Highlights and Commentary

By Roy Weitz

(Originally posted January 1, 2003) [Archive Table of Contents]
Here comes the SEC steamroller: Back in October 2002, the SEC proposed rules that would require mutual funds to disclose all of their proxy votes, as well as their underlying proxy-voting policies.....A 60-day public comment period expired in early December, and the results were both predictable and astonishing: Predictable, in that the Investment Company Institute and the major fund companies (with the exception of Putnam) opposed and whined about the proposals ("It would make our jobs too haaard!"), and astonishing, in that the SEC received over 8,000 comment letters -- the most ever -- and the vast majority of the letters came from individual investors in support of more proxy disclosure.....The SEC is still pondering its final decision, but we predict that the proposed proxy-disclosure rules will be implemented pretty much as they were originally drafted.....Why are we so sure?.....The Republican [!] chair of the committee that oversees the SEC (Michael Oxley-Ohio) has come out in favor of the proposed rules, and so has the Republican chair of the House Capital Markets Committee (Richard Baker-Louisiana)......With government friends like those, the fund industry doesn't need any enemies.

As we predicted several months ago, the SEC has also moved quickly on the portfolio disclosure front.....Rules proposed on December 11 would require all mutual funds to electronically disclose their complete portfolio holdings every three months (i.e., quarterly), instead of the current six-month requirement.....Funds would also be required to disclose the actual expenses, in dollars, incurred by a hypothetical $10,000 investor (this is presumably more illuminating than the current expense presentation in percentages).....As a carrot to these SEC sticks, fund companies would be allowed to include summary portfolio schedules in printed shareholder reports, instead of the full-blown portfolio listings that currently kill many, many trees.....Initial fund industry reaction to these proposals has generally been positive, which makes you wonder if the fund companies expected something much worse, and are secretly relieved that this is all they'll have to do.....In any event, the public comment period ends on Valentine's Day, and you can bury yourself in all the details at www.sec.gov/rules/proposed/ic-25870.htm.


Housekeeping at Janus: By the time you read this, Janus will be in charge of its own destiny,* and the firm is celebrating its independence by killing a few turkeys.....Specifically, Janus will merge the dreadful Special Situations Fund with the on-its-way-to-being-dreadful Strategic Value Fund, and the resulting fund will be renamed Janus Special Equity.....David Decker, who managed both of the predecessor turkeys, will get a chance to fly the new fund into the ground.....Also, pending shareholder approval, trustees of the Berger funds have given Janus the go-ahead to absorb the Berger growth funds into existing Janus funds, as follows:

This Berger fund will merge into...	...this Janus fund
Balanced	Balanced
Growth	Olympus
Large Cap Growth	Growth & Income
Mid Cap Growth	Enterprise
Small Company Growth	Venture
Info Tech	Global Technology
International	Overseas

Three Berger value funds (Mid Cap Value, Small Cap Value, and Small Cap Value II) will keep their current managers but assume the Janus name, while a fourth value fund (Berger Large Cap Value) will be liquidated.....Should anyone care, four Janus funds will be reopened to new investors (Worldwide, Global Technology, Global Life Sciences, and the flagship Janus).....Finally, Janus Fund 2, run by John Schreiber, will be merged into the flagship Janus fund, and the experiment to turn John Schreiber into a portfolio manager will officially come to an end.....Schreiber will become an assistant portfolio manager of Janus Mercury (managed by Warren Lammert), as well as "other funds and institutional products managed by...Warren Lammert".....We hope he and Warren get along, because it looks like they're going to be spending a lot of time together.
* Janus had been a subsidiary of Stilwell Financial Inc., but that relationship ended on December 31, 2002. Stilwell essentially dissolved itself, and turned control over to a new company, Janus Capital Management Inc., which runs the Janus funds.

