those expenses is locked up in the losing mutual funds.....To avoid selling its funds, and realizing its losses, Frist's campaign committee has been paying its day-to-day bills from the proceeds of a $360,000 bank loan that it took out in August 2001.....Or, to put it another way, Frist's campaign committee has been forced to pay its living expenses with borrowed money, because it tried (and failed) to meet its short-term obligations with a long-term investment.....This is a classic financial mistake, and it speaks well for Mr. Frist's political future.
Calamos Asset Management went public in October, but it's still run a lot like a family store (albeit a very prosperous family store).....Calamos (the company) rents its headquarters building from Calamos family entities, at an apparent premium rate, and $2.8 million is paid from company to family.....Calamos (the company) rents aircraft from Calamos family entities, and another $1.5 million is paid from company to family.....Last year, CEO John Calamos earned $13.3 million in cash compensation, 60% more than the CEO of General Electric, and we're betting that Calamos had a much easier job.....Most mutual fund shareholders probably don't care how their money manager runs its business, as long as the manager delivers good investment performance (as Calamos generally has).....But money management is ultimately a fiduciary business, and being a good fiduciary is as much a state of mind as a set of rules.....To the extent that Calamos seeks to maximize every possible financial advantage in one part of its business, that kind of attitude seems likely to carry over to the fiduciary part of its business.....Eventually, fund shareholders will be affected.
According to the prospectus for Apex Mid Cap Growth, manager Suresh Bhirud "may be difficult to replace in the event of his death, disability, or resignation".....We were surprised that the manager of such an epically dismal fund "may be difficult to replace," but further research confirmed the accuracy of this statement: Over the past 10 years, Mr. Bhirud has turned each $1,000 of shareholder money into about $250, and virtually every manager of similar ineptitude is already out of business.
On the other hand, maybe Mr. Bhirud (above) does have some unique skills.....Here, in a screen shot from his Web site, Bhirud appears to date his fund's 2004 Annual Report five months before its year even began (FundAlarm has added the underlines):
And a slightly more serious matter: As far as we can tell, the Web site for Apex Mid Cap Growth contains exactly one piece of performance information, which we have circled below:
According to a recent research study, brain-damaged individuals performed better in a simple investment experiment than individuals with non-damaged brains.....Participants were given $20 and asked to bet on 20 rounds of coin tosses.....A win was worth $2.50, a loss cost only $1.00, and there was no cost for sitting out a round.....Since the odds of a win were always 50-50, it made logical sense to bet in every round.....As it turned out, individuals with damage to the emotional centers of their brains, but with otherwise normal intelligence, bet in 84% of the rounds, and ended up with higher average earnings than individuals with non-damaged brains (who bet in only 58% of the rounds).....It seems that the brain-damaged individuals didn't experience normal levels of financial fear and anxiety, while the non-damaged individuals tended to be influenced by the outcomes of previous rounds.
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