Highlights and Commentary
By Roy Weitz
(Originally posted October 1, 2001)
[Archive Table of Contents]

The Alger funds suffered a staggering human tragedy on September 11, while Oppenheimer lost offices in the World Trade Center, but no employees. As far as the mutual fund world is concerned, those were the major outward signs of disaster. The stock market, of course, is a mess, and it's too early to put the current situation in any kind of perspective. At a time like this, history may be our only guide. As a country and an economy, we've faced huge problems before, and we've come back stronger after every single one of them. Every single one. There's simply no reason to believe that our new challenge will end any differently. Starting September 17, when the markets reopened, I've been buying Vanguard Total Stock Market VIPERS (an exchange-traded fund) on significant market dips, and I plan to continue doing so for as long as the market keeps dipping and I have the cash. I haven't sold any investments, and I don't plan on selling any. In some small way, perhaps, my actions might help the country and the economy, and that's good. Mostly, however, I'm buying (and not selling) because I think it's the smart thing to do. Everything in my investment experience tells me so.


Ron Baron runs the Baron funds, and The Wall Street Journal recently caught him in a mea culpa state of mind.....It seems that Baron feels bad because he allowed some of his favorite stocks to dominate his fund portfolios during the past few years..... Since most of Baron's oversized stock positions have since turned south, investors in his funds have lost most of their sizable paper gains.....And exactly why did Baron drop the ball on this one?.....According to the man himself, "I was flush with success and not willing to listen to criticism...I basically got caught up in the same thing that was going on with Internet stocks. I was holding onto stocks because they were doing well...The thing is, I knew it was a bubble".....Baron now says that he learned at least one lesson from the market of 2000-2001: "Don't forget to sell."
"Live and Learn: Baron Gains by Learning How to Let Go," Tom Lauricella, The Wall Street Journal, September 4, 2001


FundAlarm ruminates: If your fund manager were incapable of learning and growing on the job, you'd be better off hiring a computer.....But at some point, isn't it reasonable to expect that your fund manager will stop making stupid, rookie mistakes?.....The little vignette about Ron Baron, above, highlights both of these issues.....On the one hand, it's encouraging to hear that Baron is still able to learn from his screw-ups. and it's refreshing that he's willing to talk about them so openly.....On the other hand, Baron has been in the money management business for 30 years, and you'd think that somewhere along the way he would have learned something as basic as when to sell a stock.....Sure, you could argue that the past few years have been unusual, but isn't that why you hire a 30-year veteran in the first place, to deal with unusual situations?.....You might also assume that Baron will never make the same mistake again, but that's an extremely cold comfort.....In fact, it's no comfort at all.....In the first place, you can't know that Baron won't make the same mistake again until he's presented with the same temptation.....And since Baron has already shown that he's susceptible to making this kind of rookie mistake, you have to wonder what other rookie traps Baron will fall into (and, of course, "learn" from) next time the market goes crazy.

The situation with Baron is even more complicated because, even with his recent lapses, Baron's funds are still performing relatively well.....In the end, what we're talking about is more lost opportunity than lost money: If Baron hadn't overloaded his portfolios, and if he had learned how to manage stocks under unusual market conditions, many of his fund investors would be quite a bit wealthier today.....Does all of this mean that you should fire Baron, and find another fund manager?.....Or is Baron still one of the better managers around, even with his failings?.....Honestly, we don't know the answer.....We also don't know what we'd do right now if we owned one of Baron's funds.....We would probably chalk this episode up to experience (ours, as well as Baron's).....We'd also probably file this episode under the mental tab, "More reasons to invest in index funds."


Remember when "never" meant "never"? Here's Lawrence Auriana, co-manager of the Federated Kaufmann fund, in a recent interview with Investor's Business Daily:*

"We never played the Internet area, the telecoms or telecom equipment companies."