Another tough day marketing the Vice Fund

According to its self-proclaimed mission, the Vice Fund invests in the "socially irresponsible" stocks of the alcohol, gambling, tobacco, and defense industries.....This year, the fund plans to market itself at gambling industry and alcohol distribution shows.....If you're planning to attend The Nightclub and Bar/Beverage Retailer Convention in Las Vegas (March 2003), reps from the Vice Fund will be there to discuss the finer points of portfolio construction and drunk driving.....You can also spend some quality time with the Vice Fund folks at the Global Gaming Expo in Las Vegas (September 2003), and the Southern Gaming Summit in Biloxi, Mississippi (May 2003)....."People who work in these industries seem to love the concept of our fund," says Eric McDonald, co-portfolio manager of the Vice Fund....."These trade shows give us great exposure to the leading gaming and alcohol industry experts and employees, as well as the customers who are spending money in these areas".....Sure, Eric, and it's also a chance to get ripped with the pros.

Wouldn't it be interesting to know how mutual fund companies invest their own money, and especially what funds they favor when it's time to put their own cash on the line?.....Unfortunately, we can't come up with that information, but we have come up with something almost as good: How mutual fund companies invest the money in their own charitable foundations.....First, a bit of background:

• A charitable foundation is a separate legal entity, and it's usually organized as a corporation or a trust (for example, Janus has The Janus Foundation, and Vanguard has the Vanguard Group Foundation). The charitable foundations that we're talking about here are corporate foundations, not the donor-advised funds that many mutual fund firms have established for their customers.
  
  
• Charitable foundations exist to give away money. Generally, foundations must give away at least five percent of their assets to charity each year, but there is no upper limit.
  
  
• Mutual fund charitable foundations typically get their funding from a related advisory firm. For example, in 2001, The Janus Foundation received all of its contributions ($5.7 million) from Janus Capital Corporation, the company that manages the Janus mutual funds.
  
  
• And then, of course, there's the exception to the rule: The Vanguard Group Foundation gets its funding from the Vanguard mutual funds. About two-thirds of all Vanguard funds contribute to the Vanguard foundation, and the amount of each fund's contribution appears to be in proportion to its assets. For example, in 2001, the relatively small Vanguard Growth Equity Fund contributed $6,000 to The Vanguard Group Foundation, while Vanguard's largest fund, 500 Index, contributed a hefty $515,600. It's interesting to note that these charitable contributions don't show up as separate line items on the respective fund financial statements. Also, as far as we can tell, no Vanguard legal or marketing materials disclose these contributions, and fund shareholders have no say in how these contributions are ultimately disbursed by the Vanguard foundation.
  
  
• We looked at charitable foundations affiliated with five mutual fund companies: Fidelity, Vanguard, Janus, T. Rowe Price and Putnam. Not surprisingly, each of these foundations invests exclusively in its own mutual funds. But within this group, foundation investment strategies vary widely, as you can see from the following chart:

Name	Total assets*	Funding received by foundation during year*	Grants awarded by foundation during year*	% of foundation assets invested in:*
				Cash & equiv	Mutual funds	Other
The Fidelity Foundation	$306 million	$1.77 million	$20.2 million	29%	29%	42%
The Vanguard Group Foundation	$3.8 million	$3.0 million	$3.0 million	48%	52%	0%
The Janus Foundation	$2.4 million	$5.7 million	$5.5 million	55%	38%	7%
T. Rowe Price Associates Foundation	$25.2 million	$30 thousand	$3.7 million	17%	83%	0%
Putnam Investments Foundation	$3.8 million	$3.0 million	$1.4 million	100%	0%	0%

* All amounts rounded. Data as of December 31, 2001,
or for the year ended December 31, 2001, which is the latest information publicly available

• Fidelity's charitable foundation is by far the largest, and it has, by far, the most diverse investment portfolio. The Fidelity Foundation holds considerably more of its assets in individual stocks (the 42% "Other" on the chart above) than in mutual funds, which is somewhat surprising for an entity related to a mutual fund company. But The Fidelity Foundation still owns 18 different mutual funds worth almost $89 million; the foundation's five largest fund holdings, and their respective market values, are as follows:
  
  

  Fidelity Japan Smaller Companies	$12.7 million
  Fidelity Value	$11.1 million
  Fidelity Magellan	$10.9 million
  Fidelity Diversified International	$8.3 million
  Fidelity Growth Company	$6.6 million

  
  
  
• The Vanguard foundation owns only one mutual fund, Vanguard Asset Allocation, worth about $2 million.
  
