FundAlarm - Highlights & Commentary Archive

Highlights and Commentary

By Roy Weitz

(Originally posted December 1, 2000) [Archive Table of Contents]

What have we learned from Heartland? As we reported last month, on October 13 Heartland revalued bonds in two of its muni bond mutual funds (Heartland High-Yield Municipal Bond Fund and Heartland Short Duration High-Yield Municipal Fund)..... In one day, the net asset values of these funds dropped by 69% and 44%, respectively.....In the weeks since the revaluation, lawsuits have been filed, fingers have been pointed, and Answers have been sought.....Out of all this mess, even FundAlarm has been able to make a little sense:

Liquidity matters: When you invest in a mutual fund, you expect to be able to get out with only a day's notice, and that's one of the reasons the SEC doesn't allow a mutual fund to contain more than 15% "illiquid" assets.....According to the Investment Company Institute, an "illiquid" investment is one that can't "be sold or disposed of in the ordinary course of business within seven days at approximately the value at which the mutual fund has valued the investment"*.....Whatever else you want to say about the Heartland debacle, it's clear that the two revalued funds didn't meet the SEC standard for liquidity and, as a result, investors suffered harm.....We suspect that there are other liquidity bombs out there -- both bond and stock funds -- and this might be a good time to take a closer look.....The best place to start is your fund's prospectus.....If the lawyers felt it was necessary to include a separate warning about potential liquidity problems, especially in bond funds, you'll probably want to pay attention.....Unfortunately, it's tough for non-professionals -- heck, it's tough enough for professionals -- to make judgments about liquidity problems with individual securities in a fund portfolio.....If you have a financial advisor, ask for help.....Otherwise, go with your gut instinct and err, if you must, on the side of caution: Consider switching to another fund without liquidity problems.
* "Two Muni Funds Pay the Price for Extreme Credit Risk," Elizabeth Roy Stanton, TheStreet.com, October 27, 2000
Experts can be very, very wrong: You've probably known for some time that experts can be wrong, but a little reminder can't hurt.....Here's an excerpt from a list of recommended muni bond funds that appeared in Eric Kobren's FundsNet Insight newsletter for August 2000:

Sure enough, that top-rated fund (which we have underlined in red), is the same fund that lost 44% of its value just a few weeks after Kobren's newsletter appeared.

Some experts do get it right: Over two years ago, on October 22, 1998, a reader asked TheStreet.com columnist Elizabeth Roy Stanton to comment on the Heartland Short Duration High-Yield Municipal Fund ("Heartland Short Duration Municipal Bond is billed as an alternative to tax-exempt money-market funds. Good yield, stable NAV. I like the manager. What do you think?").....As it turned out, Stanton's reply was right on the money:

"You should steer clear of this fund, at least as an alternative to a money-market fund.

As you know, a money-market fund all but guarantees you will not lose principal. Money-market funds are managed to maintain a stable net asset value of $1.

Maybe you can stand some more principal fluctuation than that, but picking a high-yield fund is going as far in the opposite direction as is possible to go. In other words, you're putting your principal at the most risk possible by getting yourself into a high-yield fund. The only way to get a high yield is by taking more risk."

Some experts don't get it right, even after they've been hit over the head with a baseball bat:

FundAlarm reader "Ralph" received the following recommendation on October 26.....It came in a mailer from Sheldon Jacobs ("The Dean of No-Load Fund Watchers"), almost two weeks after the big troubles at Heartland became public:

