Highlights and Commentary
(Originally Posted January 1, 1998 - Some editing) [Archive Table of Contents]
Is your fund out of control? If you have been following FundAlarm for a while, you've probably noticed that 3-ALARM funds exhibit many different patterns of underperformance.....For example, some 3-ALARM funds have significantly lagged their benchmark for the past 12 months, although three-year and five-year performance is reasonably good.....Other 3-ALARM funds consistently trail their benchmark by a small margin, but no single period (i.e., 12-months, three-years, or five-years) stands out as noticeably worse than any other...... Then there's a pattern that we find especially interesting (and potentially ominous), which we call "accelerating underperformance".....This is the 3-ALARM fund that has a poor five-year record against its benchmark, a worse three-year record, and an even worse 12-month record...... The following tables list all funds in our database which have achieved less than 90% of their respective five-year benchmark, less than 80% of their respective three-year benchmark, and less than 70% of their respective 12-month benchmark -- in other words, funds that appear to be getting progressively worse over time.

Out-of-Control large-cap funds	Out-of-Control mid-cap funds	Out-of-Control small-cap funds
(Funds are listed alphabetically -- see below for Out-of-Control Balanced and Specialty funds)
Berger 100	American Cent-20thC VistaInv	Janus Venture
Dreyfus	Delaware DelCap A	Keystone Small Co Grth
Dreyfus Growth Opportunity	EV Traditional Spec Equities	Lindner Growth Inv
Evergreen Value Y	Fidelity Trend	Oberweis Emerging Growth
Fidelity Growth Company	Founders Frontier	PIMCo Opportunity C
Fidelity Retirement Growth	Founders Special	Vanguard Explorer
Fortis Fiduciary A	Janus Enterprise
Fortis Growth A	Merger
Founders Blue Chip	Meridian
Franklin Growth I	Merrill Lynch Phoenix B
Gateway Index Plus	Parkstone Mid Cap Instl
Hancock Growth A	Phoenix Mid Cap A
IDS Diversified Equity-Inc A	Pioneer Mid-Cap A
IDS Managed Allocation A	Shelby
Janus	Smith Barney Spec Equities B
Kemper Growth A	Strong Discovery
MainStay Value B	United New Concepts A
Neuberger&Berman Guardian	USAA Cornerstone Strategy
Phoenix-Engemann Growth A	USAA Growth
PIMCo Growth C
Scout Stock
Seligman Common Stock A
Seligman Growth A
Smith Barney Fundmntl Val A
Smith Barney Fundmntl Val B
Smith Barney Growth & Inc A
Strong Total Return
T. Rowe Price Spectrum Grth
TCW/DW Core Equity B
United Vanguard A

*Each of these funds shows a pattern of accelerating underperformance. In other words, each fund has achieved less than 90% of its respective five-year benchmark, less than 80% of its respective three-year benchmark, and less than 70% of its respective 12-month benchmark.

Out-of-Control balanced funds	Out-of-Control specialty funds
American Cent Balanced Inv	American Cent Global Gold
Fidelity Asset Manager: Inc	Fidelity Sel American Gold
Lindner Dividend Inv	Fidelity Sel Industrl Materl
Prudential Balanced B	Fidelity Sel Paper&Forest Pr
	Fidelity Sel Prec Mets&Mins
	GT Global Telecommun A
	Invesco Strat Gold
	Lexington Goldfund
	Midas
	Oppenheimer Gold & Spec MinA
	Prudential Natural Res A
	Smith Barney Natural Res A
	U.S. Global Inv Gold Shares
	U.S. Global Inv World Gold
	USAA Gold
	Van Eck Gold/Resources A
	Vanguard Spec Gold&Prec Mets

One big surprise in the tables above: Neuberger & Berman Guardian, which was on many lists of the best mutual funds not too long ago.*

*Disclosure: Your FundAlarm publisher currently own shares of Neuberger & Berman Guardian. He plans to unload them as soon as possible in 1998.
The squirrel. Until now, an animal not often mistaken for a pig. The cute little guy on the left is the current logo of Ralph Wanger's Acorn fund family.....The big guy on the right is logo heir apparent, now that Acorn Fund has pushed through a huge increase in management fees.....Mutual fund management fees are typically expressed in percentages, and fund investors don't always translate those percentages into dollars.....We thought it would be interesting to take a closer look at Acorn's fee grab, and see what it means in terms of cold, hard cash.

