Highlights and Commentary

By Roy Weitz

(Originally posted November 1, 2001) [Archive Table of Contents]
What happened to my tech fund? Last month, the three-year return for Van Wagoner Technology fund was +11.8%, and this month it's -10.6%.....Last month, the three-year return for Amerindo Technology A was +4.8%, and this month it's -17.1%.....In fact, many tech funds in this month's FundAlarm database show a dramatic drop in three-year return just since last month.....What's going on?.....Although it seems like ancient history, these drops can all be traced back to the Asian financial crisis in the summer of 1998.....August 1998 was a terrible month for stock mutual funds, but most funds recouped their losses by the end of the next month.....Tech funds were especially volatile, with relatively larger losses on the downside (August) and relatively bigger gains on the upside (September).....In last month's FundAlarm database, three-year return numbers still included the strong positive month of September 1998.....This month, those returns have rolled off.....As a result, three-year returns for many tech funds have taken a nosedive.....Unfortunately, this downward trend is likely to continue through early next year.....That's because October 1998 through January 1999 were also strong months for most tech funds.....As those months roll out of the three-year return calculation, tech-fund numbers could look even uglier than they do today.....As you evaluate your tech funds over the next few months, you might want to remember this quirk of arithmetic.

How's your tech fund holding up? The accompanying page compares three-year returns, as of August 2001 and September 2001, for all tech funds in this month's FundAlarm database.

Money magazine has released its annual list of "The Best 100 Funds" and, as usual, we were most interested in those funds that have been kicked off the list since last year.....In the category that Money calls "rethinkings," five funds were booted because of "second thoughts":

• CGM Realty: According to Money, Manager Ken Heebner is not at his best in a sector fund.
  
  
• Japan Fund: Do investors really need country-specific funds?
  
  
• Masters' Select Equity: The managers represented in this fund are available through other funds with lower expense ratios.
  
  
• Schwab 1000: This fund uses an oddball benchmark, and it has relatively high expenses for an index offering.
  
  
• Vanguard Small Cap Index: Maybe indexing doesn't work with small-cap funds, after all.

In the category that Money calls "we could do better," ten funds were dropped for "lackluster results relative to their peers":

Deutsche International Equity Eclipse Small Cap Value Hancock Financial Industries MFS Capital Opportunities Neuberger Berman Partners Nicholas Applegate Growth Equity Safeco Equity Scudder International Templeton Developing Markets T. Rowe Price Science & Technology

None of these funds is a certified turkey -- yet -- but several are developing a suspicious gobble, including Nicholas Applegate Growth Equity, Hancock Financial Industries and T. Rowe Price Science & Technology (the latter being one of Roy's personal holdings, but not for long).

To view Money's list of the top 100 funds, click Selected Web links at the top of this page


For the entire decade of the 1980s, stocks (as measured by the S&P 500) posted an average annualized return of 17.5%.....The decade of the 1990s was even better, with an average annualized return of 18.2%.....So, what's in store for the decade of the 2000s?.....Nobody knows, of course, but the weight of history and the law of averages both suggest considerably lower numbers.....John Bogle, founder of Vanguard, recently prognosticated average "stock market" returns of 7% to 8% per year through 2009, while Professor Jeremy Siegel, of Wharton, predicts returns in the range of 8% to 10%.....Looking further out (way further out), data maven Roger Ibbotson projects that "large-cap" stocks will return an average of 11.6% per year from 1999 through 2025, while "small-cap" stocks will do only slightly better (12.5%).....For investors who aren't accustomed to such low returns for even a single year, let alone an entire decade, these predictions seem impossible.....History, however, suggests that it can happen .....Beginning in 1960, the S&P 500 returned less than 9% annualized for every 10-year period over the next 14 years (in other words, 1960-1969, 1961-1970, and so on, ending with 1973-1982).....Historically, some recent twenty-year periods have also been grim: For example, for the twelve 20-year periods beginning in 1955 (ending with the period 1966 to 1985), the S&P 500 never returned more than 8.66% annualized.

The prospect of lower investment returns can be discouraging, but getting upset about the investment markets is like getting upset about the weather: It ain't gonna help.....From columnist Scott Burns, here are some observations to keep in mind during a decade of potentially lower returns:

• Bonds could become more competitive with stocks.
  
