FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

(Originally posted September 1, 2002) [Archive Table of Contents]

Don't get caught by surprise: This month's FundAlarm database contains 645 funds that have been in existence at least three years, but less than five years.....By definition, none of these funds can be 3-ALARM, but that doesn't mean poor performance should be ignored.....Forty-four of these funds, listed on the accompanying page, have undeperformed their respective benchmarks by at least 10% (1,000 basis points) over the past 12 months and three years, and each fund on this list is a good candidate for 3-ALARM status when it's eligible.....Among the funds that aren't yet 3-ALARM, but are hurtling in that direction:

Vantagepoint Aggressive Opp (VPAOX)
Evergreen Emerging Growth A (EKAAX)
Oppenheimer MidCap A & B (OMDAX, OMDBX)
Kopp Emerging Growth A (KOPPX)
AIM Aggressive Growth B (AAGBX).

A couple of years ago, if you admitted that you owned a stable-value mutual fund, you might have been the object of some serious mockery.....Today, you're more likely to be the object of some serious envy.....As part of a fixed-income allocation, stable-value funds may deserve a place in your portfolio.....Here's a quick overview to help you decide.

What are they? The typical stable-value fund seeks to achieve a "high level of current income" while "preserving principal" and maintaining a "stable" net asset value (NAV) per share.....Stable-value funds are often compared to money-market funds: Like money-market funds, stable-value funds attempt to maintain a constant NAV (for example, $10 per share).....But stable-value funds also seek a higher return......Stable-value mutual funds operate in a manner similar to the stable-value investment pools that are available within many 401(k) retirement plans.....The big difference: Stable-value mutual funds are available to the general public, while the 401(k) versions are available only to participants of the plans that offer them.
How do they work? Most stable-value mutual funds invest in fixed-income investments with relatively short maturities (say, two to five years).....But even short-term fixed income investments can fluctuate in value, so managers keep their fund's NAV constant by entering into "wrap contracts" (also referred to as "book value maintenance contracts," by those who really want to impress their friends and neighbors).....The wrap contract is basically a financial leveling device.....If a stable-value fund sells a holding at a loss, in order to meet shareholder redemptions, the party on the other side of the wrap contract (often an insurance company) must reimburse the fund for that loss.....Conversely, if the fund sells for a gain, it must hand over the profit to the other side of the wrap contract.
What are the risks? Investors in stable-value funds are subject to credit risk, which means that one or more of the fund's holdings could stop paying interest, or the underlying company could go bankrupt....In this respect, a stable-value fund is no different from hundreds of other fixed-income funds.....A stable-value fund is also subject to the unique risk that the wrap contracts will fail to limit fluctuations in the fund's NAV.....This could occur because an issuer of a wrap contract defaults on its obligation to pay, because the fund is not able to cover all of its holdings with suitable wrap contracts, or (more likely) because of some nasty development that no one currently foresees.

What funds are available? Six stable-value funds are currently available, and all of these funds must be purchased through an individually-administered tax-deferred plan, such as an IRA, SEP-IRA, or SIMPLE (in other words, no purchases are allowed through personal accounts).....Here's the list:

Stable-value fund	Current yield* (%)	Return (% annlz'd) (as of July 31, 2002)
Stable-value fund	Current yield* (%)	12 Mo.	3 yrs.	5 yrs.
Gartmore Morley Capital Accumulation IRA (NMIRX)**	4.01	5.16	5.41	NA
PBHG IRA Capital Preservation (PBCPX)	4.50	5.40	NA	NA
Principal Investors: Capital Preservation J (-)	NA	3.18	NA	NA
Scudder (formerly Deutsche) Preservation Plus Income (DBPIX)**	NA	5.51	6.21	NA
Security Capital Preservation A (SIPAX)**	4.30	4.01	5.62	NA
Vantagepoint Income Preservation (VPIPX)***	4.08	4.03	NA	NA

* 30-day yield, from the respective fund's Web site or communication with fund via e-mail, as of August 29, 2002.

