FundAlarm - Highlights & Commentary - (Updated 1st of Each Month)

Highlights and Commentary

By Roy Weitz

(Originally Posted October 1, 1998 - Some editing) [Archive Table of Contents]

Is your 3-ALARM fund a veteran or a rookie? If you've been following FundAlarm for a while, you've probably noticed a pattern: Some funds seem to appear on the 3-ALARM list every month, some funds never appear, and others move on, off, and back on again.....On the accompanying page, we list every 3-ALARM fund in this month's database, and we show its 3-ALARM history for the past six months.

For example, the Janus Fund:

Name	Appeared as 3-ALARM fund in:
Name	Oct-98	Sep-98	Aug-98	Jul-98	Jun-98	May-98
Janus (JANSX)	YES	NO	NO	YES	YES	YES

This table tells us that Janus appeared as a 3-ALARM fund in the May 1998 issue of FundAlarm ("YES").....Janus stayed 3-ALARM for two months, then climbed out of 3-ALARM territory for August and September ("NO").....This month (October), Janus is back on the 3-ALARM list.

The data on the accompanying page also helps highlight funds that are making their first 3-ALARM appearance this month (or at least their first 3-ALARM appearance since May 1998).....Among this month's 3-ALARM rookies: Alliance A, Brandywine Blue, Fidelity Emerging Growth, Robertson Stephens Value + Growth A, Selected American, Stein Roe Capital Opportunity, Strong Schafer Value, Vanguard Growth and Income.

[Go to the 3-ALARM history page]

Two guys in trouble:

Has anyone noticed that Charles Freeman's fund, Vanguard Windsor, is a disaster?.....It seems that almost everyone has, including someone who matters a lot....In a recent interview, John Bogle contrasted the horrendous performance of Windsor to the decent performance of Windsor II: "Windsor II has done just fine. So [the other Windsor is] a portfolio manager decision problem".....Bogle went on to say: "I think he [Freeman] should be given more time. But if the result continues to be bad for an extended period, something has to happen"*....."Something" might include a new solo manager, or a multi-manager arrangement like Windsor II.....Business Week recently suggested that Freeman's rope may be shorter than usual, since Bogle and John Brennan (Vanguard CEO) each personally own more than $2 million of Windsor.....Vanguard's other trustees are also heavily invested in Windsor, to the tune of about $3 million.

Since Arieh Coll took over in January 1997, Fidelity Trend has trailed the mid-cap benchmark by about 25% (2500 basis points).....Columnists Syre & Bailey recently suggested that a manager change would be in order if Trend doesn't turn around by the end of 1998**.....Before joining Fidelity, Coll was a writer for Fortune magazine, and Syre & Bailey may be just a bit envious that a former journalist is actually earning some decent money.....Still, Syre & Bailey make a good point: While the average Fidelity domestic stock fund dropped about 14% for the three months ended August 31, Trend (a mid-cap fund) dropped almost 30%....Other Fidelity funds have made a conscious effort to limit their volatility, but Coll still seems to have trouble getting with the program.

* the street.com, 9/18/98
** thestreet.com 9/16/98

He said*	We said**
"We would definitely get out of companies experiencing weakened fundamentals again but we would try to be a little more careful about those companies where the risk-reward ratio is perhaps less attractive than our typical one but is still in the positive camp."	"Next time, we're not going to a sell a stock unless it really stinks."

*Jack Fraser, a researcher/manager for the Brandywine Fund. Fraser is still trying to explain why Brandywine was in cash earlier this year, when the market was still going up, and became fully invested just in time for the downturn.

**FundAlarm translation

Take that, bloated one:

The following points are adapted from an article by Carol Curtis, in the October 1998 issue of Bloomberg Personal Finance.....We could argue with some of these, but overall they make good sense:

Never buy a large-cap fund that has more than $20 billion in assets, or a small-cap fund with more than $150 million.

Periodically review your holdings to see if any funds have reached critical mass.....Pay particular attention to the impact of asset growth on small-cap funds.
Keep a close eye on expense ratios and turnover: If you choose to hold a fund that is larger than optimal size, it should at least have the advantage of low expenses and low trading costs.
Consider building the large-cap portion of your portfolio around value funds, which historically have delivered higher risk-adjusted returns at all asset levels compared to growth funds.
Buy small- and mid-cap funds only if they promise to close at a reasonable size.
Punish funds that renege on their closing promises (e.g., Fidelity New Millennium).....Heap scorn on funds that close once, only to reopen at an even more bloated size (e.g., PBHG Growth, Heartland Value).
Venturesome investors in tax-deferred accounts might consider a flipping strategy for small-cap funds: Buy into new funds with experienced managers, and sell when the funds reach $150 million in assets.
Inside ownership of a mutual fund can be a gimmick, but significant inside ownership can also mean that a fund manager's interests are aligned with yours.....If you own a bloated fund which has significant inside ownership, you might want to give it the benefit of the doubt.....If you own a bloated fund that even the managers don't want (e.g., Kaufmann), why should you be loyal?
Purchase index funds, which are immune to bloat.