  
• The Janus Foundation owns five Janus mutual funds, as follows:
  
  

  Janus Balanced	$177,000
  Janus Worldwide	$163,000
  Janus Mercury	$186,000
  Janus Fund	$155,000
  Janus Olympus	$209,000

  
  
  
• The T. Rowe Price foundation owns two stock mutual funds and one fixed-income fund, as follows:
  
  

  T. Rowe Price Spectrum Growth	$7.4 million
  T. Rowe Price Spectrum International	$5.7 million
  T. Rowe Price Spectrum Income	$7.5 million

  
  
  
• What can we say about the Putnam foundation? With $3.8 million in cash, it doesn't own a single Putnam mutual fund -- which will turn out to be either the smartest or dumbest investment strategy of the whole lot.

Note that all of the financial information, above, comes from the respective foundation tax returns, which are a matter of public record.....Several Web sites make foundation tax returns available for public viewing, including guidestar.org, which is the site we use..... If you enjoy this kind of snooping, you can also review every donation made by each charitable foundation for the year..... Our favorite donation in 2001 was $2.5 million from The Fidelity Foundation, which went to support an organization called the Frog Pond Foundation.

Vanguard is often perceived as the good guy of the fund industry, but even good guys can't get people to work for free.....Vanguard pays salaries, of course, but Vanguard employees also participate in a performance-based bonus plan that's based on a partnership "points" system (points are awarded based on job level and years of service, and for some top executives the bonus can represent two-thirds or more of their annual income).....In June 2002, Vanguard set the value of each partnership point at $61, which was up about 13% from the year before ($54), so we know that Vanguard had a good year financially.....Point value was $3.43 in 1984, so we also know that Vanguard has had a nice financial run for the past eighteen years.....What about the future?.....Vanguard CEO John Brennan wants each partnership point to be worth $100 by 2005 -- that's a 64% increase over current share value -- and the only way Vanguard can support that kind of value is to dramatically boost its earnings*.....Many professional service firms (including the failed Arthur Andersen) base compensation on a partnership "share" system, and Vanguard's point system is similar.....Aggressive share value targets can motivate senior employees, but aggressive targets can also encourage employees to cut corners, make bad business judgments, and generally do stupid things (the aforementioned Arthur Andersen was notorious for its aggressive share value targets, and the corporate culture that resulted from these aggressive targets was a major factor in Andersen's downfall).....Vanguard is not Arthur Andersen, and Vanguard isn't going to have an Andersen-like blowup.....But it's easy to see Vanguard becoming a harder, meaner place, obsessed with an ever-growing bottom line.....How does such a fund company behave?.....It continues to cut costs, but cost-cutting alone isn't going to generate a 64% increase in the value of partnership points.....An aggressive fund company also increases fees, it ventures into new and untested business areas, it creates more (and often unnecessary) funds, and it delays closing popular but bloated funds.....The first two have already happened at Vanguard, and the second two wouldn't surprise us.
* "Fund of Information" column, Erin E. Arvedlund, Barron's, December 9, 2002


We must be looking in the wrong places:

From "When to Sell a Mutual Fund," About.com e-mail newsletter

Briefly noted:

• Bill Miller, manager of Legg Mason Value, outperformed the S&P 500 for the twelfth straight year in 2002.....Depending on how you look at this, Miller is either an investing genius or an entirely predictable statistic.....In any event, even Miller himself has reason to be humble about last year's performance.....According to his own research staff, Miller's fund (through early December 2002) would have generated a few percentage points more return if Miller had simply left the Legg Mason Value portfolio untouched as of January 1, 2002.....In other words, by showing up at the office and messing with the portfolio, Miller actually cost his investors money.
  "How Fear Rules the Fund Flock," Stephen Schurr, TheStreet.com, December 19, 2002
  
  
  
• You'd think that investors might want to know: Robert Dowlett, manager of two Millennium funds (Growth and Growth and Income), was killed in a private plane crash on November 25, 2002....Over a month later (December 30), neither fund's prospectus had been updated, and the Millennium Web site still showed Dowlett as manager of both offerings.....We e-mailed one of the "contact" links on the Millennium Web site, and asked when Mr. Dowlett's replacement would be announced.....Here's the full reply: "I haven't heard anything yet. I'm sure they will be in contact with all the shareholders once they have made their decision."
  