**Other share classes also available

*** Only open to "[IRAs] of employees of state and local governments and the IRAs of other persons having a familial or otherwise close relationship to those public sector employees"

In addition:
- Scudder Preservation Plus (Institutional and Investor classes) is a stable-value fund that's available only through defined-contribution pension plans.
- Oppenheimer Capital Preservation (classes A, B, C, N) is available only through 401(k) plans.
What else should I know?
- Since at least January 2001, it appears that every stable-value fund has lived up to its name, and no fund has seen its NAV increase or decrease by even a penny.....There's no guarantee, of course, that this will continue, but it's a pretty good record.
- There can be significant differences among stable-value funds when it comes to credit quality.....For example, Scudder Preservation Plus Income can invest in securities rated as low as BBB (i.e., four quality grades from the top), while Gartmore Morley Capital Accumulation can't invest in anything with a quality rating lower than a U.S. Government agency issue.....Similarly, Scudder Preservation Plus Income can invest up to 10% of its assets in junk bonds, while the Gartmore fund can't invest even a dollar in the category.
- Most stable-value funds charge a 2% redemption fee.....In some cases (for example, Gartmore Morley Capital Accumulation) the redemption fee is designed to penalize shareholders who try to bail out of the fund when yields on cash equivalents are higher than the yield on the fund itself.....In other cases (for example, PBHG IRA Capital Preservation), the redemption fee is triggered by any sale that occurs within 12 months of the initial investment, for any reason.
- Only PBHG and Vantagepoint are true no-load funds.....All of the others carry either a front-end load or a 12b-1 fee.

For a different take on the same subject, see "Stable-Value Funds See Inflows Amid Volatility," Bridget O'Brian, The Wall Street Journal, July 25, 2002

Department of Deep Investment Thinking:

	"We have an overriding fiduciary duty, to further the interests of our shareholders and maximize the value of their investments with us. To fulfill that obligation, we buy and hold securities that we think will appreciate in value, and we sell securities that we think won't appreciate in value."
--A spokesperson for Fidelity, explaining [?] why the firm refuses to disclose its proxy votes; Source: MutualFundWire.com

Perhaps a better explanation of Fidelity's refusal to disclose its proxy votes: Last year, more than half of Fidelity's $9.8 billion in operating revenue came from administering about 11,000 employee benefit plans, including the plans at large, publicly-held companies such as Philip Morris, Ford, General Motors and Shell*.....Management at these companies authorizes and pays Fidelity's fees, and might not take kindly to Fidelity's public vote against them.
* BusinessWeek.com, August 8, 2002

Vanguard Chairman
John Brennan:
He's mad as hell, and he's
not going to take it any more

Most Vanguard index funds are required to own certain stocks, which puts Vanguard in an awkward position when it comes to shareholder activism.....On the one hand, no matter how much Vanguard complains about company management, the executives who run those firms know that Vanguard can't sell.....On the other hand, Vanguard holds large stock positions in hundreds of public companies, and Vanguard's vote could make a difference in some proxy contests.....Not surprisingly, Vanguard has decided to focus its activism on the ballot box.....In a mid-August letter to the CEOs of its major holdings, Vanguard Chairman John Brennan outlined several areas of concern for future proxy votes:

Vanguard wants all public companies to have a majority of independent directors, and it wants certain key committees (audit, nominating, and compensation) to consist entirely of independent directors.
Vanguard will oppose stock-option plans that are "poorly designed" or overly dilutive, and it will support plans that spell out requirements for minimum stock ownership and minimum stock holding periods. Vanguard also supports the expensing of options as compensation.
Vanguard expects a company's accounting firm to earn at least as much from its audit fee as it does from any consulting fees.

Overall, it's not earthshaking stuff, but Vanguard's positions are clearly stated, and the company has said a lot more about these issues than virtually any other fund firm (in late August, under pressure from the AFL-CIO, Fidelity also released its proxy voting guidelines).....For taking this first step, Vanguard deserves credit.....Now it's time to ask Janus, Putnam, American Funds, T. Rowe Price, and all the others: Where do you stand?