[For another perspective on bloated funds, see "Nothing Fails Like Success," by John Bogle.
It's on the Vanguard Web site, and you can get there by clicking on "Selected Web links" at the top of this page]

Perhaps because mutual funds are different?

"Why is the focus on personal trading for mutual funds? How come it's okay for a bank trust department, or a private manager of a pension fund or hedge fund to have no rules on personal trading, no rules on many things?"*

* Robert Pozen, quoted in "Fidelity Weathers the Storm," Mutual Funds, October 1998

Did conservative funds live up to their promise? For most mutual fund investors, August 1998 was good for nothing.....But for investors in conservative mutual funds, August was good for at least one thing: It was the best bear market laboratory in many years, a chance to see how conservative funds performed when the chips were down.....What's the definition of a "conservative" mutual fund?.....There isn't one, which is why we approach the following analysis from several different angles.

During the recent bull market, funds that stuck with low-P/E stocks were generally considered conservative, so that's one of the broad categories we'll take a look at.....Funds that held a considerable amount of cash were considered conservative, so we'll check out how they performed, along with funds that were broadly diversified, and funds that had "contrarian" in their name.....For comparison purposes, we'll also look at the performance of FundAlarm benchmarks for the month of August.

Conservative fund group #1:
Lots of cash*

# Funds in group	Average performance (8/98)	Median performance (8/98)
31	-9.6%	-9.6%

* These are stock funds with more than 25% cash as of July 31, 1998;
funds with more than 20% of their assets in foreign stocks have been excluded.

Conservative fund group #2:
Low P/E ratios*

# Funds in group	Average performance (8/98)	Median performance (8/98)
93	-16.5%	-16.5%

* These are stock funds that had an average Price/Earnings ratio less than 18 as of July 31, 1998;
funds with more than 20% of their assets in foreign stocks have been excluded.

Conservative fund group #3:
Broadly-diversified*

# Funds in group	Average performance (8/98)	Median performance (8/98)
21	-18.6%	-18.9%

* Think of these as the opposite of "focused" or "concentrated" funds.
Included in this group are funds with less than 10% of their assets in their top-ten holdings as of July 31, 1998;
funds with more than 20% of their assets in foreign stocks have been excluded.

Conservative fund group #4:
"Contrarian"*

# Funds in group	Average performance (8/98)	Median performance (8/98)
11	-14.3%	-14.5%

* Funds with "contrarian" in their name.

FundAlarm Benchmarks

Benchmark	Performance 8/98
Vanguard Index 500	-14.5%
Dreyfus MidCap Index	-18.6%
Vanguard Index Small Cap	-19.3%

Conclusions?.....It was only one bad month, and we don't want to make too much of it.....Still, the only fund group that outperformed all benchmarks was the group with "lots of cash".....Ironically, this is the one strategy that investors can implement for themselves.....Here's how: Choose stock funds that have a history of staying fully invested.....If you want your portfolio to have less overall risk, sell some of your stock funds and put the proceeds in cash (i.e., a money market fund).....When you're ready to increase your exposure to stocks, do the opposite.....Of course, it's easier to let a fund manager make the stock/cash allocation for you.....Unfortunately, there's no evidence that fund managers in general are any good at doing this, and considerable evidence to the contrary (we're thinking "Brandywine").....Here's an even better strategy: Put a comfortable percentage of your portfolio in stock funds that stay fully invested, and leave them alone.....In the long run, you're likely to do better than managers (or other investors) who try to time their moves between stocks and cash.

Mutiny on the Baron? Ron Baron has a reputation for calling his own shots, so we'd really like to know the full story behind the management committee which was recently instituted at Baron Growth & Income*.....This fund began operations in December 1994, and August 1998 was by far its worst month ever (down 19.5%).....Doesn't it seem a bit odd that Ron Baron would agree to share power with a committee, at exactly the time his experience and skill would appear to be needed the most?.....Ron Baron's comments about the new committee are standard public relations fluff:

Blah: "I want to motivate [the analysts] to be charged up and come to me with ideas."
Blah: "I have tons of my own ideas. It's not easy [for an analyst] to get a stock included because I have lots of things I want to do myself."
Blah: "I am very anxious for people to invest in our funds and do well"

Here's what we think happened.....Ron Baron received an ultimatum from his analysts: Either you let us have more say in running this fund, or we walk.....Apparently not interested in being a sole proprietor, it looks to us like Baron gave in.
* "Baron Fund Sets Stock-Picking Change," Laura Saunders Egodigwe, The Wall Street Journal, September 14, 1998

