Highlights and Commentary

By Roy Weitz

(Originally posted September 1, 1999) [Archive Table of Contents]

"Thanks for everything, Mr. Bogle. May we show you to the gangplank?" Vanguard is a company rich in nautical imagery.....The very name, Vanguard, comes from Admiral Nelson's early flagship.....Vanguard employees are called "the crew," they eat together in the "galley," they work out together in "the shipshape" (gym), and they follow company events in the "ship to shore" newsletter*.....In what appears to be a new nautical tradition, the company CEO (John Brennan) will now be referred to as a "puffed-up pirate," and the company founder (John Bogle) will be considered "excess baggage."

Some background is in order.

John Bogle founded Vanguard in 1975, and he struggled through some tough early years, including almost eight years of net fund redemptions.....John Brennan joined the company in 1982.....Previously, Brennan had worked for the company that makes Pledge furniture polish and, by his own admission, knew virtually nothing about Vanguard.....Brennan rose through the ranks and, around the time of Bogle's heart transplant operation (1996), Bogle gave Brennan the top spot at Vanguard.....Brennan has been there ever since, while Bogle holds only a ceremonial title, and serves on Vanguard's Board of Directors.....Bogle turned 70 earlier this year, and Vanguard's Board has a rule that requires Directors to retire at the end of year in which they attain age 70.....Bogle has made it clear that he would like to remain on the Board, and he has asked for an exception to the retirement rule in his case, but Brennan isn't biting.....As things stand now, Brennan will do nothing, Bogle will be forced to retire, and Brennan will have helped extinguish his mentor's last offical vestige of authority.
* "Can Vanguard Stay the course?", Hal Lux, Institutional Investor, August 13, 1999


Why does Vanguard need to grow, anyway? Brennan is charging ahead with all sorts of expansion plans, Bogle doesn't like them, and it's pretty clear this is the main reason that Brennan wants Bogle off the Board.....Somewhere along the way, Brennan's testosterone meter got stuck at the red line, and Brennan seems to have forgotten that Vanguard is owned by its shareholders.....If Vanguard doesn't expand into Europe, if Vanguard doesn't continue to grow at double-digit rates, who really cares?.....Theoretically, Brennan should be figuring out ways to reduce the size of Vanguard, or at least slow it's growth, if that means the company could run its mutual funds better --and it probably could.....But that's never going to happen, which is too bad, because Vanguard is one of the only companies that could pull it off.....It's obvious that Brennan has some things of his own to prove, not all of them related to the welfare of Vanguard's shareholders.....Maybe Bogle's next book will tell us what he really thinks about the new Vanguard.....Sure.....And maybe I'll be invited to the Brennan house for a Labor Day weenie roast.

Update (September 6): I wasn't.
Having a bad day? It probably could be worse....In fact, Eric Kobren is coming off a bad month of press coverage.....Kobren publishes the Fidelity Insight newsletter, and our story begins with Kobren's lawsuit against the publisher of Fidelity Investor, a rival newsletter.....According to Kobren, certain "false and misleading statements" were made in one of the recent marketing mailings for Fidelity Investor.....The editor of Fidelity Investor, Jim Lowell, used to work for Kobren, and Lowell's name was signed to the offending marketing materials.....Hell hath no fury like former business associates, so this fight has quickly gotten nasty..... Kobren has called Lowell a "copycat" and, in one of the most vicious public attacks we can recall, Kobren has also branded Lowell a "philosophy and religion major".....It gets worse: According to Kobren, Lowell has "studied poetry in Ireland."

Turning and turning in the widening gyre Kobren cannot hear Lowell; Things fall apart; the center cannot hold A petty lawsuit is loosed upon the world.

Inasmuch as Kobren decided to take his grievances public, the press decided to take a closer look at Kobren's various operations.....According to Barron's,* "Kobren has every reason to be defensive".....Newsletter subscriptions have declined about 40% over the past three years.....For the five years ended June 30, Hulbert Financial Digest rates Kobren's model newsletter portfolios in 50th place out of 108 contenders.....Kobren recently lost his chief investment strategist, who might have been peeved that Kobren was publicly blaming him for poor performance.....On the mutual fund side, Kobren Moderate Growth has been a dismal performer, while Kobren Growth has posted only slightly better numbers.
* "Hissing Match," Sandra Ward, August 9, 1999


"PRESS RELEASE"

September 1, 1999 09:38



LOS ANGELES, Ca., Sept. 1 / -- The man who originated the idea of charging 12b-1 fees for closed mutual funds has announced the formation of a new consulting service, Screwem Partners, which will assist businesses in developing new ways to rip off American consumers.