On the positive side, Heartland Taxable Short Duration Municipal Bond Fund (above) wasn't one of the funds that suffered a massive revaluation.....On the negative side, this fund screams for caution, and it's astonishing that Sheldon Jacobs would want anything to do with it.....Last December, an article in Institutional Investor magazine described the type of bonds held by this fund -- taxable, non-investment grade munis -- as a "fixed-income fringe," and several bond managers from major investment houses didn't even know that this type of investment existed.....Using words that should send a shiver up every investor's spine, manager Thomas Conlin described these bonds as a "layup," and he noted that, on a risk-adjusted basis, they're "cheap"....."I'm happy to have [the area] more or less to myself," said Conlin, who also happened to manage the two devalued Heartland funds and is now gone....Let's recap: (a) This fund holds bonds that are a risky sub-specialty within a risky specialty; (b) One of the few "experts" in the country who purported to understand these bonds (Conlin) has left Heartland under suspicious circumstances; (c) The very survival of the firm that manages this fund is in serious doubt; and, (d) Sheldon Jacobs recommends it as a "remarkable bond fund opportunity".....If Mr. Jacobs wishes to proclaim himself Dean of the no-load fund watchers, we're not going to argue.....But in the FundAlarm grade book, we're giving the Dean a big, red "F for this recommendation.

Update (December 9): A FundAlarm reader informs us that Jacobs' November newsletter contains the following recommendation: "Even though further damage will probably be minor, we opt for prudence. Sell HEARTLAND TAXABLE SHORT DURATION MUNI." Prudence thanks Mr. Jacobs for his attention, but wonders where he was in October.

It still helps to have friends in high places: This item gets a bit complicated, but it's a great story.....On September 29, the sinking Heartland muni funds desperately needed cash, apparently to meet fund redemptions.....The State of Wisconsin Investment Board (SWIB), which manages Wisconsin's public-employee pensions, stepped forward to buy $8.3 million of Heartland's distressed securities.....And how did the SWIB know that Heartland was looking to sell these bonds?.....It turns out that the Chairman of the Wisconsin Investment Board, Jon Hammes, is one of Heartland's paid, outside directors, and Hammes told the folks at Heartland whom to call at the SWIB.....(Hammes says that he took no further part in the SWIB decision, and the SWIB swears that it got a great deal on the Heartland bonds).....When he's not watching the Heartland funds crash and burn, Hammes also runs the Hammes Co., a major real estate developer in the Milwaukee area.....Hammes Co. owns a 68,000 square-foot building in downtown Milwaukee, and the anchor tenant of this half-vacant building just happens to be Heartland.....So, if Heartland were to go belly-up, Hammes would not only lose his Director's job, but he'd also lose a major tenant.....Unfortunately, investors who'd like to know more about the Heartland-SWIB deal are out of luck: The details of this transaction are protected by a confidentiality agreement.
The details above come from several columns by Cary Spivak and Dan Bice in the Milwaukee Journal Sentinel (www.jsonline.com). The Journal Sentinel, and Spivak/Bice, have done a terrific job following the Heartland story.
"When sorrows come, they come not single spies, but in battalions"--Hamlet
In a November 14 filing with the SEC, Heartland announced that it planned to "vigorously" defend itself against shareholder lawsuits.....But Heartland also wanted to let folks know that, if Heartland lost the shareholder suits, the remaining assets in the two suffering funds could be used to settle the damage claims, and those potential claims "could exceed the assets of the Funds".....In other words, a total wipe-out.....Heartland also warned fleeing investors that they might not receive payment for their shares for up to seven days, since the funds would be selling illiquid securities into a difficult market.
There's at least one book that Heartland President Bill Nasgovitz hasn't read: If your car suddenly started levitating, or your vacuum cleaner started sucking up small children, you probably wouldn't need an expert, or a jury, to tell you that something was seriously wrong.....In our opinion, it's a similar situation with these two Heartland funds: Something clearly went wrong, and the goal now should be to find out what that was, and make the victims whole as quickly as possible.....Nasgovitz needs to stop treating his investors as adversaries, and start taking a leadership role.....He needs to get out in front of this crisis, and show that he feels some pain.....For starters, he might stop hiding behind his corporate PR people, and make himself available to investors and the press.....He also might try posting daily updates on the Heartland Web site, and start staffing a 24-hour 800-number for aggrieved Heartland investors.....Even if those actions compromise his legal position, they're the right thing to do, and it's the least he can do for the people he has put though this gut-wrenching nightmare.....If Nasgovitz continues to treat his investors as the enemy, he deserves to lose every dollar that's still invested in his other funds.....If you have money with Heartland, and Nasgovitz continues to stonewall, you might seriously consider voting with your feet.