In other words, they fired some people: Here's a quote from Lawrence Lasser, CEO of Putnam Investments, who's apparently never met a straight answer that he couldn't avoid:

	"Out of that [reorganization], which wasn't designed to reduce people, we did have the consequence of reducing the scope of our work, and that, in turn, stimulated assignments and some actual reductions."
--Source: Interview in Pensions & Investments, August 19, 2002

Last fall, we reported that Strong was attempting to convert its American Utilities Fund into a more diversified offering, to be called the Strong Dividend Income Fund.....Shareholders approved the change and, as of December 2001, the new Strong Dividend Income fund conveniently inherited the old fund's track record, which instantly propelled Dividend Income to the top of its new peer group (large-cap value).....OK, that's fairly sleazy, but new funds glom onto unearned track records all the time.....Here's the best part: Strong recently announced that it's starting a new utilities fund, Strong Advisor Utilities, which will be a load fund available only through financial advisors*....If Strong had any concern for its shareholders, it easily could have added a load class to the no-load American Utilities fund, which would have allowed Strong to sell through financial advisors, and also would have allowed existing no-load shareholders to keep the fund they bought.....Instead, Strong pushed the American Utilities shareholders into a new fund (Dividend Income), with a new investment mandate, presumably because Strong thought the new fund would have greater asset-gathering potential.....And now, if holders of the old American Utilities Fund want to put their money in the new Strong utilities fund, they will have to sell their holdings and then pay a commission.
* "Strong's New Dividend Fund Rides on Utility-Fund's Record," Karen Damato, The Wall Street Journal, August 15, 2002

The Goofy Greenspan caption contest: The winner of last month's Goofy Greenspan caption contest is Jim Baske, of Oak Forest, Illinois, and our Classic Collection book package is on its way to him.....Jim's winning entry appears below the photo:

Mr. Greenspan shows signs of confusion
at a karaoke bar in Queens while singing
"Once, Twice, Three Times a Lady"

Other close contenders included the following:

"Thus we see the current evanescences in algorythmic indices can be correlated to these six factors..."
(Cyndy Nickerson, Seattle, WA)
"The next item up for bidding in this bankruptcy auction is the GAAP Guide from Enron's accounting department. It's still in its original wrapping. Do I hear an opening bid of five cents?"
(Mike Romanelli, Torrance, CA)
"Senator, let me explain the four basic concepts of Economics to you"
(Bob Loies, Frankfort, IL; variations on the same theme from Jack Dianis, George Well,
Carl Carpenter, and Christopher Pluck)
"In an effort to liven up an otherwise dreary FOMC meeting, Alan Greenspan does his imitation of Marcel Marceau's 'Man in a Box'"
(Bill Hall)
"I did *NOT* have sex with that market!"
(Ron Logan, Orono, ME)

Thanks to all of you for your great responses, and we're already looking for the next photo.

Briefly noted:

End of an era (error?): Bob Markman, head of a family of mutual funds that invest in other funds, is throwing in the towel.....If shareholders approve, the three dismal Markman "multifunds" -- Aggressive Allocation, Moderate Allocation, and Conservative Allocation -- will be merged into a new fund, Markman Total Return, sometime in mid-December.....Markman, who has now failed in his self-proclaimed area of expertise (open-end mutual funds) will have the opportunity to fail in several new areas with the Total Return fund, including individual stocks, closed-end mutual funds, and exchange-traded funds.
A couple of years ago, Jim O'Shaughnessy walked away from his two mutual funds (Cornerstone Growth and Cornerstone Value)..... O'Shaughnessy had decided that mutual funds were an "antiquated" vehicle, a "relic of the 1920s," and he wanted to devote his time to a new Internet business, Netfolio, that would help investors create do-it-yourself stock portfolios.....Netfolio lasted about a year, and guess what?.....O'Shaughnessy is now back in the mutual fund business,* running a new antiquated vehicle, a new relic of the 1920s, called the Bear Stearns Alpha Growth Portfolio (formerly, Bear Stearns Focus List Portfolio).....If you're tempted to put money in this fund, you might want to remember two things about O'Shaughnessy: (1) He has a history of abandoning his shareholders, and (2) He doesn't believe in the work he's doing.....On a more positive note, however, O'Shaughnessy has never been indicted.
* "Funds give up on 'best picks' of Wall Street analysts," James Paton, Reuters, August 2, 2002
If you've been following the news about America's fastest-growing criminal class, you know that CEOs of public corporations are now required to personally certify their company financial statements.....But what about mutual funds?.....There had been some uncertainty whether mutual funds came under the certification requirements, but in late August the SEC cleared things up.....Henceforth, the "principal executive" and "financial officers" of each mutual fund will be required to personally certify the accuracy of Form N-SAR, which is an odd little checklist form (with financial information) that's filed only with the SEC.....The SEC is also proposing amendments that would require funds to certify each shareholder report, which seems to make a lot more sense.
Toyota Announces New Family Sedan ------------------------------------- Engine Has Never Been Tested,
Owners Not Allowed To Look Under Hood-------------------------------------Will Sell for Premium Price