  
  
• You're all fired. Now what's for breakfast? On December 16, Neuberger Berman employed a small team of growth-fund managers working out of its Boston office.....On December 17, the president of Neuberger's fund business flew into town at 6:30 a.m., fired the entire team, and was back in his New York office by the afternoon.....Gone are Jennifer Silver, Brooke Cobb, and Michael Malouf.....Cobb was solo manager of Neuberger Berman Century, Cobb and Silver shared the reins at NB Manhattan, and Malouf was co-manager at NB Millennium (with Richard Judka, who apparently also got the boot).
  "Neuberger fires Boston fund group," Beth Healy, boston.com, December 18, 2002
  
  
  
• Replacing the Neuberger Berman casualties, above, are various members of a four-person growth team that was lured away from Northern Trust Corp., which means that several Northern mutual funds have also been affected.....To an outsider like us, this mass-defection of managers from Northern Trust appears to be a disaster, but a Northern spokesman insists that the company is "excited about these changes"*....Indeed, FundAlarm has learned that Northern plans to use these changes as an opportunity to clean out all the "lint and paper clips and stuff" in the departing managers' desks, and that may partially account for Northern's upbeat mood.
  * Healy article, above
  
  
  
• Stop me if you've heard this one before: An Internet stock is hot, hundreds of mutual funds suddenly discover that they love it, and all of them must own the stock in their portfolios.....In this case, the stock is eBay, whose shares jumped about 30% in the fourth quarter of 2002, and which is now owned by twice as many mutual funds as owned it a year ago (291 vs. 142).....Say what you will about eBay, with a P/E ratio of 100+, it's unlikely that the stock has much more upside, yet fund managers continue to pile in.....Some managers buy eBay for window dressing, some because they're lazy, and some because they figure that they will be smart enough to get out at the top, and leave other fund managers holding the bag.....If that doesn't bring on a flood of late-1999 nostalgia, how about this: As of September 30, the Janus funds were the largest institutional owners of eBay, with holdings worth about $1.1 billion.
  "eBay Love Fest Could Become Heartbreak," Stephen Schurr, TheStreet.com, December 3, 2002
  
  
  
• A mutual fund is born, and FundAlarm is there:
  
  

  "It serves no investment purpose." "But it may sell." "It serves no investment purpose." "But it may sell." "It serves no investment purpose." "But it may sell." "Aw, what the heck. Let's give it a try."

  
  The newcomer in question is Turner Strategic Value and High Income.....It's a fund-of-funds that will invest forty to sixty percent of its assets in Turner Small Cap Value Opportunities, and the rest in Turner High Yield.....Small Cap Value Opportunities is a niche fund with essentially no track record, and High Yield probably wishes it had no track record.....For the privilege of investing in this bizarre pair of funds, investors will pay 50 to 75 basis points (0.50% to 0.75%), on top of the expense ratios of the underlying funds.
  
  
  
• Speaking of funds that the world could live without, the Van Wagoner shop has filed papers to start the Van Wagoner Growth Opportunities fund.....Presumably, this fund will own the stocks that the other five Van Wagoner funds have missed, and it will therefore avoid the abysmal performance of its siblings.
  
  
  
• Think we're kidding? In a universe of about 350 tech funds, Van Wagoner Technology now has the worst three-year record (-49.6% annualized), trailing even such paragons of futility as Monterey Murphy Technology.....That, folks, takes some doing.
  
  
  
• Who Cares? (Part III): Patrick Adams, who built a modest growth-fund reputation at Berger, has announced the formation of the Choice Market Neutral Fund.....Choice, which is owned by Adams, runs three other funds -- Focus, Balanced and Long-Short -- each of which has been about the worst-performing fund in its respective category since its inception.....Let's think about this for a moment: Adams currently runs three ineffectual funds that only buy "long" positions, and now he wants to double his opportunities for screwing up with a market-neutral fund that can also go short?.....The line to invest forms to the right, winds out the door, and plunges off a cliff.
  "Hedger's fund offers 'smooth ride'," Jeff Benjamin, Investment News, December 23, 2002
  
  
  