The perils of chasing performance (#282): Exactly one year ago (December 1999), the Kinetics Internet fund (WWWFX) had a 12-month return of almost +254%, while the large-cap value Clipper fund (CFIMX) had basically returned 0% over the same 12-month period.....This month, in FundAlarm, the Kinetics Internet fund shows a 12-month return of -5.10%, while Clipper has returned slightly more than +24% over the same period:

Dozens of other funds show the same kind of pattern that you see in the graph above: Spectacular 12-month returns that head almost straight down, month after month, and mediocre 12-month returns that show gradual, but significant, improvement.....A year ago, if we had predicted that Clipper would have a better 12-month record than Kinetics Internet, you might have called us crazy.....Today, it seems obvious.....But a year ago, just as surely as you're reading this, some folks bought the Kinetics Internet fund based solely on its short-term performance, and some folks sold the Clipper fund for the same reason.....Next time you're tempted to chase short-term performance -- and it'll probably be soon -- try to keep this little graph in mind.....Hot funds never stay hot, and cold funds with decent managers don't stay cold forever.....Could we be so tedious as to suggest, once again, that diversification is the key to investment success?

He's on TV, too. But
would you buy his fund?

Are you a sucker? Mutual fund companies have a nice little racket going: They've discovered that some of you will buy their funds if they can simply get their fund managers on the TV financial shows.....That's why more and more fund companies are building in-house television studios, which makes it easy for CNBC, et al., to quickly find talking heads when they need them.....A new television studio at Federated headquarters has helped that firm boost its TV appearances from 25 to 250 a year, and Federated is convinced that these appearances have resulted in millions of new dollars for its mostly mediocre funds.....T. Rowe Price has a television studio, as does Strong, Fidelity, Putnam, John Hancock, and -- yes -- even penny-pinching Vanguard.....Lord Abbett Funds is still in the process of building its studio, so all you Lord Abbett fans will need to contain your excitement just a little while longer.

Except for the total lack of public interest, these funds might have made it:

The de Leon Internet 100 fund has the distinction of being the first pure Internet fund (out of about 20) to fold.....The fund struggled to accumulate about $2 million of assets, but had little difficulty losing about 40% of its value this year.....According to Morningstar, six other Internet funds have less than $6 million in assets, and 11 have lost at least at least as much as de Leon Internet this year.....Among the Internet funds that are most likely to become ex-Internet funds: Potomac Internet Plus and Westcott Nothing But Net.
By the time you read this, the online mutual funds from X.com also will be history.....In case you've forgotten, X.com was founded about a year ago by 28-year old Elon Musk, and its no-fee, no-minimum, no-track record, no-reputation mutual funds were supposed to be just the beginning: "You can expect down the line, brokerage capabilities, insurance, personal financial management, tax management -- some of it done with partners, some by ourselves -- but always seamlessly integrated together".....Well, those great plans are history, and now about all you can expect from X.com is an e-mail cash payment service, called PayPal.

Words that suddenly take on a whole new meaning: Here's an excerpt from a December 1999 interview with John Story, who was hired by Elon Musk to head the X.com asset management unit:

"I didn't really understand how [the Internet] revolution would look until I met Elon...."

Monument Funds Group is changing the name of the Monument Internet Fund to the Monument Digital Technology Fund.....The newly-named fund will concentrate on Internet stocks that everyone today thinks are hot, versus the old fund, which concentrated on stocks that everyone thought were hot last February.