  
• Relatively new vehicles, such as TIPS (Treasury Inflation Protected Securities), could be especially competitive with stocks on a real-return basis.
  
  
• The return from paying off debt, especially high-interest or non-deductible debt, should be competitive with many investments.
  
  
• Low investment expenses, including low management fees, become even more important.
  
  
• Tax-deferred retirement plans (IRA, 401(k), etc) become more attractive.
  
  
• Participants in retirement plans may need to increase savings or defer their retirement date.
  
  
• Income-consuming toys, such as cars, boats, RVs, or you-name-it, need to be carefully evaluated.

Sources:

- "Lesser, Not Greater, Expectations from Stocks," Scott Burns, scottburns.com, September 9, 2001

- "Where Are the Markets Headed Over the Next 10-Year Period?," Jonathan Clements, The Wall Street Journal, October 14, 2001

- "Predictions of the Past and Forecasts for the Future: 1976-2025," ibbotson.com

Thanks again to "Ted," stalwart of the FundAlarm Discussion Board, for bringing these articles to our attention. If you like to stay current on mutual fund news, and you're not following Ted's almost-daily posts, you're missing out on a tremendous resource.

I'm excited. How about you?

	"For investors who are looking for broad diversification to provide the possibility of potential protection from an under-performing market, without giving up the hope of possibly outperforming the market, the Masters 100 Fund is a logical fund to consider as a core holding in an investor's portfolio."
--Ken Kam, portfolio manager of the new Masters 100 Fund
As you may recall, Ken Kam helps people set up fake mutual funds at his Web site, Marketocracy.com.....Kam identifies the 100 top-performing fake funds each quarter, and he sticks 1,500 stocks from the top fake-fund portfolios into something he calls the "m100 Index" (m=master. Get it?)..... Kam plans to run the new Masters 100 Fund by drawing on the best ideas from the "m100 Index".....Unfortunately, investors in Kam's new fund will be required to use real money.....Kam's management fee, a hefty 1.5%, also will be taken in real U.S. dollars.

Speaking of dumb fund ideas, the death watch continues for the IPS iFund.....We periodically check in at the IPS Web site, to see if the iFund is still around.....Imagine our excitement when we recently glanced at the upper left-hand corner of the iFund page, and noticed the following title:


Alas, the past tense is only the result of some sloppy writing.....It looks like the IPS iFund will survive through 2001, so we'll run the 2002 death watch contest for in next month's edition of FundAlarm.....As before, a $100 Amazon.com gift certificate will go to the person whose guess is closest to the actual date of death.


Mutual funds have been very, very good to me: This year's Forbes 400 listing of rich folks includes a "Finance" section.....As you might expect, the mutual fund world is well represented.....The wealthiest "finance" person, by far, is Abigail Johnson, daughter of Fidelity CEO Ned Johnson.....Ms. Johnson is reportedly worth $9.1 billion, while her father is worth a mere $4.6 billion.....Essentially all of Ms. Johnson's wealth has come from her father, who happened to inherit the business from his father.....If Ned hadn't been so nice to his daughter, and he still owned Abigail's share of the business, Ned's net worth ($13.7 billion) would have made him the 11th richest person in the U.S., behind only Bill Gates, Warren Buffett, Larry Ellison, a couple of Microsoft billionaires (Ballmer and Allen), and five relatives of Sam Walton.....Here's the complete list of mutual fund money bags, several of whom will probably surprise you:

Name	Fund affiliation	Net worth
Abigail Johnson	Fidelity	$9.1 billion
Ned Johnson	Fidelity	$4.6 billion
Where John Bogle probably would have been, if Vanguard had a conventional ownership structure
Alfred West Jr.	SEI	$1.2 billion
Tom Bailey	Janus	$1.1 billion
Alberto Vilar	Amerindo	$1.0 billion
Michael Price	Mutual Series	$900 million
Charles Bauer	AIM	$800 million
Richard Strong	Strong	$850 million
Tom Marsico	Marsico/Janus	$750 million
Jim Oelschlager	Oak Associates (White Oak, Red Oak, etc.)	$600 million

Finally, let's not forget the supremely dysfunctional Fayez Sarofim, who mostly runs separate accounts, but also runs four mutual funds for Dreyfus (Dreyfus Appreciation, Dreyfus Tax-Managed Growth, Dreyfus Premier Worldwide Growth, Dreyfus Tax Smart Growth).....Forbes pegs Sarofim's net worth at $1.8 billion.