In the car world, this kind of announcement would be a joke, but in the mutual fund world it still passes for business as usual.....For example: Schwab's new Hedged Equity Fund will be run by a computerized stock-rating model that's never been tested in the world of real mutual funds.....For a princely expense ratio of 2.0%, the fund will take both long and short positions, which means that the model has to be right not just once, but twice.....(And, of course, Schwab refuses to explain how its model is constructed, or how it works)....If this particular black-box isn't to your liking, Schwab also offers a long-only black box, the Schwab Core Equity Fund (which used to be called Schwab Analytics).
Montgomery is changing the strategy, manager, and name of its Global Long-Short Fund*.....Otherwise, there's nothing newsworthy to report.

* According to Morningstar.com, the strategy will change from global to domestic equities, the name will change to Montgomery Partners U.S. Equity Long-Short Plus Fund, and SSI Investment Management will take over for current manager Chetan Joglekar.
People invest in index funds for many reasons, and "lack of surprises" is certainly high on the list.....But if you own certain Vanguard index funds, you might want to prepare for one of those surprises that you try to avoid: The underlying index that your fund follows may be about to change.....Currently, Vanguard has the right to unilaterally change the underlying index at 19 funds, and proxy materials filed in late August would give Vanguard the right to change the underlying index at nine additional funds*.....What's Vanguard up to?.....Gus Sauter, Vanguard's index guru, has become increasingly unhappy (and vocal) about the deficiencies of the indexes that Vanguard currently follows, and Sauter has his eye on a series of upcoming Morgan Stanley indexes that he thinks will cut transaction costs, improve tax-efficiency, and better define the dividing line between "growth" and "value" stocks.....Assuming that Morgan Stanley succeeds in developing "clearly superior" U.S. stock indexes, Vanguard says that "fund management intends to recommend" these indexes for adoption by the eight of the nine funds currently requesting the right to an index change**.....The new indexes are due out in early 2003, and Vanguard will probably want to monitor them for a while, perhaps for several years.....When the change does occur, expect some portfolio turnover, possible capital gains distributions, and the loss of historical performance data that is directly comparable to current data.
* The funds are: Total Stock Market Index, Extended Market Index, Small-Cap Index, Growth Index, Value Index, Mid-Cap Index, Small-Cap Growth Index, Small-Cap Value Index
** "Vanguard Eases Way Funds Change Indexes They Mimic," Aaron Lucchetti, The Wall Street Journal, August 27, 2002

Waddell & Reed is buying the Ivy Funds.....W&R reportedly will leave the Ivy funds intact, and it even plans to launch new funds under what is optimistically referred to as the Ivy "brand name."
Morningstar.com, August 30, 2002

Amy Domini greets
the FundAlarm
Spy Photographer

Like, groovy:

"I'm in the stage of touching, feeling, experiencing and making decisions..."

--Amy Domini, of Domini Social Investments, explaining how she will decide whether to replace two key executives who have just left her firm. Source: Reuters (Christopher Noble)

