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

David Snowball's
New-Fund Page for December, 2009

[Open for business | Coming attractions | Stars in the shadows]

Dear friends,

Welcome to the last month of 2009, a time when even Hindu investors pray fervently for the arrival of the Santa Claus rally. Which, for once, we hardly need. The market is up handsomely and nearly a dozen of the funds we’ve profiled over the past four years have gained more than 50% through Thanksgiving:

Wasatch Emerging Markets Small Cap	102%
Metzler Payden European Emerging Markets	98
Aegis Value	77
Matthews Asian Technology	56
Fidelity Emerging Middle East & Africa	55
Buffalo China	52
Tilson Focus	51
Oakmark Global Select	50

Only three of the 101 funds we've profiled are in the red: ETrade Delphi Value (-0.05%), Rydex/SGI Managed Futures Strategy (-2.0) and Nakoma Absolute Return (-7.8).

Quality Funds in a Junk Environment
If we’re all making wads of money this year, why are so few investors – professional or amateur – relaxed and happy? One possibility is that we realize that the wrong investments are making the most money, a situation that seems unsustainable. And maybe ripe for sharp reversal.

What do I mean by "the wrong investments" making money? At base, I mean that the lowest-quality assets have seen the year’s strongest returns. Consider these examples:

Morningstar rates all stocks as having either a "wide moat" (i.e., a sustainable competitive advantage over their competition), a "narrow moat" (an erodible or transitory advantage) or "no moat" (they’re in the midst of "eat or be eaten land"). Over the long term, wide moat firms should be your best bet. But here are their YTD returns (as of 11/26/09):

Wide moat companies: 17.9%

Narrow moat companies: 31.0%

Moatless wonders: 42.7%

Institutional investor Grantham, Mayo, van Otterloo (GM0) tracks the performance of both high quality US stocks and others. GMO's October 2009 Quarterly Letter reports that junk has outperformed quality by this much only one before:

. . . our financial leaders so overstimulated the risk-taking environment that junk, weak, marginal companies and zombie banks produced a record outperformance (the best since 1933) of junk over the great blue chips. (Ouch!)

At the mutual fund level, we can compare the performance of a set of funds which represents the "quality" and "junk" sectors of the market. For "quality," I looked at the performance of a handful of great funds which specialize in investing only in great companies (Bridgeway Blue Chip 35 Index, FMI Large Cap, GMO Quality, Industry Leaders Fund, Lexington Corporate Leaders, LKCM Equity). For "junk," I looked at all of the funds which invest in sub-microcap value stocks. That is, in the tiniest companies with the shakiest financials. Here’s the YTD result:

Quality composite: 22.8%

Junk composite: 40.4%

Twenty-five funds have returned more than 100% YTD. Twenty-two of them are either leveraged 2:1 or invest in emerging markets or use 2:1 leverage in emerging markets.

Six-hundred-sixty-six funds have returned more than 60% YTD. Twenty-five of those funds are diversified, domestic offerings. Here’s the Morningstar rating for those 25:

Five star funds: 0

Four star funds: 0

Three star funds: 5

Two star funds: 8

One star funds: 10

Unrated: 2

In consequence, there’s a sense that the greater opportunities – now and for the foreseeable future – may lie with higher-quality companies. You don’t need to buy the judgment of Randall Forsyth, a respected Barron’s columnist, that the sharp reaction to the Dubai insolvency signals that "It appears the end game for this market phase has begun" ("Dubai Debt Woes May Mark End of Risk Trade," 11/27/09). You could focus on more quantitative estimates. Morningstar’s stock analysts calculate that the universe of "wide moat" stocks is undervalued by about 10% (again, as of 11/27/09). GMO’s Jeremy Grantham argues that "Quality stocks (high, stable return and low debt) simply look cheap and have gotten painfully cheaper . . . in our seven-year forecast, the quality segment has a full seven-percentage-point lead of the whole S&P500, or 9% over the balance ex-quality. This is now at genuine outlier levels." Grantham argues that these firms, with little debt and substantial revenue from outside the US, are the market’s "one free lunch": you don’t have to pay a premium for acquiring the best investments. Morningstar stock strategist Jeremy Glaser reported at the end of November that, for the first time in 2009, quality was gaining traction: "The Morningstar Wide Moat Index rose 4.6% over the last month, compared with a 1.05% gain for narrow-moat firms and a 0.13% loss for no-moat names" ("Junk Rally Takes a Breather," 11/28/09).

