Highlights and Commentary

By Roy Weitz

(Originally posted January 1, 2002) [Archive Table of Contents]
"Mutual fund managers, repeat after me: 'This year, I will learn how to price securities'": If you bought shares of a Van Wagoner mutual fund during 2000, especially in the last half of the year, you may have paid too much.....The problem stems from certain pricing practices at the Van Wagoner funds, specifically the pricing practices for private placement securities.....The private placements bought by the Van Wagoner funds were typically stock investments in non-public technology and Internet companies.....As of December 31, 2000, the five Van Wagoner funds held a total of 35 private placements, which represented about 13% of total assets.....While some of these private placements had been purchased relatively recently, a number were acquired up to 15 months before.....Nevertheless, as of December 31, 2000, a majority of Van Wagoner's private placements were still valued at their original cost, and those private placement values were reflected in the each fund's overall net asset value (NAV)..........Given the turmoil in the technology and Internet world during the year 2000, there was essentially zero chance that a private placement stock acquired in late 1999 hadn't declined in value as of December 31, 2000.....Van Wagoner Emerging Growth owned two-thirds of all Van Wagoner private placements as of December 31, 2001, so its NAV was most likely to be overstated by the improper pricing of those securities.....Like the Heartland funds a year ago, the folks who run the Van Wagoner funds appear to have taken their pricing responsibilities, shall we say, casually.....At the very least, this incident highlights the danger of investing with a small, cowboy shop like Van Wagoner's.....At worst, Mr. Van Wagoner is likely to meet many more class-action attorneys than he ever wanted to.
"Private Placements Beef Up Van Wagoner Funds' Value," Tom Lauricella, The Wall Street Journal, December 11, 2001


Uh oh, it looks like lawyer time: Several days after we wrote the item above, the Milwaukee law firm of Ademi & O'Reilly filed a federal class-action lawsuit.....Named as defendants were the Van Wagoner funds, several Van Wagoner execs and, of course, Van Wagoner's accounting firm.....Allegations include violations of several securities laws, as well as "gross overvaluation" of private placement investments at Van Wagoner Emerging Growth fund.


Technology mutual funds have started to climb out of their deep hole, but most still have a long way to go until they claw back to their March 2000 highs.....You wouldn't know this, however, from the self-satisfied tone that's starting to creep into some tech manager comments.....Consider, for example, the following quote from Michael Sandifer, a member of the investment committee at Amerindo Technology Advisors:

"...it is especially rewarding to see the strong [technology] rally, which is evidence that things are working and that risk is being handsomely rewarded."*

We're wondering what planet Mr. Sandifer resides on.....The net asset value (NAV) of Amerindo Technology D hit an all-time high of 40.44 on March 9, 2000, and its NAV was 5.82 on December 28, 2001 (the fund declared no dividends during this period, so the change in its NAV is equivalent to the change in the value of an investment).....If you had invested $10,000 in this fund at its March 9, 2000 peak, your shares would have been worth about $1,400 in late December 2001.....Even if you had invested $10,000 in this fund on October 31, 2000, when it was 50% below its peak NAV, you'd only have about $2,900 in your account today.....If you really had guts, and you took a chance on this fund when it was 75% off its all-time high (on January 2, 2001), you'd still have a loss of about $4,200.....In other words, contrary to what Mr. Sandifer says, things aren't "working" yet for the vast majority of his investors, and the only investors being "handsomely rewarded" are those who took the plunge immediately after September 11 (this fund's NAV dropped to a low of 3.49 on September 26, 2001, and folks who invested around that time have indeed made some money).....If the current tech rally continues, you can expect more and more tech apologists, like Mr. Sandifer, to simply ignore the period from March 2000 through September 2001.....Don't let them.
"Rally by growth funds suggests recovery," Craig Tolliver, cbs.marketwatch.com, December 21, 2001


And the best thing is, the manager doesn't give dumb quotes: Over the past 12 months, the unmanaged E*TRADE Technology Index (ETTIX), down 34.1%, has still outperformed 75% of all technology funds in this month's FundAlarm database.