Under the old fee structure, Wanger Asset Management, L.P. (WAM) was paid on a sliding scale for managing the Acorn Fund.....The new fee structure is also based on a sliding scale, but with different "breakpoints" and different percentages applied at each breakpoint:

Fund Assets	Old Structure	New Structure
$2 billion+	0.40%	0.65%
$1.51 - $2 billion	0.40%	0.70%
$701 million - $1.5 billion	0.50%	0.70%
$101 - $700 million	0.50%	0.75%
0-$100 million	0.75%	0.75%

The Acorn Fund currently holds about $3.6 billion in assets.....Under the old structure, Wanger's firm would have earned $16,150,000 per year for managing this fund .....Under the new structure, WAM will earn $24,750,000 per year -- an increase of $8,600,000 per year, or 53% over previous fee levels.....Wanger says that WAM sought the fee increase primarily to help attract and retain talented stock analysts, and the firm expects to add four new analyst positions.....If Wanger pays each new analyst $200,000 per year, he will need to spend $800,000 of his $8.6 million fee grab.....We estimate that the Acorn Fund currently employs six analysts, and let's assume that WAM gives each of them a $50,000 raise......That will cost another $300,000..... WAM also says that it will use the fee grab to pay for additional client servicing staff, and to improve internal systems....Let's be generous, and assume that WAM spends another $1 million per year on these enhancements.....Let's be even more generous, and assume that WAM spends another $1 million per year on miscellaneous expenses, including expenses we might have overlooked.....Even after paying for all these goodies, Wanger's company will walk away with an additional $5,500,000 per year of pure profit.

Is it any wonder that so many people want to be in the mutual fund business?.....If your fund requests an increase in management fees, please let us know.....We'll analyze the proposal, and post the results in FundAlarm

Investment Techniques of the Pros

"Let's buy a bunch. There's got to be a winner in there someplace."

-- Gerald Perritt, explaining the technology investment strategy of the Perritt Capital Growth fund
in 1994 (recently renamed Perritt Micro Cap Opportunities)
Another example of not-so-careful analysis: The same article that contained the Perritt quote (above) noted that Perritt Capital Growth recently received more new investor money in one day than it had received in the preceding 12 months*.....Why?.....Because the fund bet big on one stock (Asyst) and its bet paid off, propelling the fund to the top of the four-week [!] performance charts.....Investors who one day had never heard of Perritt Capital Growth suddenly couldn't wait to shower the fund with their hard-earned cash.....We are pleased to report that no FundAlarm readers were spotted in this crazed mob of performance-chasers.
*"How Fund Managers Buy Microcap Stocks In Hopes of Big Profits," The Wall Street Journal, December 1, 1997


A mutual fund mystery: Here's the scenario: First Union Corp. owns Evergreen, one of the largest mutual fund families in the U.S.....Evergreen U.S. Real Estate Equity Fund is the #20 stock fund over the past three years, and the fund is up 48.6% for 1997, which also makes it the #9 fund for the year....U.S. Real Estate only has about $30 million in assets, but other real estate funds (with less impressive records) are managing as much as $3 billion.

You'd think that First Union would be licking its chops, planning to turn this tiny fund into a billion-dollar giant..... But no: First Union recently sold Evergreen U.S. Real Estate to its manager, Sam Lieber, for what appears to be a bargain price (included in the sale is another, less successful fund, Evergreen Global Real Estate Equity).