And here's a partial listing of portfolio holdings as of December 31, 2000, taken from the Federated Kaufmann annual report:

(...sure looks like the "Internet area" to us )
(...sure looks like "telecoms" to us)
(...sure looks like "telecom equipment companies" to us)

* September 7, 2001


Is your core fund rotten? Most investors should own at least one core mutual fund, but the definition of a core fund varies widely.....Here at FundAlarm, we believe that the best kind of core holding for most people is a large-cap blend fund -- large-cap stocks provide some protection from volatility, and the blend style, which combines elements of both growth and value, minimizes reduces the risk of picking an out-of-favor approach.....So, how have these core funds been performing?.....This month's FundAlarm database contains a total of 384 large-cap blend funds that have been in existence at least five years.....Of these, 136 are 3-ALARM, and 11 can be found on our list of the ugliest 3-ALARM funds, which is the bottom of the barrel in the FundAlarm universe

The eleven ugliest core funds
(All large-cap blend, all 3-ALARM)
Delaware Devon B (DEVOX)
Delaware Devon C (DECVX)
Dreyfus Founders Growth and Income (FRMUX)
Evergreen A (EVRAX)
Evergreen B (EVRBX)
Evergreen I (EVGRX)
Fidelity Adv Growth Oppty A (FAGAX)
Fidelity Adv Growth Oppty T (FAGOX)
Fidelity Destiny I (FDESX)
Smith Barney Peachtree Growth A (SBOAX)
Smith Barney Peachtree Growth B (SBOBX)

The accompanying page contains a list of all large-cap blend funds in this month's database, including 3-ALARM, ugliest 3-ALARM, and 54 Honor Roll funds.


Speaking of potential core funds, what about all those funds with "blue chip" in their name?.....If the name means anything, a blue-chip funds seems like it might be a good choice for the core part of your portfolio.....Alas, it isn't so.....This month's FundAlarm database contains 26 domestic funds with "blue chip" in their name.....All are large-cap funds, and they mostly follow a growth or blend style of investing.....Of these 26 blue-chip funds, 16 are 3-ALARM, and only one fund -- Ark Blue Chip Equity Instl (ARBIX)-- has managed to outperform the large-cap benchmark over the past five years.....The hands-down loser in the "blue chip" group is INVESCO Blue Chip Growth Inv (FLRFX), which is actually a concentrated, tech-fund lookalike that masquerades as a blue-chip fund.

[See the accompanying page for the performance of all
"blue chip" funds in this month's database]


According to an old financial adage, leverage is a double-edged sword.....When asset values are rising, a leveraged investor enjoys proportionately higher rates are return, but when asset values are falling the reverse is true, and losses are magnified.....Shareholders in two Credit Suisse Warburg Pincus funds -- Japan Growth and Japan Small Companies -- were recently exposed to the downside of leverage, although many were probably unaware of the ride they were taking.....The problem for these two funds began in 2000, after both had posted spectacular returns for 1999.....As redemption requests started pouring in during early 2000, the fund's manager (Nicholas Edwards) decided to raise cash by drawing on each fund's line of credit, instead of selling securities.....The asset base of both funds started dropping dramatically, while borrowings rose (both in dollar terms, and as a percentage of assets).....On many days during the fiscal year ended October 2000, these funds were leveraged to at least 15% of assets, and at times they were probably leveraged close to 30%, their legal maximum.....As the market value of fund holdings continued to drop, the losses for remaining investors were magnified as a result of this unexpected leverage.....The prospectus for both funds allows "the borrowing of money from banks to meet redemptions or for other temporary or emergency purposes," but it's questionable whether the kind of sustained borrowing practiced by Edwards falls within the prospectus guidelines.....Borrowing of this magnitude also raises questions about the manager's judgment, especially when borrowing becomes part of a fund's day-to-day operations, and not just an emergency safety valve.....Edwards says that using the line of credit saved investors from taking "fire sale" losses on the sale of stocks.....However, a reliable source tells FundAlarm that Edwards has a reputation for a huge ego, and Edwards appears to have borrowed, in part, because he couldn't believe that his stocks could continue to drop......Our source estimates that the "sustained and premeditated" borrowings at these funds resulted in additional losses of between $16 and $30 million for each fund, all of which came out of shareholder pockets.
"Funds borrowed money to meet redemptions...", Elizabeth Wine, FT.com (Financial Times), September 10, 2001



That was then

This is now
 James K. Glassman is the author of the 1999 book Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market.....Mr. Glassman, who once argued that stocks are historically no riskier than bonds, and who also insisted that the Dow would grow to the sky, isn't so sure these days....."We're having our theory put to the test," said Mr. Glassman, in a sentence notable both for its hubris -- "theory" -- and its understatement -- "test".