Back in May 1999, we published an item about U.S. Global, a publicly-traded company that runs the U.S. Global funds (and the Bonnel Growth Fund) out of San Antonio, Texas.....At the time, CEO Frank Holmes had run the company for about 10 years, and he just realized that he had a problem....."The performance sucks," Holmes said.....Holmes also admitted that some of U.S. Global's portfolio managers suffered from "lack of discipline," and that portfolio management at times bordered on the "haphazard"....."I have a plan," said Holmes. "If I didn't have a plan I'd be very worried. I understand money management and what it takes to drive performance".....Holmes was recently back in the news,* proudly proclaiming his "process, process, process" approach to money management.....For example, Holmes says that he's now mapping how his portfolio managers spend their time, and when they arrive at the office (7:30 a.m.).....Holmes also requires documentation of every investing move his managers make.....At least for now, Holmes allows his managers to take bathroom breaks at will, and they aren't timed.
"Texan faces his Alamo in bid to revive funds," Brooke Southall, Investment News, December 3, 2001


Can you name the top 10 mutual funds owned in 401(k) and other types of defined-contribution retirement plans?.....And, even if you can, why should you care?.....First, here are the 10 most popular funds for retirement plans, in descending order:*

Fidelity Magellan Vanguard 500 Index Fidelity Contrafund Fidelity Growth & Income Fidelity Growth Company Fidelity Spartan U.S. Equity Index Fidelity Equity-Income Fidelity Blue Chip Growth Vanguard Primecap American Funds Washington Mutual

And here's why you should care: If you didn't already know, this list makes it clear that Fidelity virtually owns the defined contribution/401(k) market.....On the one hand, this is good, because these popular Fidelity funds are unlikely to do anything crazy, invested assets should be relatively stable during market downturns, and these funds are likely to be first in line when Fidelity allocates brains and money.....On the other hand, these funds will always have bloated asset bases, and it's unlikely that any of them will ever post dazzling performance numbers over a sustained period of time.....Many people who own these funds through retirement plans have few other choices (if any), which isn't necessarily bad, since all of these funds are at least decent.....But if you do have other choices in your plan, you might want to explore a less-traveled path....Outside of a retirement plan, if you own one of these funds, or if you're thinking about investing in one, you clearly have other choices.....You might want to investigate some.
* Investment News, December 17, 2001

That was then

This is now

Writing a book is the easy part: Less than a year after its launch, the Marketocracy Change Wave Fund has been liquidated.....The fund was managed by Tobin Smith, author of ChangeWave Investing: Picking the Next Monster Stocks for the New Economy.....The fund had attracted only about $5 million in assets, and had lost about 20% of its value this year.....Smith joins Clayton Christensen, author of The Innovator's Dilemma, who was also probably surprised when his trendy book failed to translate into a successful fund.

John Bogle, founder and former CEO of Vanguard, doesn't like mutual fund turnover, because turnover triggers transaction costs, and transaction costs create a drag on performance.....Recently, Bogle has been forced to face some turnover in his own front yard.....In 2000, Vanguard Small Cap Index fund had 49% turnover, Vanguard Small Cap Value Index had 82%, and Vanguard Small Cap Growth Index had 136%, all because small-cap indexes tend to be rearranged quite often....."It's not that small-cap index funds don't work," Bogle says, "but we need better small-cap indexes"*.....Which is somewhat like saying, "It's not that dogs eat disgusting things, we just need more discriminating dogs".....If Bogle can design a small-cap index without turnover, it seems to us that it can't really be a small-cap index.....He's picked himself quite a project.
* Mutual Funds, January 2002


Speaking of John Bogle, he recently provided Forbes with his personal list of the "best" and "worst" mutual funds.....Forbes had only two stipulations: No more than one fund could be from the Vanguard family, and not all of Bogle's choices could be index funds.....Here's what Saint John came up with (the performance data comes from FundAlarm):

Bogle's best...