"The opportunities for new rip-offs are unlimited," according to Will Screwem. "You just have to be creative. When I first came up with the idea of charging a 12b-1 fee in a closed mutual fund, everyone thought I was crazy. Now, it's an accepted part of the mutual fund business."

Although the 12b-1 fee was originally intended to cover a fund's marketing and distribution costs, and closed funds have no marketing and distribution costs, 26 closed stock and balanced funds continue to charge a 12b-1 fee. "At first," says Mr. Screwem, "nobody at the fund companies thought they could get away with charging a fee for doing nothing. But when I showed them how easy it was, I became an industry legend." What do fund companies do with the 12b-1 fees they collect from closed funds? "Some put in their pocket. Others use it as a bribe." Mr. Screwem explained: "Over 80% of all funds with a front-end load charge a perpetual 12b-1 fee of .25%. The fund companies turn around, and they pay this fee to the selling broker as a 'service fee.' But it's really a bribe, so the selling broker doesn't try to switch the client to another fund, or churn the client's account. These days, even when a fund closes, the brokers still expect their bribe, and they get it in the form of the 12b-1 fee."

Mr. Screwem's new consulting service will attempt to leverage the 12b-1 model, and apply it to other industries. "For example, take real estate," says Mr. Screwem. "Under the current system, a broker sells a house, receives his or her commission, and that's the end of it. I'm going to convince brokers that they should send an annual bill to every seller, based on .25% of the value of the house, and call it a 'service fee.' Of course it sounds ridiculous. The broker has already been paid for the sale, and the broker doesn't do a damn thing to earn the additional service fee. But that's the beauty of it! Remember, the same approach works for the mutual fund industry, and it's worth $100 million a year in 12b-1 fees."

[The factual parts, above, are based on an article by Lewis Braham
in SmartMoney.com, August 18, 1999 ("You're Being Ripped Off")]
Twenty-six funds that bring joy to Will Screwem's heart*
(*Closed funds that still charge a 12b-1 fee)

Ameritor Industry Ameritor Investment Ameritor Security Trust Barr Rosenberg US Sm Cap Sel BlackRock Small Cap Growth Inv (all classes) Chase Vista Small Cap Equity (all classes) ESC Strategic Small Cap (all classes) Franklin Balance Sheet Investment Franklin Micro Cap Value Ivy International (all classes) Lord Abbett Small Cap Value (all classes) Montgomery Global Long-Short (all classes) Munder Value

Neuberger Berman Genesis Assets Northstar Balance Sheet Oppty Northstar Growth Northstar Special Oppenheimer Enterprise (all classes) Putnam Capital Appreciation (all classes) Putnam New Opportunities (all classes) Rainier Small/Mid CapEquity SSgA Small Cap State St Research Aurora Van Eck/Chubb Capital Appreciation Van Kampen American Value (all classes) Van Kampen Growth (all classes)

Big pecs, small assets:

According to a recent survey by Prudential, 75% of American adults say they exercise an average of 12 hours each week.....Only 56% say they seek to learn about investments, and they spend an average of seven hours per week doing so.....About half of all "prime-time" wage earners (ages 35-49) spend no time at all learning about investments.