A smart investor?

Good advice can be hard to follow, because good advice often runs contrary to basic human instinct.....Consider, for example, the good advice recently offered by mutual fund columnist Charles Jaffe: Don't look at the performance of your fund portfolio, especially in these troubled times.....But aren't times like these precisely when investors should be watching their portfolios? .....Not necessarily.....If you've designed your portfolio around an asset allocation, and that asset allocation is still appropriate for your situation, you accomplish nothing constructive by constantly tracking the value of your portfolio.....Try putting yourself on a schedule for monitoring your investments, perhaps just once a month, or even once a quarter.....In the days between reviews, simply ignore the market.....Jaffe makes another good point: Not looking is fine, but when you finally do look, don't ignore what you see.....Reevaluate what you own, ask yourself (again) how you feel about it and, if necessary, take prompt action.....The goal of these reviews is to periodically reestablish confidence in your plan.....That confidence should be enough to tide you over until the next time you take a look.

"Don't turn 'no-look' strategy into head-in-sand behavior," Charles Jaffe, October 10, 2001


If you like paying too much, you're going to love these funds: A recent article in Barron's put the spotlight on "closet index funds".....These are actively-managed large-cap funds that have returns and volatility similar to the S&P 500, but carry expense ratios significantly higher than most S&P 500 index funds (many closet index funds also charge a sales load)....Some of the following funds would deny they are closet indexers, and claim it's just a coincidence that they track the S&P 500 so closely....Other funds acknowledge that they track the sector weightings of the S&P, but they hope (and often fail) to produce better-than-index returns through skillful stock selection....Of course, it's better to own a large-cap fund that comes close to the S&P, if the alternative is missing the S&P by a mile.....But if you're paying a manager top-dollar to beat the S&P, and all you get is the index (or less), you might want to reconsider.

Listed in descending order
of being "most like" the S&P 500 Index

Closet Index Fund ("A"-class)	3 Yr. Return (%)	Expense Ratio (%)	Max Sales Load (%)
Goldman Sachs Core U.S. Equity	2.69	1.14	5.50
Nations Blue Chip	1.54	1.21	5.75
Lutheran Brotherhood	-0.1	0.83	4.00
John Hancock Core Equity	1.16	1.41	5.00
Dreyfus Premier Lg Co Stock	0.81	1.15	5.75
One Group Diversified Eqty	1.94	1.20	5.25
AXP Blue Chip Advantage	-1.31	0.83	5.75
Goldman Sachs Capital Growth	3.97	1.44	5.50
AXP Research Opptys	-0.01	1.13	5.75
Benchmark:
Vanguard Index 500	2.05	0.18	None

"La Cage aux Funds," Gene Epstein, Barron's, October 8, 2001


When a fund's assets are growing, "breakpoints" in management fees can result in continually lower expenses.....But when fund assets start to shrink, because of declining stock prices, shareholder redemptions, or both, those same breakpoints can result in higher expense ratios.....Consider, for example, the following management fee breakpoints for an actual fund:

Fund assets	Rate of management fee
First $100 million	1.20%
$100 million to $500 million	0.95%
In excess of $500 million	0.75%

At $900 million in assets, this fund would have an effective management fee of 0.89% ($8,000,000 / $900,000,000).....But if assets drop by half, to $450 million -- a fairly common occurrence these days -- the effective management fee would increase to 1.01% ($4,525,000 / $450,000,000).....For a shareholder with a $100,000 investment, the difference in annual management fees is relatively small in dollar terms ($890 versus $1,010), but quite large in percentage terms (13.5%).....If you're in a shrinking fund that has fee breakpoints (currently, about 50% of all funds do), you might want to keep your eye on the effective annual expense ratio.....It probably doesn't make sense to sell just because the expense ratio is going up.....Combined with other factors, however, a creeping expense ratio might be enough to push you over the edge.
"Some investors can't catch a break point," Michael Fritz, Investment News, October 15, 2001