Fund	Performance vs. Benchmark (% annualized)			Alarm Status	Benchmark	Exp. per $100	Max. sales charge (%)
	12 mo.	3 yrs.	5 yrs.
American Funds Washington Mutual A	18.52	3.91	1.58	NO ALARM	Vang 500 Idx	$0.65	5.75
Dodge & Cox Balanced	16.97	8.20	3.42	NO ALARM	Vang Bal Idx	0.53	none
TIAA-CREF Equity Index	0.9	NA	NA		Vang 500 Idx	0.22	none
TIAA-CREF Tax-Exempt Bond	Not followed by FundAlarm					0.30	none
Vanguard Tax-Managed Balanced	-0.31	1.17	-0.53		Vang Bal Idx	0.20	none

...and Bogle's worst

Fund	Performance vs. Benchmark (% annualized)			Alarm Status	Benchmark	Exp. per $100	Max. sales charge (%)
	12 mo.	3 yrs.	5 yrs.
AIM Municipal Bond A	Not followed by FundAlarm					0.84	4.75
Liberty Intermediate Govt A	Not followed by FundAlarm					1.20	4.75
Markman Moderate Allocation	-22.64	-10.11	-7.36	3-ALARM	Vang Bal Idx	0.95	none
Merrill Lynch Focus 20 B	-55.71		NA	NA	Vang 500 Idx	2.20	4.00
Van Wagoner Emerging Growth	-64.35	-2.16	-16.12	3-ALARM	Dreyf MidCap Idx	1.79	none

Morningstar wants to get into the index business, so its going to make 16 proprietary indexes available for licensing in early 2002.....One of the new Morningstar indexes will track the broad market (such as the Wilshire 5000), three will be based on investing style (growth, value, blend), three will track market capitalization (large-, mid-, and small-cap), and nine indexes will correspond to the Morningstar style boxes.....In our opinion, that's nine indexes too many.....The Morningstar style boxes are a terrific conceptual tool, and a great first cut for designing an asset allocation.....Unfortunately, no one has ever been able to retire simply because his or her manager stayed within the proper style box.....People retire because they accumulate enough capital, and style purity, by itself, has almost nothing to do with investment success.....The Morningstar style boxes have helped create a kind of investment tyranny, spurred on by some professional advisors who use the style boxes to justify their own existence.....With nine indexes based on the Morningstar style boxes, the style tyrants will soon have a new quantitative tool that makes their tedious exercise appear even more precise and scientific.....Not a good development for folks who just want to make some money in the market.


The votes are in: December was the month to enter the IPS iFund Death Watch for 2002, and the contest is now closed.....You can check the accompanying page to see how everyone voted.....April Fool's Day was the most popular death date, which suggests that a sense of irony is alive and well among FundAlarm readers.


Briefly noted:

• Berger has decided to kill its two worst-performing funds, New Generation and Select.....New Generation will be merged into Berger Mid Cap Growth, and Select will be merged into Berger Growth, which isn't much of a consolation, since Berger Growth is the third-worst- performing fund in the Berger family.....Not only that, Berger Growth has posted miserable cumulative numbers stretching back at least a decade, while Select has been dismal for only about four years.....At least with Select, you could hope that things might get better.....With Berger Growth, you can be virtually certain that they won't.....Mark Sunderhuse, who is manager of New Generation and Mid Cap Growth, and co-manager of Select, is reportedly leaving the firm "voluntarily,"* which appears similar to the voluntary manner in which Mullah Mohammed Omar recently left office in Afghanistan.....Jay Tracey and Paul LaRocco will take over Mid Cap Growth from Sunderhuse, and they will run New Generation until it's euthanized....Tracey, LaRocco and Steve Fossel will shuffle paper and count the remaining hours at Berger Select, while Tracey will continue as sole manager of Berger Growth.....Finally, Tracey will drop off as co-manager of Berger Large Cap Growth, and Fossel will handle that fund solo.
  * Forbes.com, December 17, 2001
  
  
  
• Let's say your family of funds is on a roll, and you're posting some terrific performance numbers.....Do you stay with the basic strategy that got you there in the first place, or do you make a mid-course adjustment?.....In the case of the Wasatch funds, the decision is clearly not in favor of the status quo.....Despite an exceptional winning record in recent years, the Wasatch funds are asking shareholders to allow them to engage in limited short selling.....Wasatch claims that short positions will never make up more than 15% of net assets, and that short selling will only be used in limited, strategic situations.....But the question remains: Why do they need this?.....It's possible that these good funds will get even better with a new tool at their disposal.....But it seems equally likely that the capability to sell short will be a distraction that doesn't lead to better performance.....When faced with a change like this, there seem to be two basic attitudes: "If it ain't broke don't fix it" versus "good enough is never enough".....In the case of the Wasatch funds, we'd say don't fix what isn't broken.....If these funds have thrived for so long without the ability to sell short, why risk screwing things up now?.....Alas, Wasatch didn't ask for our advice.
  