"A man with his head in the oven and his feet in the freezer is, on average, comfortable": This old saying is brought to mind by the recent performance of micro-cap mutual funds.....According to Lipper, the average micro-cap fund was up 22.6% for the year, through July 28.....However, the average for this category masked a huge disparity in the returns of individual funds.....In one corner, weighing in at 87.9% for the year, was the bruising Van Wagoner Micro-Cap.....In the other corner, struggling to keep its trunks up, was Perritt Micro Cap Opportunities (-9.9%).....So, what does it mean if your micro-cap fund was outperforming (or underperforming) the average fund in its peer group for the first seven months of 1999?.....Basically, nothing.....The problems with the micro-cap "peer group" may be instructive for other peer group comparisons as well..... Problem #1: As defined by Lipper, the micro-cap universe consists of only about 60 funds, so a few mega-performers can seriously skew the average......Problem #2: Multiple classes of the same fund count multiple times in the average (in other words, the five classes of BlackRock Micro Cap, each returning about 65% for the year, count as five separate funds).....Problem #3: The definition of micro-cap is a fuzzy, moving target.....Lipper defines micro-cap as a fund that "generally invests in companies with market capitalizations below $300 million," but the leading fund in the category for the year (the Van Wagoner Micro Cap) has a median market cap of about $550 million, mainly because it has held on to so many winners with increasing market valuation.
Source: "Microcap Funds' Performance Is Skewed but Promising," Karen Damato, The Wall Street Journal, July 30, 1999


"Okay, Roy. So the micro-cap category is all screwed up. But at least when you buy a large-cap 'value' fund, you know what you're getting, and it's possible to compare one value fund to another."

Not so fast, my smug little challenger.....The "value" label on your large-cap fund might not mean as much as you think.....As The Wall Street Journal recently noted,* "value" is now applied to three very different styles:

• Funds that practice traditional value seek stocks that sell at a discount to the market, as measured by price/earnings ratio, price/book value, or dividend yield. By definition, traditional value funds tend to load up on out-of-favor industries.
  
  
• Funds that practice deep value buy stocks that even traditional value funds don't want -- for example, companies with serious financial or legal problems. Deep value funds often make big bets on downtrodden cyclical stocks (a good example would be energy stocks, prior to their recent rebound).
  
  
• Funds that practice new value are mostly run by managers who are tired of being whipped by the S&P 500. New value funds use different yardsticks and definitions for value, such as gross revenue, industry leadership, and amount of fairy dust. These days, new value funds tend to be heavy with technology holdings.

This month's FundAlarm database contains 96 domestic large-cap funds that have the word "value" in their name.....Returns for this group over the past 12 months have varied widely, from a low of 2.03% (Preferred Value) to a high of 32.86% (Legg Mason Value).....What accounts for this difference in returns?.....Many factors, of course, but one factor seems to be technology holdings.....As shown by the chart below, value funds with relatively small technology holdings (as of July 31, 1999) tend to be on the low end of the 12-month performance spectrum, and you can assume that most of these are "traditional" or "deep value" funds.....At the other end of the spectrum, "new value" funds, with heavy technology holdings, tend to have better 12-month performance numbers.


What does all this mean?.....If you believe in peer-group comparisons, be careful.....A "value" fund with heavy tech holdings should be performing better than a value fund with less tech exposure.....If you own a tech-heavy value fund, and you compare it to value funds in general, you may be setting the performance bar way too low.
* "Managers Interpret Labels on Value Funds Differently," Patrick McGeehan and Pui-Wing Tam, The Wall Street Journal, August 20, 1999


Geezers get a break: According to a recent academic study, young fund managers who seriously underperformed the market had a 37% chance of losing their jobs in any given year, versus a 17% chance of termination for managers over age 45.....One possible reason for this gap: Older managers are a known quantity, and fund companies are more willing to cut them some slack.....Among the study's other findings: Matching or outperforming the market didn't bring greater job security for either age group.....Younger fund managers generally strayed less than older managers from the typical industry allocations of a diversified fund, and they constructed portfolios with less risk.....This makes sense, since the study found that deviating from the typical sector and risk profile significantly raised the chances of a young manager deciding to pursue other interests.
Source: "Memo to Young Managers: Study Says Follow the Herd," Darren McDermott, The Wall Street Journal, August 2, 1999

[The study referred to above is available online. If you have the Adobe Acrobat reader
and lots of spare time, click on "Selected Web Links" at the top of this page]

What are your rights as the owner of a 401(k) account?.....Perhaps less than you think, according to this recent exchange from the FundAlarm Bulletin Board:

Original posting ("Devin103"):

Last Tuesday, my employer advised me that last April my 401k funds had been sold and switched to funds offered by Merrill Lynch. This change was done without my prior knowledge or consent. Also my funds (Janus Worldwide, Babson Value, Dreyfus S&P 500 Index, Loomis Sayles Bond) were substituted with Merrill Lynch Global Growth, MFS Investors, Merrill Lynch S&P 500 Index, and Aim Income. All of the new shares are B shares and have expenses from double to 400% more than the shares I had owned. Additionally, The Morningstar and Lipper Analytical Ratings on the funds are lower. I think I got a rotten deal. Is there anything I can do about it????