• If you're a senior citizen, brokers and planners want to sell you financial products, but they often don't know how.....That, at least, is the contention of Michael P. Sullivan, who runs a consulting firm for financial professionals called 50+ Communications Consulting.....According to Sullivan, the "fluid intelligence" required for financial decisions declines rapidly after our mid-20s, and "by our early 60s, most of us operate at about the level of a boiled potato".....When dealing with these boiled potatoes, Sullivan does not advocate fork or butter.....Instead, he suggests that advisors look directly at their older clients, move slowly, install better office lighting, use bigger typefaces, and speak in sentences of "no more than eight or nine words."
  "Older People Respond, Like the Young, to Emotions," Mutual Fund Market News, November 4, 2002
  
  
  
• The following paragraph is about annuities.....Since most annuity products are purchased by senior citizens, and we want senior citizens to understand us, we are taking Mr. Sullivan's advice (above) and making each sentence no longer than eight or nine words:
  
  Variable annuities are insurance policies wrapped around mutual funds.
  Any appreciation in the mutual funds is already tax-deferred.
  Therefore, people shouldn't purchase annuities within retirement plans.
  Otherwise, they get double tax deferral, which is wasteful.
  But brokers make lots of money by selling annuities.
  American Express Financial Advisors has lots of brokers.
  Some AmEx brokers sold annuities to retirement plans.
  These brokers are the scum of the earth.
  They are crooks, and they should go to jail.
  But these AmEx brokers won't go to jail.
  Instead, AmEx was fined $350,000, and it's very sorry.
  This will happen again, because it's so profitable.
  Don't let yourself be fooled by these sleazeballs.
  Never -- never-- buy an annuity in a tax-deferred account!
  
  
  
• If you ever need someone to predict the next 1987 stock market crash, Elaine Garzarelli is undoubtedly the go-to person.....But if you want someone to manage a mutual fund, it's becoming increasingly clear that Ms. G. lacks some essential element, perhaps ability.....As you may recall, Garzarelli delivered dismal performance at the late and unlamented Shearson Sector Analysis fund, and she folded her own fund (Garzarelli Balanced) only seven months after it was born (she also advised her newsletter readers to sell their stocks in the summer of 1996, just as the market was getting ready for one of its biggest growth spurts in history, but that's another story).....Now, Garzarelli has been fired from Forward Garzarelli U.S. Equity, which will be renamed the Sierra Club Stock Fund.
  
  
  

• 	"The terrible stock market has cost us a lot of money. In the first nine months of this year, Liberty Acorn Fund alone saw at least the temporary disappearance of about $956 million in assets. That is an inconceivably large amount of money. To figure out how much of a loss we have suffered, I tried to calculate how much work it would have been to destroy that much money on purpose. One way to do it would have been to convert $956 million into $100 bills on January 1, 2002 and order our 20 investment professionals to spend all their time burning it...[If] one person diligently burned one $100 bill at the rate of one bill every 10 seconds and worked seven hours a day (we need lunch and breaks), five days a week, 50 weeks a year, that one person could burn up $63 million in a year. It would take all 20 of us working full time at this repetitive task to get rid of $956 million in just nine months."
  --Ralph Wanger, manager of Liberty Acorn, in his Third Quarter (2002) commentary

  
  
  

  	"I can only imagine the employees' practice sessions and holiday parties..."
  --"Nords," from the FundAlarm Discussion Board, December 6, 2002

  
  
  
• These days, in the business world, it seems that a rule is a rule, unless it's not a rule, in which case you do whatever please.....Sound confusing?.....Consider this example from the Vanguard funds.....Back in 1999, Vanguard founder John Bogle was forced to resign as a trustee of the Vanguard funds, because he had reached Vanguard's mandatory retirement age of seventy....According to recent Vanguard proxy materials, current trustee Burton Malkiel also turned seventy during 2002, but Malkiel has been asked to stay on the board for another two years.....Why the different treatment for these two septuagenarian trustees?.....Malkiel does his job and apparently keeps his mouth shut, while Bogle has opinions and expresses them.....Bogle was a thorn in the side of CEO John Brennan, and the mandatory retirement rule was a handy way of silencing the annoying guy who started it all -- and who also gave Brennan his job.
  MutualFundWire.com, December 6, 2002
  
  
  