  
  
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  As of December 12, the "C" class of Invesco Cash Reserves was the lowest-yielding money market fund in the U.S., at 0.01% (that's approximately $1 of interest per year on a $10,000 investment).....The following day, Invesco waived part of its management fee -- a whopping 0.10% -- to push the yield up to 0.11%*....This fund has an absurd expense ratio of 1.74%, due in part to a 1.00% 12b-1 fee, and that accounts for its extra-low yield.
  * Bridget O'Brian, The Wall Street Journal, December 17, 2001
  
  
  
• There's not much new that we can say about the Enron fiasco, but it certainly highlights the risk of owning stock in a company that also issues your paycheck.....What are some of the specific lessons from the Enron collapse?.....If you receive company stock as a matching contribution to your retirement plan, and even if you're required to hold that stock for some period of time, you might as well take it.....If the stock drops to almost nothing, you'll still have something left, which is more than you would have had without the match.....Also, if you have the opportunity to buy your employer's stock at a discount, and the shares will be completely liquid, you might want to participate.....On the other hand, you should always be careful about buying your employer's stock at full price in the open market, whether that stock is destined for a retirement or a personal account (this is where Enron employees appear to have most seriously tripped up).....You should also make sure that you don't own any mutual funds that are overly-concentrated in the company that you work for....As an employee, your cash flow is already subject to employment risk.....Be careful about adding to that risk by loading up on company stock.
  
  
  
• And an important reminder: A "money market fund" is not necessarily the same as a "money market mutual fund," as U.S. employees of British oil company BP PLC recently found out.....These employees had the opportunity to invest in a "money market fund" through their company retirement plan.....Turns out that about 2% of the assets of this "money market fund" were invested in short-term debt obligations of Enron.....When Enron debt was marked down on December 3, this "money market fund" lost 1.9% of its value, and its share price fell below the inviolate $1.00.....Before its devaluation, Enron debt was rated just below highest quality....."Money market mutual funds" can't invest more than 1% of their assets in debt from any single issuer with a less-than-top rating, and they also must keep at least 95% of their total assets in the highest quality debt.....If the BP employees had been offered a true "money market mutual fund," their Enron losses couldn't have been this large.....You might want to take a look at your own retirement plan money fund.....See if it's truly a mutual fund and, if not, what its investment limitations look like.
  "Fail Safe? Some Find Risks in Money Funds," Aaron Lucchetti, The Wall Street Journal, December 14, 2001
  
  
  
• In most cases, when "U.S." appears in the name of a fund, it means "United States".....In the case of Vontobel U.S. Value, however, the "U.S." might as well mean "Undiversified Sector".....Recently, Vontobel U.S. Value had 87% of its portfolio in financial stocks, and the fund held only 21 securities.....Parroting a line from Warren Buffett, Vontobel manager Edwin Walczak claims that he actually reduces risk " by putting all [his] eggs in one basket"*.....Maybe that's possible when your egg picker and basket maker is a financial genius like Warren Buffett.....But Walczak isn't Buffett and, until Walczak found his hot financial sector, this fund was just another mediocre performer.....We predict that it will be mediocre again, and relatively soon.
  "Financial follies," Steven T. Goldberg, Kiplinger's, January 2002
  
  
  
• Attention, lawyers!
  
  

  	"We will be back. I guarantee it."
  -- Tom Bailey, CEO of Janus, uttering the dangerous "g" word at a recent press gathering

  
  
  
• More from the Janus press gathering (above): Janus research analyst Marisa Arredondo claims that she once went into an operating room at Stanford University to check out the product of a medical device manufacturer....."So, they had this guy, like, open on the operating table, and they were doing all this stuff around him. And one of the doctors had this weird-looking medical device, and I think he used it on the sick guy, only I'm not positive, because that's just about the time I passed out......OK, it's not exactly a transcript of Arredondo's research report.....But it's probably just as useful.
  