Reply ("ERISA in WI"):

I work in the ERISA field, particularly on 401(k) plans, and unfortunately there is nothing you can do unless you find evidence that the plan administrator or employer did not act with your best interests or [committed] fraud...In short, you got the short end of the stick. If that isn't bad enough, consider this: 401(k) plans are trusts and as such, contributions made by you to your 401(k) plan are considered to be assets of the 401(k) plan, not yours. The plan administrator is entrusted to manage and disburse those assets per the plan document, and can exercise considerable discretion. Not a comforting thought, is it?

A 401(k) participant can also be the victim of investment-switching when one plan is merged into another.....For example, consider the forlorn employees of Signet Bank.....According to recent articles in USA Today and Kiplinger's,* participants in the Signet 401(k) plan were able to invest in Capital One stock and several brand-name mutual funds prior to 1997.....When First Union bought Signet Bank in 1997, First Union unilaterally moved Signet employees from the Capital One stock into First Union's proprietary mutual funds, including the First Union Stable Fund.....For 1998, Capitol One stock gained 112%, while the Stable Fund returned about 6%.....Needless to say, many former Signet employees were not pleased....Some employees undoubtedly noted the ironic linguistic connection between the "Stable Fund" and the place where horses, too, make deposits.....Other employees took a more activist approach, and filed a lawsuit against First Union.....The trial could start later this year, and some observers think it could redefine the standards for employers who have investment responsibility for 401(k) plans.....We'll keep you posted.
* "Employee's 401(k) lawsuit watched closely," USA Today, Christine Dugas, August 1, 1999;
"The case of the 401(k) sellout," Kiplinger's, September 1999


Gluttons for punishment: The following funds have each returned less than -10% annualized over the past 36 months, yet each still has more than $100 million in assets:

Sorted alphabetically

Fund	Net Assets ($MM)	3 Yr. Return (%)	Benchmark
American Cent Global Gold (BGEIX)	210	-25.01	Specialty
Contrarian (RSCOX)	135	-14.01	Schwab Intl Idx
Dreyfus Premier Aggress Growth A (DRLEX)	130	-11.01	Dreyf MidCap Idx
Fidelity Emerging Markets (FEMKX)	441	-15.66	Schwab Intl Idx
Fidelity Sel Gold (FSAGX)	179	-20.58	Specialty
Fidelity Sel Prec Metals & Mins (FDPMX)	122	-22.59	Specialty
Franklin Gold A (FKRCX)	215	-14.89	Specialty
Invesco Gold (FGLDX)	108	-32.75	Specialty
Prudent Bear (BEARX)	118	-23.18	Vang Bal Idx
Rydex Ursa Inv (RYURX)	456	-18.69	Vang 500 Idx
Scudder Gold (SCGDX)	119	-21.29	Specialty
Van Eck Intl Invest Gold A (INIVX)	225	-24.16	Specialty
Vanguard Gold & Precious Met (VGPMX)	332	-14.79	Specialty