First Union is supposedly selling because it wants Evergreen to concentrate on "broad-based" funds, yet Evergreen will continue to operate a utility fund, a natural resources fund, an emerging markets fund, and muni bond funds for Georgia, North Carolina, and Missouri.....It also has been reported that Evergreen wants to concentrate on less volatile funds, yet Evergreen will continue to operate its Aggressive Growth fund, which is both larger and more volatile than the U.S. Real Estate fund.....Evergreen has said that it is disappointed in the small size of the U.S. Real Estate fund, but who's to blame for that?

None of the public explanations for this sale makes complete sense, so we are left to solve this mystery on our own.....Perhaps the Evergreen marketing staff is truly incompetent, and it can't sell a winning fund.....Or perhaps Evergreen is willing to sell the U.S. Real Estate fund to Lieber if it can also unload the struggling Global Real Estate fund as part of the package.

Dedicated mystery fans should note one additional fact: Sam Lieber, the buyer and manager of U.S. Real Estate is the son of Stephen Lieber, who is Chairman and Co-CEO of Evergreen, and himself manager of several important Evergreen funds.....The senior Lieber (Stephen) also founded the Evergreen Funds in 1971 and sold them to First Union in 1994.....We're not suggesting that anything improper has occurred, but here are two other possible solutions to our mystery: Dad simply put in a good word for his son, or Evergreen came up with the idea as a way to keep a key employee happy.....Such things have been known to happen.


Weird science: These days, it seems as if everybody (including FundAlarm) is trying to develop a new and better system for evaluating mutual fund performance.....At FundAlarm, we've learned that no methodology is perfect, and every mechanical system for classifying funds (including ours) inevitably generates some strange results.....But even allowing for the occasional strange result, a couple of new systems for evaluating mutual funds appear to have some serious credibility problems:

• If Dr. Frankenstein had been a statistician, it's unlikely that he could have come up with anything more bizarre and complex than the fund rating system recently introduced by Worth magazine.....Using the services of a 200-person research firm, a Sun Sparc workstation, 100 different simulated future [!] scenarios, ten years of monthly betas, and perhaps even eye of newt and toe of frog, the Worth system introduces such concepts as the "Regret %," the "Reward %" and the "Outperformance %".....The Worth system is basically a black box, and the important calculations are hidden from view, but as nearly as we can tell Worth uses the S&P 500 to benchmark all funds....Therefore, it's not surprising that 64% of Worth's "best" funds are large cap, only 21% are small cap, and not a single balanced fund makes the Worth "best" list..... After the tremendous run-up by large-cap stocks, you've got to wonder about any system (like Worth's) which purports to predict future performance, yet gives two-thirds of its top ratings to large-cap funds.
  
  
• The fund rating system at SmartMoney.com is more straighforward than Worth's , and all SmartMoney calculations are out in the open.....There's just one problem: Recently, out of SmartMoney's 61 "best" (or "AAA") funds, we counted 12 funds that we classify as 3-ALARM.....Now, reasonable people can disagree about a fund like T. Rowe Price Equity Income.....We classify TRP Equity Income as 3-ALARM, although not by much, and SmartMoney rates it "AAA," presumably because of its low volatility......But when it comes to a fund like Janus, or Founders Blue Chip, or Safeco Income, or Stein Roe Growth & Income, or Strong Opportunity, we draw the line: SmartMoney calls each of these "AAA," and we call them serious underperformers.....User beware.
  
  

Briefly noted:

• Mellon Bank Corp. has agreed to acquire Founders Asset Management and the Founders mutual funds......Founders' big-name fund managers, including Edward Keely, Michael Gerding and Brian Kelly, have reportedly signed long-term employment contracts, and Founders offices will remain in Denver.
  
  
• U.S. Bancorp has agreed to buy Piper Jaffray Cos. (which includes the Piper mutual funds).
  