In celebration of the possibility of profiting by investing in great companies, this month’s two fund profiles highlight tiny funds with superb management and a focus on high-quality, dividend-paying stocks: Manning & Napier Dividend Focus (MNDFX) and Royce Dividend Value (RYDVX).

Babes in Alarm-Land

In celebration of the Thanksgiving holiday, several lists of "turkey" funds have appeared.

The most modest list, but also the most widely distributed, was Russ Kinnel’s Fund Spy column, "Four Mutual Fund Turkeys That Survived Thanksgiving" (11/26/09). His essay begins:

Not all turkeys get killed on Thanksgiving. Consider these four mutual funds. No sane person would ever invest in them. But they're still around even though two of the four managers have no money in their funds, while the other two have only token investments in theirs. I don't blame them.

His nominees for decapitation (possibly defenestration and certainly deportfoliation) are:

GAMCO Mathers (MATRX) - a high cost perma-bear fund whose manager of 35 years still hasn’t gotten around to investing a dollar of his own money in the thing.

ProFunds UltraShort Mid-Cap (UIPIX) – leverage kills.

AMIDEX Cancer Innovation & Healthcare (CNCRX) – what do you get when you combine a remarkably narrow focus, a 50% cash stake and a 5.13% expense ratio?

Berkshire Focus (BFOCX) – down by 12%/year for the past decade!

SmartMoney columnist Rob Wherry shared his list of "Turkeys: 20 Big Funds Down in the Dumps," which represent the bottom 15% of their respective Lipper categories over the trailing one-, three-, five- and 10-year time periods" (Wherry notes that his "Screen only focuses on equity mutual funds"). He turned up 64 gobblers in all, only seven of which top $100 million in assets. These biggest turkeys are:

	Assets	Snowball's Note
SEI International Fixed-Income A	$545 million	Uhhh . . . "fixed income," dude. Why is this showing up in a list of bad equity funds? The $100,000 price of admission will protect most of us.
Calvert World Values International Equity A	$410 million	High expenses, high front load, a bad quant model, consistently rotten returns and the most Morningstar came up with: "We’re not sold on this mutual fund."
Goldman Sachs Structured Large Cap Value A	Wherry reports $250 million but the total rises to $1 billion when all the very bad share classes are included	A "Most Alarming Three-Alarm Fund" by our calculation
Franklin Real Estate Securities A	$204 million	It’s trailed 95% of its peers in three of the past four years, so I guess the managers should get credit for consistency.
GMO Currency Hedged International Bond III	$134 million	And, again, "international bonds" generally don’t show up in equity fund lists. Good news: with a $10 million minimum initial investment, most of us are safe from their wiles.
Dreyfus Emerging Leaders	$133 million	Safe again: it’s closed to new investors. This once-promising no-load small cap fund has been sucking for, oh, about 10 years. Investors should harvest their tax losses and move on.
Morgan Stanley S&P 500 B	$103 million	A nice illustration of the danger of expensive index funds: this fund charges 10 times more than Vanguard’s cheapest S&P fund and modestly more than the average actively-managed fund. Those expenses kill it.

Here’s the good news: Of Wherry’s 20 biggest turkeys, only three are no-load retail funds:

	Assets	Snowball's Note
US Global China Region (USCOX)	$52 million	The adviser notes, "like a delicious micro-brewed beer, we believe our funds offer a unique experience that isn't found elsewhere." To which, in the spirit of Thanksgiving, one might add a fervent "amen." In fairness to USCOX, this fund performed brilliantly from inception through 2007, outgaining its benchmark by almost 2:1. Same management team for the whole time.
UTC North American (UTCNX)	$33 million	Have you ever read a fund document and been reduced to "well, okay then." This one got me: "The Manager is a wholly owned subsidiary of the Trinidad and Tobago Unit Trust Corporation, a quasi-governmental entity which was created by the Unit Trust Corporation of Trinidad and Tobago Act, 1981." Neither of the managers – Sean Achong or Jamela Akinlana – has been silly enough to invest a penny in the fund.
Value Line Fund (VLIFX)	$ 87 million	The managers are pretty much stuck with a mandate to buy stocks rated 1 and 2 by ValueLine’s stock rating system and selling any rated 4 or 5. During the years in which the system works – about half the time – the fund tends to be solidly above average. But in the years in which the system fails, it fails disastrously.