Once again, mutual fund managers have invested in something they didn't fully understand, and once again investors have been left holding the bag.....In this case, the investment that blew up is a "funding agreement," issued by General American Life Insurance Co, and it is estimated that about 100 money market funds are affected.....It appears that no investors will lose any money, but that's only because of some fancy footwork by the fund companies, and a fairly liberal interpretation of the rules on pricing securities.....Meanwhile, managers of most money market funds will continue to chase after miniscule extra returns, sometimes with little understanding (or concern) for the additional risk they incur.....We suspect that many money market managers resent the rules under which they operate, but these rules may be the only reason that money market funds have stayed out of really big trouble.....According to the SEC, money market funds must have at least 95% of their assets in securities rated highest-quality by a recognized rating service.....A money fund may not have more than 5% invested with an issuer of even the highest-quality securities, and may have a maximum of only 1% in securities of lesser quality.....Illiquid securities are limited to 10% of a money fund's holdings, the maximum maturity is limited to 13 months, and the average maturity must be 90 days or less*.....One observer of the money market scene refers to the General American problem as a "hiccup" and, in his opinion, nothing will change.....He is, of course, correct.....But since we hate to end on such a discouraging note, we'd like to offer the more upbeat view of an analyst for the Moody's rating service: "Before there was a blow-up, nobody was asking these questions [about funding agreements]. Now they will be asked more often, and rightfully so".....Sleep tight, everyone. * "What's Going On With the Money-Market Funds Stuck With General American Paper?", Elizabeth Roy, TheStreet.com, August 23, 1999

Briefly noted:

• Ryan Jacob left in early July as manager of the Internet Fund (WWWFX).....Ever since then, Jacob and the folks who now run the fund have been hissin' at each other like a sack full of snakes.....Jacob says he started managing the Internet Fund in December 1997, while his former kinfolk say he started in March 1998.....We think the earlier date is the correct one, although some evidence does point to March.....The parties are also wrasslin' over who actually made investment decisions for the fund and here, we, think the answer is obvious: It was Jacob.....Peter Doyle, now "chief investment strategist" for the fund, claims that he was always involved on the investment side, but the evidence for this is simply non-existent....Here's the clincher: Numerous legal documents, filed way up in Washington, DC, fail to mention Doyle's name in any fund capacity*.....So either Doyle is now telling tall tales, or the person who signed those documents committed perjury.....Dagnabbit: This fund business is tougher than it looks.
  * "So Ryan Jacob Didn't Run the Internet Fund?", Danny Hakim, SmartMoney.com, August 12, 1999
  
  
  
• After making lots of noise, fund company PBHG and fund manager Jim McCall have dropped their dueling lawsuits.....McCall (who has already left PBHG Large Cap 20, Large Cap Growth, and Core Growth) will now be allowed to manage funds for Merrill Lynch.
  
  
  
• "Follow the smart money": This is ancient investment advice but, as always, the problem is making it work.....For a small group of mutual funds, following the smart money means following corporate insiders.....These funds track public information about insider buying and selling, and construct their portfolios accordingly.....In theory, this makes good sense, since few people have better insight into the prospects of a company than its top executives.....In practice, these funds have been unimpressive performers.....The Bear Stearns Insiders Select Fund, started in June 1995, has trailed the large-cap benchmark almost since inception.....Tweedy, Browne American Value uses insider activity as a primary screen for stock selection.....On a cumulative basis, this fund has trailed the mid-cap benchmark since about March 1997 (although earlier performance was better).....Schwab Analytics Fund also uses insider activity as one of its major screens.....Since inception in July 1996, this fund has been in a dead heat with the large-cap benchmark -- highly respectable performance, but hardly the key to fabulous wealth.
  Source: "Mutual Funds Following Insiders Toil to Keep Pace With S&P 500," Danielle Sessa, The Wall Street Journal, August 11, 1999
  
  
  
• This month marks the first appearance of the Sequoia Fund on our 3-ALARM list (did you ever think you'd live this long?).....Long-term performance for this fund has been steadily declining since December 1998, when Sequoia last appeared on our NO-ALARM List.....As of June 30, 1999, Sequoia held only 10 stocks, and Berkshire Hathaway accounted for about 30% of the total portfolio.....Berkshire Hathaway has had a tough 12 months, and this is a big part of Sequoia's problem.....Sequoia has also been hurt by an ill-timed move into cash (now about 21%), and a continuing huge bet on the financial sector (about 92% of the total stock portfolio, if Berkshire Hathaway is included in this sector).....There's one additional concern, and it's a potentially big one: The recent swoon in performance comes as long-time managers Ruane and Cunniff are phasing out of day-to-day control, and new manager Robert Goldfarb is getting his feet wet.....Given the amazing record of this fund, the fact that it's closed to new investors, and the fact that getting back in would be virtually impossible, shareholders will probably want to take a cautious wait-and-see approach.....But at some point, even the Sequoia Fund might deserve to be sold.
  [E-tomatoes can be sent to "Are you out of your mind?, c/o FundAlarm]
  
  
• Here's a handy rule of thumb for investors in zero-coupon bonds: For every 100 basis point change in interest rates (say, from 5% to 6%), the price of a zero-coupon bond (or of a "target maturity" zero-coupon bond fund) moves approximately 100 basis points in the opposite direction for every year remaining to maturity. For example, if interest rates were to rise 100 basis points, the share value of American Century Target Maturity 2025 would drop approximately 26% (100 basis points x 26 years).
  