At the trough:

MFS Massachusetts Investors Trust is seeking an increase in its management fee.....Previously, this fund was able to scrape by on income of $8.7 million per year.....Now the trustees are asking for a 72% increase, which would allow the fund to scrape by on about $15 million per year.....Proxy materials offer the usual excuses for a fee increase, which we have taken the liberty of paraphrasing:

Everyone else is making more money than we are and, besides, the stock market is really complicated, and we need all kinds of people and computers and stuff to keep up with everybody else who's making more money than we are. If we don't get this huge fee increase, we don't know how we can continue delivering returns that almost exactly track the unmanaged Vanguard Index 500 fund

FundAlarm is getting weary: Will shareholders ever learn to say "NO" to this kind of shameless money grab?

"Soft dollars" are kickbacks that fund management companies receive for directing business to certain brokers.....For example, Fund Company A places trades and generates trading commissions for Broker Z.....Broker Z kicks back some of the commissions in the form of free "research" for Fund Company A.....Surprisingly, it's all legal: Fund Company A makes some murky disclosure of the overall kickback arrangement in its prospectus (no disclosure of dollar amounts is required), and everybody is happy, including the SEC.....A couple of problems here: Fund Company A is receiving an economic benefit for directing investor trades, yet investors don't receive a penny of benefit in return.....Investors also don't know why Broker Z has been selected: Because it provides the best service, or because it pays the largest kickbacks?.....The SEC recently investigated the soft dollar situation, and issued a report.....New rules may follow, but don't count on it.

[We have grabbed the soft dollar report from the SEC Web site.
If you're interested in reading it, click on "Selected Web links" at the top of this page]

We're entering the season for year-end tax planning.....Here's a reminder that one of the lowliest tax strategies is still one of the best: Careful planning for capital losses.

To see how you can benefit from planning for capital losses, let's say you invested $10,000 in Scudder Latin America at the beginning of the year, and the shares are worth $7,000 on October 15 (we're ignoring any dividends).....You are now the proud owner of a $3,000 short-term capital loss, which you can "recognize" by selling the shares.....You can use your recognized loss to offset an equal amount of recognized gains, if you have them.....You can also use your $3,000 loss (the maximum amount allowed per year) to offset ordinary income, such as salary, dividends, and interest.....In the latter case, your tax savings will depend on your tax bracket: In the 39.6% bracket, a $3,000 loss can save as much as $1,188 in taxes......In the 15% bracket, the tax savings are lower ($450), but most people would consider even this amount worth their while.

If you engage in this kind of classic tax planning, you need to watch out for the classic tax trap: the "wash sale".....The best way to understand the wash sale rule is to imagine a world without wash sales: In a wash-less world, you could sell Scudder Latin America at 12:00 on October 15, buy the shares back at 12:01, recognize a $3,000 loss for tax purposes, and still have exactly the same economic position that you had at 11:59....Not bad for two minutes of work.....The wash sale rule is the government's way of saying this: "If you are going to benefit from a capital loss, your economic position must be significantly altered for a reasonable period of time"......Congress has determined that 30 days is such a reasonable period.....Therefore, in our example, if you acquired an equal number of Scudder Latin America shares 30 days before or after you sold them on October 15, your loss would be disallowed (technically, suspended).

Is there a way to beat the wash sale rule?.....Hey, it's the tax law: Of course there is.....The wash sale rule applies only to acquisition of the same or "substantially identical" mutual funds....The trick is to identify a mutual fund that is similar to Scudder Latin America, but not the same or substantially identical.....How about T. Rowe Price Latin America?.....Looks good, and now your strategy is complete: On October 15, you sell your shares of Scudder Latin America, and reinvest in T. Rowe Price Latin America.....You maintain your exposure to the Latin American stock market, without missing a day, and you get to deduct a $3,000 capital loss without running afoul of the wash sale rule.....Thirty days later, you can safely sell your T. Rowe Price Latin America shares and reinvest in Scudder Latin America, or you can stay with T. Rowe Price.

FundAlarm readers already know the following, but we have to say it anyway: For all but the simplest transactions (like our example), you should consult a tax advisor.....The strategies above only apply to taxable accounts.....Tax-loss planning may result in transaction costs, especially if you trade through a mutual fund supermarket..... But keep your perspective: Tax savings can far outweigh trading expenses, and this is still one of the freest lunches around.