The same pattern repeats in Wherry’s complete 64 fund list: 44 of the funds carry sales loads, a half dozen were institutional funds and a few were the dead remnants of former no-load funds which had been adopted by load families.

This is also the time of year when Maxfunds offers up their annual "Mutual Fund Turkey Awards," but I haven’t heard a peep from them just yet. Turkey burnout, perhaps?

And to the whole bunch we say: Amateurs! Dilettantes! Once-a-year warriors!

The quest to root out Alarming Funds isn’t a once-a-year exercise. Nay, nay – at FundAlarm, it’s a daily (okay, "monthly") devotional activity. Wretched incompetence never sleeps, so neither do we. FundAlarm tracks both Three-Alarm funds (1353 little darlings which trail their benchmark index for the past 1, 3, and 5 years) and the Most Alarming Three-Alarm funds (i.e., essentially those Three-Alarmers that trail their benchmark by the greatest amount over three-year and five-year periods).

The burning question of the day: which are America’s Most Alarming Fund Families? To answer the question, I started with our Most Alarming Three-Alarm fund list and removed all of the instances of multiple share classes from funds so that I only counted each wretch once. And then I sorted by family. Herewith are the winners:

Family	Number of Most-Alarming Funds	Lesson
ProFunds	17	Leverage kills!
Rydex	15	Ditto.
Dreyfus	6	A bewildering mix of 105 load and no-load funds, many run by outsiders, none of which qualify as Morningstar "analyst picks." With over 100 offerings, you’d think they’d stumble into one gem anyway.
DWS	6	A family of 70 load-bearing funds with only about 15 above average.
Fidelity	6	If you see Growth & Income (FGRIX) or Mid Cap Growth (FSMGX) in your portfolio, report it immediately to responsible authorities.
ICON	6	A nice balance of bad sector funds and bad diversified funds.
Legg Mason	6	Ridiculously high expenses are not the investor’s friend.

The data in this table, and the preceding discussion, is based on last month's FundAlarm update.
But awfulness doesn't change much in the FundAlarm world, so this month's results should be quite similar.

Curious to find out which individual funds are über-alarming? Check out this month's list of three alarm funds, newly-minted three-alarm funds, and most-alarming three-alarm funds, all of which can be found here.

Lift proudly your glass of "Two Buck Chuck"

Trader Joe’s, one of my favorite shops, loves to offer good stuff for cheap. There’s nothing that exemplifies that ethos more than their beloved "Two Buck Chuck," simple wines from Charles Shaw that sold for . . . well, two bucks. The New Yorker describes it as "cheap wine that yuppies would feel comfortable drinking" ("Drink Up," 05/18/09). It goes well with spaghetti.

But wouldn’t you really rather be sipping a Guigal La Landonne Cote Rotie? For $400, you could have a wine where "aromas of Peking duck, bouquet garni, graphite, asphalt, blackberries, and charcoal soar from the glass." A superb score of 95 points from Wine Advocate. Connoisseurs on a bit of a budget (or those hopeful of beverages less redolent of paving) might go for Guigal Hermitage Ex Voto, where its "honeyed quince, white truffle, marzipan, hazelnut, marmalade, and buttered citrus characteristics emerge from the aromas and flavors of this gigantic, well-endowed, massive, dry white." Ninety-six points from Wine Advocate and a bargain at barely half the price!