• Maybe he wants to become a growth-fund manager: Hollywood director Michael Bay ("Pearl Harbor," "Armageddon") was recently awarded $300,000 in an arbitration case against Merrill Lynch, but that was far less than the $8 million he was asking for..... Bay claimed that his broker mismanaged his $3 million account by making more than 8,000 trades over a 15-month period (that works out to about 27 trades a day).....The arbitration panel disagreed, finding that Bay was a "sophisticated investor" who was responsible for his own trading activity.
  Bloomberg News, December 12, 2002
  
  
  
• In April 2002, Federated Kaufmann Small Cap Fund was merged into the much larger Federated Kaufmann fund.....Less than eight months later, in December 2002, Federated launched a new fund with the identical name (Federated Kaufmann Small Cap).....What's going on here?.....Nothing, except a cynical end-run around the performance record of the old small-cap fund.....Now that the merger has erased the old fund's horrendous track record, the old name can be recycled, and the marketing folks won't have to make any excuses or offer any explanations.
  
  
  
• Through the end of January, Scudder is encouraging brokers to push a handful of its funds by offering what brokers like best: cash.....Selected brokers can earn an additional 50 basis points (0.5%) of commission for selling "B" shares of four Scudder funds: Contrarian, Mid Cap, Fixed Income and High Yield Tax Free....Brokers earn slightly less juice (25 basis points) for selling "C" shares of the same funds.
  MutualFundWire.com, December 5, 2002
  
  
  
• Every time we run an item like the one above, we get a few e-mails from brokers who point out that the small amount of additional commission would never cause them to sell an unsuitable fund.....We believe these folks, we really do, but that isn't the issue.....Financial incentives motivate brokers and financial planners, otherwise fund companies wouldn't regularly roll them out.....The concern isn't so much that a broker will sell a totally unsuitable fund, but that a suitable -- yet slightly inferior -- fund will get pushed ahead of another offering that isn't dangling a financial incentive.....In most fund searches by brokers and financial planners, several offerings make the final cut, and the differences among the various contenders are seldom crystal-clear.....Therefore, a slightly higher commission can easily tip the balance.....A broker can honestly tell himself, and his client, that the fund with the financial incentive was a "good" fund.....What the broker can't say is whether he would have made the same decision without the financial incentive, and that seems to us the very essence of conflict of interest.
  
  
  
• Ever since Fidelity started offering its own index funds, several years ago, those funds have been managed by a subadvisor (i.e., outside manager).....Fidelity recently announced plans to bring the management of its five Spartan index funds in-house.....Fido says that expense ratios will stay the same, although it remains to be seen how well (or poorly) Fidelity's in-house staff will perform.
  "Fidelity move to cut Northern/Deutsche assets," Kathie O'Donnell, Reuters, December 27, 2002
  
  
  
• Here's a trick question: Which mutual fund company spent the most money advertising its products during 2002?.....The answer is penny-pinching Vanguard, and that probably says less about Vanguard than it does about the sorry state of the other mutual fund companies.....Last year, Vanguard spent about the same number of dollars as it did in previous years, while other companies cut back dramatically, moving Vanguard to the top of a diminished field.....Here's another question: Can you remember a single Vanguard ad from 2002, or a single ad from any other fund company?
  "Mutual Funds Cut Ad Spending Almost in Half, Tracker Says," Frank Byrt, Dow Jones Newswires, December 23, 2002
  
  
  
• Scott Adams, the "Dilbert" guy, likes to think of himself as a personal finance guru, but Adams can't find a company that is willing to publish his one-page book.....The literary world's loss is our gain, as we are pleased to reproduce Adams' personal finance book in its entirety:
  
  

  Make a will. Pay off your credit cards. Get term life insurance if you have a family to support. Fund your 401k to the maximum. Fund your IRA to the maximum. Buy a house if you want to live in a house and you can afford it. Put six month's expenses in a money market account. Take whatever money is left over and invest 70 percent in a stock index fund and 30 percent in a bond fund through any discount broker and never touch it until retirement. If any of this confuses you, or if you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner.

  
  Hey, don't laugh.....You could do much worse in 2003, and we guarantee that millions of people will.
  "Dilbert weasels say Merry Christmas," Paul B. Farrell, CBS.MarketWatch.com, December 3, 2002

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