Funds giveth, and funds claweth back: As long as we're talking about fees, here's something you might not be aware of (we weren't): Many mutual fund companies have a "claw back" provision that allows them to recoup fees they have previously waived, often for marketing reasons.....The vast majority of fund companies don't take advantage of claw-back provisions, even when they exist, but some folks just can't resist.....Last year, for example, MFS took back almost $300,000 in fees it had previously waived on the MFS New Discovery Fund, while Blackrock recouped about $228,000 in fees it had waived on three different funds.
"Clawing back fund fees," Michael Fritz, Investment News, October 15, 2001


Briefly noted:

• If your boss asked you to contribute your best ideas to a company project, and your ideas proved to be a complete flop, there's a good chance that you might be out looking for a new job.....Wanna bet that doesn't happen to Ed Kerschner?.....Kerschner was the alleged brains behind the Paine Webber Strategy fund (since renamed Brinson Strategy), which was designed to hold the best stock ideas of Kerschner and his fellow Paine Webber analysts.....Since the fund started in November 1999, with over $2 billion in assets, it has lost about 55% of its value.....Compared to any relevant benchmark, this fund has been a disaster.....The usually garrulous Mr. Kerschner, as well as the fund's manager (T. Kirkham Barneby) , recently refused to discuss the fund's performance with a New York Times reporter.
  "Experts' Top Choices, Gone Awry," Patrick McGeehan, The New York Times, October 7, 2001
  
  
  
• Strong funds is proposing to convert its specialized American Utilities fund to a diversified, large-cap "dividend income" fund.....Along the way, Strong is also proposing to increase the management fee for its new fund by a hefty 20 basis points (0.20%).....These days, such cynical moves by mutual fund managers barely raise an eyebrow.....But buried in the Strong proxy materials is a cynical provision that caught even us by surprise: The change from utility fund to dividend income fund is contingent on shareholder approval of the increase in management fee.....In other words, even if shareholders vote to approve the change in fund structure, that vote will be disregarded unless shareholders also agree to cough up the extra management fee (which adds about $500,000 to Strong's bottom line).....Here's our question: If the directors of Strong American Utilities "unanimously" believe that the change to a diversified fund is in the "best interests" of the fund's shareholders (which is what the proxy materials say they believe), why should the change in fund structure be contingent on anything, especially a higher management fee?.....If shareholders vote to change the structure of the fund, but also vote to deny the higher management fee (fat chance, but bear with me for a minute), how in good conscience could directors allow the first part of the shareholder vote to be totally disregarded?.....In effect, the Strong directors are engaged in a minor act of extortion: Swallow the bitter pill (the fee increase), or you won't get the pill that's good for you, even if you want it (the change to a diversified fund).....The directors of Strong American Utilities should be ashamed of themselves, and shareholders should vote this proposal down.....Unfortunately, we predict that neither will happen.
  
  
  
• The Alger funds, which suffered devastating losses on September 11, continue to slowly rebuild.....Former Alger employees Teresa McRoberts and Amy Ryan have returned to the firm as health care and retail analysts, respectively.....The firm has also announced plans to reestablish an office in Manhattan.....Before his death, David Alger subadvised several funds.....As of October 1, three of his subadvised funds had not decided whether they would continue with the Alger firm....Now, two of these three funds have weighed in, and both (IDEX Alger Aggressive Growth and SunAmerica Focused Growth) have decided to stay put.....Among the Alger subadvised funds, only Sentinel FlexCap Opportunity hasn't formally announced whether it will stay with the Alger firm or find another manager.
  
  
  
• One deception down, one to go: Last month we ran a brief item on so-called "blue chip" funds, noting that Invesco Blue Chip Growth was actually a tech-fund look-alike, and the "hands-down" performance loser in the blue-chip group.....Apparently, someone at Invesco had already noticed this.....Effective October 1, the "blue chip" ruse was dropped, and the fund is known simply as the Invesco Growth Fund.....Now, if they could only do something about that "growth" word: Over the past five years, this sorry fund has returned -5.8% annualized -- considerably less than the +5.3% returned by U.S. T-bills over the same period.
  