Would that be ever so much better than the $5 bottle of Le Grotte Reggiano Lambrusco Dolce (another TJ special) which awaits me and long-simmered pot roast tonight? The answer, according to Leonard Mlodinow, author of The Drunkard’s Walk: How Randomness Rules Our Lives, is "no." In a splendid essay in The Wall Street Journal, Mlodinow presented a stunning array of evidence to support what Two Buck Chuck fans have long suspected: most of that pretentious wine blather is, pretty much, pretentious wine-fueled blather ("A Hint of Hype, A Taste of Illusion," 11/20/09). Among Mlodinow’s points:

"even flavor-trained professionals" can detect no more than three or four taste components in a mixture, though wine critics routinely report six or more.

two professional wine-tasters, given the exact same wine, will report two entirely different flavor profiles.

when presented with the same dry white wine doctored with varying amounts of red dye, a panel of judges reported dramatically different levels of sweetness based on their guess about what wine (from super-sweet sauterne to bone-dry burgundy) it looked like they were drinking

when one vintner submitted the same wine to a wine competition under three different labels, two were rejected by the judges ("undrinkable") while the third bottle of the same stuff received a double gold medal from those same judges.

Only one wine judge in ten will, when drinking the same wine on three occasions during the day, give that wine even vaguely-comparable (plus/minus 2 points) scores.

All of which led the editor of Wine and Spirits to observe that "even though ratings of individual wines are meaningless, people think they are useful."

So, why exactly are you paying through the nose for high salaries and expensive marketing? Do you simply feel good when you can start a sentence with, "My broker . . ."? The research on the value of brokers is painfully clear. The most recently published study from Harvard Business School researchers concludes, "we do not find that brokers deliver substantial tangible benefits. In short, while brokerage customers are directed toward funds that are harder to find and evaluate, brokerage customers pay substantially higher fees and buy funds that have lower risk-adjusted returns than directly-placed funds" ("Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry,' Review of Financial Studies, 2009). Those conclusions are essentially unchanged from the researchers’ early examinations of the data, which also found "brokered funds exhibit no better skill at aggregate-level asset allocation than funds sold through the direct channel" (Working papers, 2004 and 2006). One intriguing doctoral dissertation, entitled "The Duplicity Effect: Professional Investment Decisions for Other versus Self" (2008) matched brokers with demographically-similar clients (e.g., a 48-year-old broker in good health with $250,000 income advising a 48-year-old client in good health with $250,000 income). The researcher found that the portfolio recommended by the broker (a) looking nothing like his or her own portfolio, (b) offered higher risks than the broker’s own portfolio, and (c) didn’t typically optimize asset allocation to reduce risk.

Do you recall that more than two-thirds of Rob Wherry’s turkeys, and the vast majority of the largest turkeys, carry sales loads?

The eminently-sensible Scott Burns (columnist, raconteur, co-author of Spend 'Til the End: The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire and a handsome devil) has been railing for years against paying excessive fees for illusory gains. Scott recently shared with us his new Fat Fund Report, a careful analysis of fees and performance which reaches the confident conclusion that "the vast majority of investors are overpaying for under-delivered service." Mr. Burns’ report offers a useful chart on the distribution of expense ratios: for example, among large cap domestic core funds, the most expensive 10% charge 2.03% or more, the most expensive 25% charged 1.57% or more, and so on. Look at your portfolio, look at the table, and ask whether your money is going into your account or your manager’s. Scott’s simple injunction for novice investors who are looking to make better returns and who rely on advisers: "if you financial adviser only offers high cost funds, you know that serving your interests is probably not his primary concern."

In closing . . .

Magazines such as Fortune and BusinessWeek, which were launched during The Great Depression, seem to be suffering now during a period we might call The Great Disinterest. Fortune already announced plans to publish seven fewer issues each year and was in line for staff cuts. Fortune Small Business was just terminated and Time-Warner, Fortune’s publisher, is slicing an additional 500 jobs including 40 at Fortune. Forbes fired 100 staffers in October. That follows the closure of Business 2.0 and Portfolio, both earlier this year. BusinessWeek was recently sold, reportedly for a song, to Bloomberg. The plan is to refashion the magazine to look more like the business press’s one success story: The Economist. Heck, even the monopolist Morningstar reported a 4.3% decline in revenues for the third quarter of 2009 with a substantially larger drop YTD.