"Stock Risks Are Poised to Rise As War on Terrorism Looms," Robert O'Brien, Dow Jones Newswires, September 24, 2001


Legally, a deal is a deal.....But when that deal is part of a business relationship, and one party to the deal feels cheated, there's a good chance that the aggrieved party will eventually find a way to get even.....That's exactly what seems to be going on in the trademark dispute between Vanguard and Standard & Poor's.....As you may recall, Vanguard already licenses the "S&P 500" name for the Vanguard 500 Index fund, and Vanguard planned to treat its new S&P 500 VIPER (an exchange-traded fund) as an additional class of its existing index fund.....Vanguard lawyers assumed that their mutual fund license would carry over to the VIPER, but Standard & Poor's lawyers said "No".....A couple of months ago, Standard & Poor's won its case in court.....Now, Vanguard is working on its appeal, while both sides dance around each other looking for a possible settlement.....At the inception of the Vanguard S&P 500 index fund, in 1976, Vanguard negotiated a lifetime licensing fee of $50,000 per year for the right to use the S&P name.....At the time, the Vanguard fund was a tiny joke in the mutual fund industry, and the S&P index wasn't widely followed, so both parties probably felt pretty good about their arrangement.....These days, the Vanguard fund is the largest in the U.S. and, if it were negotiating its license today, Vanguard would have to pay well over $500,000 for its annual S&P license.....Over the years, S&P has reportedly tried to get Vanguard to agree to a higher fee, and Vanguard has repeatedly refused.....So, when the trademark issue arose, S&P wasn't exactly in a charitable mood.....If Vanguard had been a little more flexible on the licensing fee, it's possible that Vanguard's S&P 500 VIPER would be up and running.....As things stand now, however, that VIPER may never see the light of day.


Financial publications (including FundAlarm) probably do a disservice to their readers by emphasizing tax-loss selling only at the end of the year.....The truth is, tax-loss selling can make sense at any time of the year, but no one ever seems to talk about it until December......In fact, even as you are reading this, there's a good chance that the market has handed you an opportunity for tax-loss selling, and it's an opportunity that might not be available in December.....To start off, let's take a look at the different types of tax-loss selling, since the term often means different things to different people.....Here's are some of the possibilities:

#1 -- The Clean Break: You sell a fund at a loss, and you don't reinvest the proceeds.
#2 -- The Forward Step: You sell a fund at a loss, and you reinvest the proceeds in a different kind of fund.
#3 -- The Side Step: You sell a fund at a loss, and you reinvest the proceeds in another fund that's as similar as possible to the one you sold.

Obviously, the appropriate tax-loss strategy depends on your own situation.....The Side Step (#3 above) makes sense for someone who's comfortable with his or her basic investment allocation, but wants to squeeze a little bit of tax advantage out of it .....With a properly executed Side Step, you generate a tax benefit that you can use immediately, while your financial and investment situation remains essentially unchanged.....In that sense, the Side Step comes as close to a free investment lunch as anything we've ever seen.

In the classic Side Step transaction, you sell mutual fund shares at a loss, and you use the loss to offset an equal amount of recognized gains (if you have them).....In effect, these gains become tax-free.....You can also use up to $3,000 of your loss to offset ordinary income, such as salary, dividends, and interest.

Since the side-step strategy requires that you replace your loss fund with a new one, you also need to watch out for the "wash sale" rules.....Basically, the wash sales rules say that you can't replace a loss fund with the same fund, or one that's "substantially identical," within 30 days before or after your loss sale.....Fortunately, this rule still leaves you plenty of side-step flexibility.....For example, while you couldn't sell your shares of Firsthand Technology Value at a loss and buy them back the same day, you could clearly buy any other Firsthand fund and still avoid the wash-sale trap.....At the end of the day, your portfolio looks almost exactly the same as it did in the morning, except now you've got a nice tax loss in hand.....Are there any complications?.....It's a tax law, so of course there are.....For example, you'll want to avoid side-stepping into a fund that's about to declare a large capital gain distribution, since that could negate your loss.....Your best bet is to call the target fund and ask about distribution plans, or check the fund's Web site.

Side-step sales are not panic sales, and a side-step sale makes sense in any kind of market (of course, there tend to be more opportunities for side-stepping in a down market).....And remember, there's no particular reason to wait until December to execute a tax-loss sale.....If you have a loss now, consider taking it.....It can help you make the best of an otherwise bad situation.


Briefly noted:
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FundAlarm © Roy Weitz, 2001