When we first revealed that Janus was planning to dominate the world, nobody believed us:

[A partial list of Internet domain names recently registered
by Janus Capital Corporation]

JANUSSWITZERLAND.COM
JANUSLUXEMBOURG.COM
JANUSINDIA.COM
JANUSJAPAN.COM
JANUSNORWAY.COM
JANUSFRANCE.COM
JANUSSAUDIARABIA.COM
JANUSINDONESIA.COM
JANUSSOUTHAFRICA.COM
JANUSSINGAPORE.COM
JANUSPANAMA.COM
JANUSNETHERLANDS.COM
JANUSHUNGARY.COM
JANUSICELAND.COM
JANUSSPAIN.COM
JANUSTAIWAN.COM
JANUSISRAEL.COM
JANUSURUGUAY.COM
JANUSPAKISTAN.COM
JANUSGERMANY.COM
JANUSGREECE.COM
JANUSKOREA.COM
JANUSOMAN.COM
JANUSITALY.COM
JANUSHONGKONG.COM
JANUSTURKEY.COM
JANUSHK.COM
JANUSSWEDEN.COM
JANUSUNITEDKINGDOM.COM
JANUSPOLAND.COM
JANUSRUSSIA.COM
JANUSNEWZEALAND.COM
JANUSUAE.COM
JANUSFINLAND.COM
[and, finally, no kidding..]
JANUSWORLD.COM

A year ago, when we last wrote about wash sales, we noted that nobody knew for sure how index funds should be treated for purposes of the wash sale rules.....Well, that's still the case.....A wash sale is triggered by the sale of one security at a loss, and the repurchase of a "substantially identical" security within 30 days before or after that sale..... One school of thought says that all funds keyed to the same index are "substantially identical" -- in other words, you couldn't sell one S&P 500 index fund at a loss, and buy any other S&P 500 fund within 30 days, without causing a wash sale.....But another school of thought says that index funds are not subject to the wash sale rules if they are sufficiently different -- for example, two S&P 500 funds managed by different fund companies might not be considered "substantially identical".....With the widespread introduction of exchange-traded funds (ETFs), the wash sale rules for index funds have gotten even murkier.....For example, even if there might be a problem swapping one S&P 500 index fund for another, perhaps it's OK to swap an S&P 500 index fund for an S&P 500 ETF?.....Risk-averse taxpayers will probably want to treat all index funds and ETFs as "substantially identical" if they are keyed to the same index.....But other taxpayers might want to take the more aggressive position, which could open up some interesting tax planning opportunities with index funds.

If you decide to take an aggressive position on wash sales, you should also know that a wash sale is almost impossible for the IRS to spot from the face of a tax return unless it's flagged on Schedule D.....If you take an aggressive position on the exchange of one index fund for another, and you believe the transaction doesn't qualify as a wash sale, you obviously wouldn't show it as a wash sale on your tax return.....So how does the IRS identify these "potential" wash sales? In the vast majority of cases, they're spotted only if your return is under audit for something else, and even then it's rare.....This doesn't mean that investors should flout the wash sale rules, but it does give quite a bit of leeway for legitimate tax planning.

We call it Really Obvious^SM

From the MFS Web site:

Briefly noted:

Value Line Aggressive Income isn't the worst high-yield bond fund this year, but it's certainly within hailing distance of the bottom (for the record, Paine Webber High Income B occupies the bottom high-yield slot, with a YTD return of -31.1% through November 27; Value Line Aggressive has returned -22.3% over the same period).....Are there problems at Value Line Aggressive Income?.....One FundAlarm reader thinks so.....According to our anonymous (but credible) informant, the lead portfolio manager of Aggressive Income (Nate Grant) left in September, and his replacement (Brad Brooks) has no high-yield experience at all -- not one day.....Former manager Grant had a rough six months before he left, and the problems he created have apparently been compounded by Brooks......And here's an interesting sidelight: Although all Value Line funds are officially run by nameless teams, our informant insists that each fund is actually run by a single person.....The reason for the "team" fiction is reportedly to keep fund managers from getting media attention, which might make the managers more employable elsewhere....."But the turnover is very high, nonetheless," notes our informant.....We'd like to bring you Value Line's side of this story, but the PR person we spoke to (twice) wasn't able to get his fund managers to pick up the phone and call us back.