New York Times columnist David Carr attributes the fall to what I called "The Great Disinterest." His argument, in a November 2 column, is that regular folks have become disenchanted with failed financial wizards and stories of the clueless avarice implied by $30 billion in bonuses being awarded at just three firms (Goldman Sachs, JP Morgan Chase, Morgan Stanley). Michael Silverstein, a Wall Street Journal columnist, calculates that the average bonuses awarded at those three firms will be greater than the annual incomes of five average American families ("Wall Street Bonuses – Are You Angry Yet?,"" 11/27/09).

Ironically, the latest report suggests that readership at many business publications --Forbes, Fortune, Inc., Smart Money, The Wall Street Journal and The Economist -- have seen year-over-year readership gains of 6-12% as folks scramble for whatever edge they can get. The problem, for most, is the disappearance of advertisers. Condé Nast Publishing, for example, lost 8400 pages of advertising across its various magazines this year. Two things you might not know:

You’re not actually paying for the magazines you’re paying for – advertisers are. For instance, a $4-5 lifestyle magazine like Cosmo actually costs something on the order of $10 to produce and distribute. When you get those desperate letters offering long-term subscriptions for pennies ("reply now to confirm your 47-year subscription of Mutual Funds Magazine for the low, low rate of eight cents an issue!") , you’re mostly seeing a "raise cash, stabilize the ‘rate base,’ and pray, oh pray, for advertisers" move.

Most publications live at the edge. For example, Fortune Small Business was forced to close because of a 17% decline in ad pages. A MarketWatch columnist, observing SmartMoney’s noticeable drop in ad pages, prophesied, "This magazine will close" (1/11/09).

Maybe Smart Money.
But, thanks to our readers,
not FundAlarm.
This brings me to my occasional reminder of our collective need to support FundAlarm with some reasonable regularity and vigor. The average American adult plans on spending $658 on holiday gifts this year. If just one person’s spending were channeled through FundAlarm’s link to Amazon, that would generate something on the order of $40 to $50 (FundAlarm's actual percentage varies, depending on total monthly purchases by readers). Netbook computers are projected to be the most popular electronics purchase of the season. If you indulge yourself by buying Amazon’s top-rated netbook, the white Acer AOD250-1515 with Windows 7 and a 10.1-Inch screen, you’ll get a great machine and free shipping while generating about $26 for FundAlarm. A lovely Mr. Squiggles Zhu Zhu Pet (don’t ask, I’m too old to understand) will generate a helpful $4 or so. Heck, even a copy of The Drunkard’s Walk or Spend’ Til the End will kick in about 60 cents. And if you get a chance to sneak the Amazon link onto your crazy brother-in-law Murray’s PC, all the better!

Folks who aren’t into holiday shopping have easy alternate options for supporting FundAlarm. Even those who don’t have the budget to help out financially are always welcome to join the party at FundAlarm’s one-of-a-kind discussion board (we’ll be serving virtual donuts in celebration of our 273,000th posting) and our first-on-the-web, largest-on-the-web list of Alarming and Most Alarming 3-Alarm fund.

Take care, keep in touch, celebrate with joy and I’ll see you in the New Year (yes, it’s that close!).

David

Open for business: These funds have already begun accepting investments.

NEW Discussed this month:
	Manning & Napier Dividend Focus (MNDFX): Manning & Napier launched at the outset of "the lost decade" of the 1970s when the stock market failed to beat either inflation or the returns on cash. The "strategies and disciplines" they designed to survive that tough market allowed them to flourish in the lost decade of the 2000s: every M&N fund with a ten-year record has significant, sustained positive returns across the decade. With Dividend Focus, they’re bringing those strategies to their first low turnover, index-like product.

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Coming Attractions: These are funds that have filed a prospectus with the Securities and Exchange Commission, but won't be available for purchase for a while. We'll keep an eye on these funds, and discuss the more interesting of them at length as their opening date draws nearer.

Biondo Focus will pursue long-term capital appreciation by investing primarily in a combination of long and short positions in domestic stocks, ADRs, foreign stocks, corporate bonds, and ETFs. The fund will be run by Joseph R. and Joseph P. Biondo who also run the distinctly underwhelming Biondo Growth fund. Expenses not yet set. $1000 minimum investment, reduced to $500 for IRAs.