  
  
• Whatever else you might think about Eric Ryback of the Lindner Funds, at least he stuck to his guns.....Even when Ryback's stock-picking system was delivering abysmal returns, and even as investors were racing for the exits, he was willing to make only minor changes.....As we reported in the May issue of FundAlarm, Ryback has basically been fired, and his replacements are a former dentist and a computer consultant.....If you're curious about the current state of the Lindner funds, four months after April's coup d'entiste, take a look at the September issue of SmartMoney magazine, or call it up online (smartmoney.com; subscription required)....."Ryback sits virtually alone in a corner of the nearly vacant Lindner offices, his only companion an assistant to help answer the phones".....Ryback's old stock-picking model has been scrapped, and a new, untested, apparently theoretical model has been put in its place.....Several Lindner funds have recently shown some signs of life, but who cares?.....The firm's credibility and integrity are gone.....Now, the only question seems to be how fast can these funds be sold, and how many investors will allow their hard-earned money to sit there and help boost the selling price.
  
  
  
• Chase Vista has fired its entire team of New York-based fund managers, and reassigned their Chase Vista funds to new managers at the Chase Bank of Texas.....Chase says that the change is "in the best interest of shareholders".....Observers of the mutual fund scene are astounded that so many managers could turn bad all at once, and amazed at the coincidence that Chase will now be able to realize significant cost savings.....Details at Recent Manager Changes.
  
  
  
• In a typical regulatory half-loaf, the SEC recently announced new rules governing personal trades by mutual fund managers.....Effective October 29, 1999 (but not mandatory until March 1, 2000):
  
  
  • Fund managers must provide an initial report of their securities holdings to their employers, and annual reports thereafter.
    
    
  • Managers must obtain advance approval for any investment in an initial public offering (IPO) or private placement.
    
    
  • A fund's registration statement must contain its policy on employees' personal investment activities, as well as a copy of the fund's code of ethics.
  
  In 1995, it was estimated that 72% of all mutual fund companies already had rules barring fund managers from investing in IPOs.....This is good.....It also means that the remaining 28% of fund companies have been on notice for four years that industry practice overwhelmingly opposes IPO trading by managers.....If the minority of fund companies haven't voluntarily imposed an IPO ban by now, the SEC should have done it for them.....The requirement to "report" and "approve" manager IPO trades is likely to be a charade, especially at smaller fund companies.
  
  
  
• A bad month for Founders.....New England Star Advisers Fund has fired managers Thomas Arrington and Scott Chapman (who also run the Founders Growth and Founders Growth and Income funds).....Their portion of the fund portfolio will now be managed by Fred Kobrick, of the Kobrick Funds.....(It's interesting to note that Kobrick was recently bought by Nvest, and Nvest also owns the New England funds, but never mind.).....Founders was also booted as co-manager of the New England Star Worldwide Fund.....The portion of that fund previously run by Founders will be redistributed among Janus, Oakmark, and Montgomery Asset Management.
  
  
  
• Salomon Smith Barney has filed registration documents for what it calls the first "animal friendly fund" (The Humane Fund).....Strictly as an investment, this probably isn't your best choice.....But a few bucks in this fund might be a nice way to say "thank you" to Spot, Fluffy, and all their friends.
  
  
  
• Speaking of causes guaranteed to annoy someone: Calvert has a new search tool that can tell if your mutual fund owns stock in companies that manufacture firearms or ammunition (" www.calvertgroup.com, under the heading "Know What You Own").
  
  
  

---

[Top | Home]

FundAlarm © Roy Weitz, 1999