  
  
• Most mutual fund firms don't even employ 400 professionals, so it's big news when one firm announces that it's going to fire 400 mutual fund managers, analysts, and traders.....According to The Wall Street Journal, that's exactly what's going to happen at the Scudder funds, now that they've been acquired by Deutsche Bank (although some of the firings may come from the Bank side as well).....The Scudder CEO says that the company "will end up as a stronger organization"......Note: FundAlarm officially declares this the first B.S. Quote of 2002.
  "Deutsche Bank Plans Job Cuts As Part of Scudder Acquisition," Aaron Lucchetti, December 5, 2001
  
  
  
• Deutsche Bank (above) has its eye on another fund firm that it should be able to improve by firing people.....Amvescap, which runs the AIM and Invesco funds, is reportedly the German bank's next acquisition target.
  "Deutsche Bank eyes Amvescap," Justin Wiser, cbs.marketwatch.com, December 6, 2001
  
  
  
• We smell a rat: Actually, morningstar.com sniffed this one out.....Credit Suisse International Equity, formerly known as Credit Suisse Warburg Pincus International Equity, is seeking shareholder approval to merge with Credit Suisse International Focus, formerly Credit Suisse Warburg Pincus Major Foreign Markets (is all that perfectly clear?).....International Equity is the firm's flagship foreign fund, and it has more than 10 times the assets of International Focus ($390 million vs. $31 million), yet the smaller fund will be the survivor if the merger is approved.....Why is Credit Suisse so willing to sacrifice the larger fund?.....Those of you who answered "performance" may advance to the head of the class.....Over the past three years, the soon-to-be-forgotten International Equity has returned a forgettable -4.66%, while International Focus (nee Major Foreign Markets), has returned a more respectable +2.56%.....If the merger is approved, it's also interesting to note that all those folks who bought International Equity, thinking they were getting a diversified foreign fund, are likely to end up with a considerably more concentrated offering that has considerably more exposure to emerging markets.....Oh, and the management of both funds has been like a revolving door.....Oh, and there's still considerable turmoil among the ranks of Credit Suisse managers, so additional turnover is likely.....Do we hear "Sell"?
  "An Awkward Fund Merger Raises a Red Flag," Gregg Wolper, morningstar.com, December 5, 2001
  
  
  
• Have you ever seen a mutual fund company analyze how all of its funds work together, especially how its portfolios overlap and correlate?.....We haven't.....So here's a suggestion from mutual fund columnist Charles Jaffe, directed straight at the fund companies:
  
  

  "Do the overlap and correlation analysis for your customers, and issue a warning when funds tend to have portfolios that are, say, one-third identical. The disclosure could go something like this: 'This fund is significantly similar to the following funds offered by the firm....By purchasing this fund, shareholders in the funds listed above may not get the full diversification benefits normally associated with investing in multiple funds.' It's not perfect, but it would pass muster with the lawyers. And it's something investors could look out for to warn them of potential overlap problems."

  
  What a simple, logical, and great idea.....It's a chance for some no-load fund companies to stand out from the crowd, provide a value-added service, and establish a reputation for straight-talking integrity.....Wanna bet it doesn't happen?
  "Wish list: information and more information," Charles Jaffe, boston.com, December 2, 2001
  
  
  
• We don't usually report on new mutual funds, but a couple of offerings might be worth your attention.....Vanguard Capital Value, an actively-managed fund, will be run by Charles Freeman of Wellington Capital Management, who already runs the no-apologies, value-oriented Vanguard Windsor fund.....The wrinkle: Vanguard Capital Value will be an all-cap fund, which means considerably more small- and mid-cap representation than the Windsor fund.....Also, the folks who run the exceptional Buffalo Small-Cap Fund are starting the Buffalo Mid-Cap Fund.....Managers Kent Gassaway, Bob Male and Tom Laming say that they are "taking the same unique investment strategy behind Buffalo Small-Cap and applying it to slightly larger companies."*
  *mfwire.com, December 17, 2001
  
  
  
• In the uncertainty following the September 11 attacks, MFS was added as co-manager to the ASAF All-Cap Growth Fund, which had been managed solo by Fred Alger Management.....(As you may recall, the Alger firm was a tenant in the World Trade Center, and almost all of its professional employees were killed).....ASAF is now confident that Alger Management is on the road to recovery, and MFS has been removed.....During the transitional period, MFS and ASAF (a.k.a., American Skandia) donated their $900,000 management fee to the families of the Alger employees who were lost.
  "Alger wins back Skandia assets," Craig Tolliver, cbs.marketwatch.com, December 11, 2001
  
  
  

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FundAlarm © Roy Weitz, 2002