[If you'd like to discuss planning for capital losses, wash sales,
or any other item in this month's FundAlarm, please visit our Bulletin Board]

Briefly noted:

The Yacktman funds have survived the recent market turbulence pretty well......Now, manager Donald Yacktman must survive a hijacking attempt.....Several months ago, Yacktman fired Jon Carlson from a marketing position with Yacktman Asset Management, the company which manages the Yacktman funds.....Unfortunately for Don Yacktman, Carlson is also on the Board of Directors of the Yacktman funds.....Carlson and three other Directors recently voted to dismiss Don Yacktman as President of the Yacktman funds, and they replaced Yacktman with Carlson.....In retaliation for this retaliation, Yacktman has called a special meeting of fund shareholders (and he is soliciting proxies) to remove Carlson and his three cronies from the Board, reduce the size of the Board by one, and elect three new Directors, who presumably would be more friendly to Don Yacktman.

There's a lot at stake here: If Don Yacktman's proxy solicitation is not successful, the hostile Board currently in place is likely to terminate Yacktman's investment contract, and the Yacktman funds as we know them will cease to exist.....It's also getting ugly: In a letter to SEC Chairman Arthur Levitt, the hijackers raised "serious questions" that Yacktman managers aren't adhering to the funds' stated investment style.....The letter also alleged that the funds are being managed by people whose names don't appear in the prospectus.....Not surprisingly, Yacktman denies these allegations.
Proxy solicitations can be interesting for reasons other than pissing contests: Directors must disclose their ownership of fund shares.....Turns out that Don Yacktman owns about $1,500,000 of the Yacktman Fund, and about $2,050,000 of Yacktman Focused .
Remember not to hire Don Yacktman as a market timer: On Thursday, August 27, 1998, he bought about 94,000 shares of his Focused Fund for $1,025,000.....On Monday, August 31, the fund hit its 52-week low.....If Yacktman had waited two business days, he could have purchased the same number of shares for $80,000 less.
When we say "the Greek Marty Zweig with more hair," you probably think "Anthony Orphanos".....You're right, of course, and now Sandra Ward of Barron's reports that Orphanos has quietly resigned from Warburg Pincus.....As you may recall, Orphanos was replaced as manager of Warburg Pincus Growth & Income in early 1997, by Brian Posner.....In May, Brian Posner also replaced Orphanos as co-manager of Warburg Pincus Balanced Fund.....Orphanos was left managing the tiny Strategic Value fund, which Warburg Pincus is now seeking to dissolve.
We predict that no male child in the Orphanos household will ever be named Brian.
According to someone who claims to know, the "average" mutual fund investment was made when the S&P 500 was at 824 ......(To put this in perspective, the S&P closed at 1,045 on September 25).....We have no idea if 824 is an accurate number.....But if it is, 824 could be an important psychological barrier.....When the S&P 500 drops below 824 (about 21% below its current level), the "average" mutual fund investor will start losing money in the stock market, perhaps for the first time.....Is the market "different" this time?.....Is the average mutual fund investor truly focused on the long-term?.....Keep your eye on the S&P 500, and stay tuned.....Whether it's 824, or another number, there is some point where the balance will shift, and the majority of mutual fund investors who have been making money will become a majority of investors who are losing money.....In our opinion, that's the moment when this long bull market will finally be tested.
The PBHG funds have lost about 40 percent of their assets this year, mostly due to poor performance and resulting withdrawals by investors.....On a percentage basis, only one fund family of comparable size (Brandywine) has taken a bigger hit.....Undaunted, PBHG still has ambitious plans to distribute load versions of its funds through the brokerage community.....If you're a broker, and you've spent the past two years in a coma, PBHG would love to talk with you.
Source: Bloomberg
Over the past five years, stocks in the PSE Tech 100 Index have returned an average 28.3% per year.....Over the same period, the average technology sector mutual fund has returned just 21.6% per year.....Why are tech funds lagging the index by such a wide margin?.....According to Money (October 1998), managed tech funds are burdened by high expenses, Jabba-sized asset bases, and poorly-timed cash flows (money pours in when tech stocks are at their peak).....For those who are interested, there's now a mutual fund that mirrors the PSE Tech 100 Index....It's called, appropriately enough, PSE Tech Index Portfolio (888-832-3863: Not a recommendation).
Take a look at an old prospectus for Robertson Stephens Contrarian , and you'll see that Paul Stephens is listed as manager.....Take a look at the most recent prospectus, filed in late September, and you'll note that the fund is managed by a team.....The name Paul Stephens doesn't appear as lead manager, not even as a team member.....According to Randy Hecht, president of Robertson Stephens, the new prospectus is in error.....Contrarian will indeed be managed by a team, and Paul Stephens will indeed be one of the team members.....The firm will soon file a supplement to the new prospectus, reinstating Stephens.....Are we imagining, or do the folks at Robertson Stephens seem to be thinking about something other than running mutual funds?
Squeaky wheels get the occasional grease: Roberston Stephens had been planning to merge the woefully underperforming Developing Countries fund into its Partners Fund.....Shareholders in Developing Countries apparently objected to the merger, anticipating a large capital gain distribution from Partners.....Developing Countries will now be liquidated.