FundAlarm spies also tell us of growing unrest at Fortis Financial Group, which runs the Fortis funds.....The Fortis U.S. operations are reportedly up for sale, the VP of mutual funds and at least one other key executive have bailed, and one fund manager has already jumped ship (Laura Granger, to Oppenheimer).....The remaining Fortis-ites are said to be tense.

	Does your mutual fund also run a hedge fund? If it does, believe me, that's a massive conflict that simply should not be allowed. One of the more obvious conflicts that should be illegal but isn't is the right for a manager to take on two different tasks: a hedge fund and a mutual fund... ...Does your mutual fund run a hedge fund on the side? If so, I would pull my money out. There is no reason for this conflict. It is only to enrich the manager, often at your expense. (If you can't find out, by the way, that's not good news either. You deserve to know the answer to this key question.) Go elsewhere.
--Jim Cramer, TheStreet.com, November 13, 2000

Typical Cramer: You never know what he's really thinking.

Scudder is the latest fund family to slap loads on its no-load funds.....Also, the entire Kemper line of funds is scheduled to bite the dust -- henceforth, Kemper funds will carry the Scudder name, and several former Kemper funds will almost certainly be merged out of existence.....Among the more likely candidates for merger: Kemper Growth will disappear into Scudder Large Company Growth, Kemper Total Return will be absorbed into Scudder Balanced, and Kemper Value will find happiness within Scudder Large Company Value, even though Kemper Value has a slightly better track record, and the merger should logically go the other way.....The unresolved problem with Scudder is that it's such a boring fund family, with few performance leaders and no particular consumer identity.....To coincide with the company's backward leap into load funds, Scudder marketing executives are reportedly considering another strategy: Toss out Scudder's new and wimpy rowing logo, bring back Scudder's old sailor logo, and capitalize on consumer familiarity with the Gorton's fish stick guy.....Actually, this makes a lot of sense.....Now that the mutual fund business is almost solely concerned with moving product, the grocery freezer case could be an exciting new distribution channel for Scudder funds.