Quick: Say the first thing that comes to mind -- anything -- about the State Street Research funds.....If your brain comes up empty, you're not alone, and that may partially explain some recent moves in the State Street executive suite.....State Street has lured Kim Goodwin away from the American Century funds, and she will become State Street's new chief investment officer.....Goodwin, who's often seen on Louis Rukeyser's "Wall Street Week" television show, may be able to raise State Street's public profile above the non-existent.....Goodwin was lead manager of American Century Growth, and her former co-managers, Gregory Woodhams and Prescott LeGard, will carry on without her.
Which mutual fund suffered the largest net redemptions during the first half of this year?.....If you guessed AIM Value, you'd be right.....Seems like AIM Value (since renamed AIM Premier Equity) never did behave much like a value fund, and investors finally figured that out.....The fund lost about $2 billion of assets from January through June, and it's now down to about $12 billion.....As recently has March 2000, fund assets were about $31 billion.
"Aim Value investors flee in droves, seeking safer bet," James Paton, Reuters, August 9, 2002
Back in May, we noted that the new Rydex Sector Rotation fund was designed to invest in stocks from a handful of hot industries, with the industry mix potentially changing every month based on the fund manager's measures of price momentum.....The fund's main claim to fame seemed to be some backtested data, which shows the fund trouncing the S&P 500 for a six-year period ending December 31, 2001.....Now, this backtested data turns out to be meaningless, because the backtesting was done by a computer, and the real fund is being run on the gut instincts of its manager, Charles Tennes.....According to Tennes, a backtested model "is stupid, and we like to think we're smarter".....Meanwhile, according to the offended computer that ran the backtesting, "Tennes is ugly, and we like to think that we're prettier".....FundAlarm believes that both are probably wrong.
"A New Fund Rides the Big Mo'," Robert Barker, Business Week, July 1, 2002
FundAlarm reader David Yuro spotted the following language in a recent SEC filing by the Merrill Lynch International Fund -- in fact, it was the entire filing:

"Effective immediately, Merrill Lynch International Fund may
sometimes do business as Mercury International Fund."
Says David: "How annoying and confusing is this?! I've decided that, henceforth, effective immediately, I may sometimes do business as Bill Gates."
In grandpa's day, "utility stock" meant a conservative, dividend-paying investment, while in our day "utility stock" means companies like Enron and Dynegy....Vanguard wants out, which is why the firm is seeking to transform Vanguard Utilities Income into a more diversified offering called Vanguard Dividend Growth.....If you're a conservative investor who still owns a utility fund, you might want to view Vanguard's move as a wake-up call, and it could be time to take a close look at what you really own in that fund.
Last year, Rep James Saxton (R-NJ) introduced a bill that would have abolished mandatory distributions from Individual Retirement Accounts (which currently must begin at age 70½).....The bill is reportedly stalled in Congress, mainly because tax revenues would take such a big hit, but this seems like the kind of legislation that, once introduced, never goes away.....FundAlarm predicts: "It will be back."
"Reform of IRA distribution rules needed, experts say," Andrea Coombes, CBS. MarketWatch.com, August 5, 2002
Here's a mutual fund credential that you won't see very often (it comes from a listing of Directors for the new Index Plus Fund):

Laura Adams (above) is also manager of the fund, which will use a "proprietary mathematical model" based on "relative market capitalization" to select and hold about 50 funds from the S&P 500 index.....The fund has "no history of operations" and the manager "has no...experience in advising a [mutual fund]," although Ms. Adams does have experience as a "private investor," some ten-year old experience as a mutual fund broker and, of course, experience as a homemaker.....All of this expertise will be available for a management fee of 1.25%, hot lunch not included.

BONUS ITEM! EARN 106.9% IN FIVE MONTHS, GUARANTEED!

Last month, we ran an item suggesting that a $1,000 investment in Budweiser (the beer) would have returned more over the last year than an investment in Nortel, Enron, or Worldcom stock, thanks to the 10 cent deposit that you would have received on your 2,140 cans of brewski. FundAlarm reader Bill Colaianni, of Lake Forest, Illinois, shares an even better investment strategy:

I can get Bud wholesale for $9.52 a case, which returns $252 in can deposits for each $1,000 spent. But the real synergy of my strategy is the fact that the 105 cases of Bud you buy also contain about 378,000 calories. Assuming you burn 2,400 calories per day, you get about 158 days of metabolic energy in the bargain. If we assume that the average person spends at least $11.50 per day on "real" food, that works out to a savings of at least $1,817. This is a terrific investment!

Food savings	$1,817
Plus: Deposit return	$252
Less: Cost of beer	($1,000)
Equals: Absolute return	$1,069

This is a 106.9% return in just over five months! And don't forget the magic of compound interest: If you reinvest $1,000 of your earnings in beer (keeping $69 as a hedge against beer price inflation and for weekly beef jerky treats), you'll never have to worry about food, or investments, for the rest of your life. Guaranteed.