In order to allow you to leverage your intimate understanding of various sectors of the (wildly manipulated and opaque) Chinese economy, you’ll soon have access to Global X China Consumer ETF, Global X China Energy ETF, Global X China Financials ETF, Global X China Industrials ETF, Global X China Materials ETF and Global X China Technology. Each will charge 0.65%

Not to be outdone, you’ll also be able to exploit IQ Everywhere: in case you’re short for exposure to niches that you probably shouldn’t be in, IQ comes to the rescue with ETFs including targeting IQ International Australia Small Cap ETF, Canada Small Cap ETF, Hong Kong Small Cap ETF, Indonesia Small Cap ETF, Malaysia Small Cap ETF, Singapore Small Cap ETF, South Korea Small Cap ETF, Taiwan Small Cap ETF, and Thailand Small Cap ETF, as well as Global Natural Gas Small Cap Equity ETF, Global Crude Oil Small Cap Equity ETF, Global Gold Small Cap Equity ETF and Global Agribusiness Small Cap Equity ETF. Expenses not yet announced.

Jacob Small Cap Growth Fund plans to be a broadly diversified small growth fund which pursues an "aggressive growth style." Up to 25% of the portfolio might be international. Expenses of 2.68% after waivers (owie). The fund will be managed by Ryan Jacob and the team that’s brought you, for better and worse, the Jacob Internet fund. Minimum initial investment of $2,500.

Jacob Wisdom Fund (I find names like this modestly worrisome . . . sort of like an "I Have Seen the Future Fund") want to "to maximize total investment return consisting of a combination of income and capital appreciation" by investing, primarily, in the domestic stocks with "greatest potential for capital appreciation and income." They can also hold up to 35% fixed-income and 25% international equities but might go 100% to cash. You’ll pay 1.95%, after waivers, for the privilege of accessing the wisdom of Mr. Jacob and company. Minimum initial investment of $2,500. If you want to watch him pensively stroke his beard, and sagely pontificate, you will have to make special arrangements.

T. Rowe Price Global Infrastructure which will invest . . . uhhh, globally in companies involved in providing "energy, transportation, communications, utilities and other essential services to society." Creating a more vigorous set of global investment funds seems awfully high on Price’s current to-do list. Managed by Susanta Mazumdar, a Price Asia/infrastructure analyst since 2006 and former head of equity research at UBS India. The expense ratio will be 1.10% after fee waivers, which is in line with what competitors charge. Expenses, after waivers, of 1.10% and a 2% redemption fee if sold within 90 days of purchase. $2500 minimum, waived for accounts with an automatic investing plan.

Toews Hedged International Developed Market fund will be managed by Phillip Toews and Randall Schroeder. The strategy is to use a combination of securities and derivatives to get varying levels of exposure (from 0 – 125%) to the components of the EAFE index. At base, they’ll make a series of macro-level calls about whether to be in stocks and, if so, in what sectors then they’ll buy EFTs to achieve the desired exposure. Fees have not yet been announced. The minimum initial investment to open any type of account is $10,000. For those who like the approach, Toews Corporation is simultaneously launching Toews Hedged Emerging Markets Fund (THEMX), Toews Hedged High Yield Bond Fund (THHYX), Toews Hedged Large-Cap Fund (THLCX), Toews Hedged Small & Mid Cap Fund (THSMX) to bring that same mojo to other venues.

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Stars in the shadows (funds that perhaps you should have noticed, but haven't): These are mostly tiny funds, already open (some for quite a while), whose achievements far outstrip their public presence. Why? In many cases, these will be funds offered by institutional money managers as a sideline. They're often created to benefit their clients' (or their own) employees. Such fund managers have no incentive to solicit huge inflows, tend not to charge marketing fees, and often absorb much of the cost of running these little funds into their own overhead. As a result, stars-in-the-shadows funds often offer average investors affordable access to the services of high-powered institutional or other private account managers. While these funds aren't guaranteed winners, their unique role in their sponsoring firms gives them a leg up.

NEW Discussed this month:
	Royce Dividend Value Fund (RYDVX): Clyde McGregor likes to describe his splendid Oakmark Equity & Income (OAKBX) fund as "the Oakmark fund with an airbag." This may not earn quite the same distinction but it is, at the very least "Royce with really good seatbelts and anti-lock brakes."