New Scudder logo
Old Scudder logo
A natural tie-in?
For many years, USAA Aggressive Growth has been run with a "sliding" fee structure that lowered the management fee as assets grew -- a fair arrangement for investors, and one that was initiated by USAA itself.....In 1996, USAA asked fund shareholders to approve a fee schedule that would enable USAA to charge a higher management fee, and shareholders refused.....USAA apparently sulked for a few years, and now it has come up with the mutual fund equivalent of the petulant kid taking his baseball away.....USAA has announced that it will close the Aggressive Growth fund to new investors, which effectively freezes the management fee at 0.38%.....At the same time, USAA will open a clone fund (USAA Capital Growth) with a management fee of 0.85%, more than twice the fee charged by Aggressive Growth.....USAA says that it's "uneconomical" to run the $2.2 billion Aggressive Growth fund with a 0.38% management fee, which is simply a ridiculous statement.....What USAA means to say is this: "When we originally established our sliding management fee, the mutual fund industry had more integrity, and occasionally customers got a break. Of course we could continue to run this fund with a 0.38% management fee, and of course we could continue to make money. But now that everyone is grabbing for every buck they can, we figured 'What the heck?' If you're looking for a bunch of saints, go invest with Vanguard."
Approximately 200,000 Wall Street employees -- including traders, analysts, and back-office staff -- are expecting record bonuses this year.....Even though your personal portfolio may be down, Wall Street makes its money from activity, and there's been plenty of that during 2000....Total compensation for most securities professionals should increase 25 to 35 percent.....Luxury apartments in Manhattan rose an average of 13 percent during the first nine months of 2000, led by Park Avenue, where prices were up 52%, and Central Park West, with a more modest increase of 43%.....According to one top real estate broker, Wall Street clients make up 20% of the market for luxury apartments, and "everybody wants larger space."
Yahoo! News, November 23, 2000; thanks to FundAlarm reader Woody Collins
For 50 years, Putnam executives have served on the Board of Putnam mutual funds, and for 50 years Putnam has paid these directors out of fund assets.....(For example, Putnam's $27 million-per-year CEO, Lawrence Lasser, picks up $189,000 of lunch money for his Board chores).....Putnam's in-house Directors will continue to occupy Board seats, and they'll still be paid, but Putnam has quietly decided to stop taking the money out of investor pockets.....From now on, Putnam will dig deep into its own pockets to support its own Directors.
Several months ago, Jim Craig left his job at Janus, officially to help his wife run the new Craig Family Foundation.....Craig had owned a small piece of Janus, and last month he sold his shares back to the firm for $78 million.....That's a nice chunk of change and, if anyone would like to offer, FundAlarm would be delighted to accept any amount that's even close.....But Craig's severance deal also highlights the difference between being an employee and an owner in the mutual fund world.....Tom Marsico, who used to work side-by-side with Craig at Janus, went out on his own about three years ago.....Marsico recently sold his money management firm for almost $1 billion.....Marsico is currently #382 on the Forbes 400 list of the wealthiest Americans, and he's worth an estimated $750 million.....Even after the recent buy-back, Craig is still about $660 million shy of appearing on the Forbes 400 list.
Within the next few months, the SEC is expected to issue a new rule that cracks down on mutual funds with potentially misleading names.....According to Investment News, the rule will require a fund to invest at least 80% of its assets in the type of investment suggested by the name, instead of the 65% that is currently required.....The poster child for this new rule is Bill Miller's Legg Mason Value Trust, which has long been a leader in stretching the definition of a "value" fund.....Any rule that improves disclosure and investor understanding is a good one, but we wonder how much real-world difference this new rule is going to make.....In the long run, we're likely to see many more funds with vague names -- "Multi-Cap," "All-Cap," "Opportunity," "Flexible" -- and it's difficult to see how investors will benefit much from that.
* "Halt! Who Goes There?," David Hoffman, November 20, 2000
As long as we're attacking investor confusion, how about dealing with one of our pet peeves: Funds with misleading celebrity names.....Marty Zweig, for example, has no management role at any of the Phoenix-Zweig funds, Frank Cappiello bowed out of the Cappiello-Rushmore funds a long time ago, and folks who run some of the "Gabelli" funds probably haven't gotten input from Mario in many, many moons.....We're guessing here, but we suspect that more people have been confused by these celebrity funds than by all of the mislabeled "value" funds combined.
A subsidiary of New York Life Insurance Co., NYLIM, has acquired the Eclipse family of mutual funds.....Wesley McCain, lead manager of all the Eclipse funds, has signed a contract to continue as Eclipse senior investment officer over the next six years, with decreasing involvement.....Kathy O'Connor, co-manager of Eclipse Small Cap Value and Eclipse Mid Cap Value, has also signed an employment contract, with an unspecified term.
Clueless? Floundering? Befuddled? When it comes to Liberty Financial, the answer is "Yes," "Yes," Yes".....Over the past several years, Liberty has been assembling a stable of mutual fund firms, and the company now owns the Newport, Colonial, Crabbe Huson and Stein Roe fund families.....Liberty's latest acquisition, the Acorn funds, was completed just a few days before Liberty announced that it was putting itself on the market.....If a sale does go through, investors can almost certainly expect funds within the various Liberty families to be consolidated, and management fees to rise.....To give investors a taste of the confusion to come, Liberty also announced that it plans to merge 19 mutual funds into 10 others as soon as shareholders approves.....Among the more significant mergers: Three Liberty funds (Value Opportunities, Value, All-Star Value) and one Stein Roe fund (Growth & Income) will be absorbed into Liberty Growth & Income.....Among the strangest mergers: Liberty Newport Global Utilities and Liberty Newport Global Equities.....Global Utilities is currently allowed to invest up to 100% of its assets in the securities of utility companies, while Global Equities can't invest more than 25% of its assets in any one industry.....After the merger, the surviving fund (Global Utilities) is likely to look like just another diversified, global fund.*
* "Liberty Financial Merging 19 Mutual Funds Into 10 Others," Ann Keeton and Allison Bisbey Colter, Dow Jones Newswires, November 6, 2000