  
  
• Naughty, naughty: Legg Mason has been censured and fined for failing to properly supervise the Legg Mason High Yield Portfolio during several years that Trudie Whitehead was manager (1996 to 1998).....Whitehead intentionally overpriced certain troubled bonds, which meant that the fund's net asset value (NAV) was also overstated.....Legg Mason says that it's trying to find investors who were "adversely affected" by Whitehead's actions, so that they can be made whole.....Legg Mason has also been ordered to maintain better supervisory policies and procedures.....Whitehead has been fined and barred from the investment industry for life, while the broker she colluded with has been barred for three years.
  
  
  
• Tom Bailey, the CEO of Janus, now owns 0% of the company that he founded back in 1969.....Based on a buy-back formula contained in a 1984 agreement, Bailey had the right to receive about $600 million for his remaining Janus shares if he sold them this year.....If Bailey chose to wait, the buy-back amount could have been millions of dollars less.....Bailey decided to go ahead with the sale, and he claims that (a) his decision was a simple matter of dollars-and-cents, and (b) his commitment to Janus is as strong as ever.....Yeah, yeah, but here's our question: If Bailey really wanted to stay, and if the new owner of Janus (Stilwell Financial) really wanted to keep him, why didn't both parties just renegotiate Bailey's buy-out agreement?.....The answer, it seems to us, is that Bailey really wanted to leave, and Stilwell really wanted him to go.....Bailey will continue as a director of Janus, but he's lost the right to control the selection of Janus Board members, and that is likely to become another source of friction between Stilwell and the day-to-day managers of the Janus funds.....Simply as a matter of human nature, Janus fund managers can't possibly feel the same sense of loyalty to Bailey, or to his company.....Right on cue, however, all of the senior Janus fund managers announced that they had no plans to leave the firm in the "foreseeable future".....Which makes you wonder how far the "foreseeable future" really is.
  
  
  
• The company that runs the Kayne Anderson Rudnick mutual funds is reportedly up for sale.....The most interested suitor buyer appears to be Phoenix Investment Partners Ltd., a unit of Phoenix Cos., Inc., a large insurer.
  Investment News, October 10, 2001
  
  
  
• It's not often that a five-year old fund with $500 million in assets is liquidated, but that's exactly what's going to happen to Longleaf Partners Realty at the end of November.....The performance of this fund is currently second-worst in the entire real estate sector.....The folks who run this fund say that value is hard to find, the REIT market is shrinking, certain technical rules make the fund difficult to administer and, besides, they're tired of having such a prominent, loser fund besmirch their otherwise sterling reputation (OK, we made that last one up).....If you're a shareholders in this fund, you might want to look on the bright side: After suffering five years of dismal returns, you can finally take your money from this fund and invest it in something productive, like Longleaf Partners Small Cap, a decent fund that's closed to new investors but will open for former Realty investors.
  
  
  
• A Warren wannabe: Ameristock Focused Value is just a small and ordinary fund right now, but manager Nicholas Gerber has big plans for it.....When the fund reaches between $30 and $60 million in assets (it's at $4 million right now), Gerber plans to convert it to a holding company, which would essentially mimic the structure of Warren Buffett's Berkshire Hathaway.....As a holding company, Focused Value would be able to establish much larger stock positions than a mutual fund, even to the point of owning (and operating) businesses outright*.....As far as we can tell, the prospectus for Focused Value doesn't breathe a word of these plans, and the Ameristock Web site is mum, too.....Gerber reportedly views this mutual fund as a "smart and convenient" way of developing a holding company -- smart for him, maybe, but hardly convenient for those investors who don't share his grandiose plans.
  * "In a holding pattern," Justin Wiser, cbs.marketwatch.com, October 4, 2001
  
  
  
• Deja vu all over again: Value-oriented funds have received 94% of all new cash that investors have put into stock funds this year*.....Which brings us to one of the few certainties in the investment world: This won't last forever.
  * Bloomberg.com, October 10, 2001
  
  
  
• Ryan Jacob, manager of the Jacob Internet fund, was seven years old the last time Investment Company of America (ICA) posted a losing year (1977).....That amazing record appears likely to end in 2001.....Through October 26, ICA was down 7.9% for the year, and it's going to take a major rally to pull this one out.
  The New York Times, September 9, 2001
  
  
  

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FundAlarm © Roy Weitz, 2001