  
• The Rydex family offers several mutual funds, but its best-known fund is probably Rydex Nova, which attempts to beat the S&P 500 index by 50% using a combination of stocks, futures, and options (of course, there's also 50% more risk if the index declines).....Now, former employees of Rydex have started two new fund families: The Potomac Funds and the ProFunds.........ProFunds will initially offer six funds, many of which look like Rydex funds on steroids.....For example, the UltraBull ProFund will try to beat the S&P Index by 100%....The new Potomac family will offer some Rydex look-alikes, and also such exotica as the Japan/Short Fund, which will seek a return inversely correlated with the Nikkei Stock Average.....Coming soon (no doubt): The Double-Dog-Dare family of funds.....Its first offering, the Double-Dog-Dare S&P 500 Index Fund, will try to beat the S&P 500 by 10 times, and it will come with your choice of champagne magnum or hara-kiri sword.
  
  
• SmartMoney.com takes off the gloves, and declares that Rich Fentin, manager of Fidelity Value, is "no Peter Lynch"*......Fentin has been at the helm of Fidelity Value since March 1996, during which time it has returned about 19.1%, compared to 28.2% for the S&P 500 index .....This fund also has trailed the mid-cap index (perhaps a more appropriate benchmark) by about 400 basis points.
  *December 15, 1997
  
  
• Charles Jaffe, widely-syndicated mutual fund columnist, handed out lumps of coal in a recent column.....The managers of the Lindner Bulwark fund received a lump both for bad name and bad performance....As Jaffe points out, a bulwark is supposed to be a protective wall or barrier, yet this fund was recently down about 25% for the year ....As FundAlarm noted last month, the lead manager of Lindner Bulwark (Larry Callahan) recently departed, but his former co-manager (Bob Buettner) remains in charge.
  
  
• Fidelity is proposing to change the investment policy of its underperforming Contrafund ("contra" was originally intended to suggest "contrarian").....The redesigned Contrafund fund would no longer seek to invest in "unpopular" stocks, but would instead seek stocks that are "experiencing a positive fundamental change" and "companies whose earnings potential has increased or is expected to increase more than generally perceived".....No new name is planned for the Contrafund but, if the time comes, we'd like to propose the Can't-Beatem-Joinem Fund.
  
  
• According to an article in The Wall Street Journal,* Dean Witter tops the list of brokerage firms which push in-house or "proprietary" mutual funds....In an undercover study, 89% of Dean Witter brokers who recommended mutual funds pitched at least one Dean Witter fund.....Merrill Lynch brokers were a distant second, with 50% recommending at least one in-house fund.....Dean Witter is stonewalling the issue, but the reason for this practice seems clear: Dean Witter brokers continue to be better-compensated for selling proprietary funds over third-party funds.
  * "'In-House': Still a Magic Phrase When Dean Witter Sells Funds," Charles Gasparino, December 26, 1997
  
  
  
• Department of Grim Persistence: After attempting and failing to reorganize early in 1997, Steadman Security Corp. now wants shareholder approval to merge the assets of the four Steadman mutual funds into a single fund, which would be called the Steadman Security Trust.....A December 18 shareholder meeting on this proposal was adjourned until January.....Reason: Lack of a quorum.
  
  
• Fidelity recently introduced three "Spartan" index funds, which require investors to pay a "purchasing fee" of about $5 for each $1,000 invested......This fee is used to cover the transaction costs incurred in purchasing the underlying stocks for new and additional investments.....Watch for this elsewhere: it's likely to be popular, especially with fund families that try to keep expenses low.
  
  
• In 1996, David Ellison was the extremely successul manager of Fidelity Select Home Finance Fund, a job he had held for the preceding 11 years....Out of the blue, according to Ellison, Fidelity decided that he should be taken off Home Finance and reassigned as a REIT analyst.....Fidelity apparently felt that REITs were a bigger opportunity for the company, and also a good opportunity for Ellison.....Ellison disagreed, and he now he manages two financial services funds for the FBR family, so far with great success.....Is Ellison's version of events accurate? We don't know, but it sure sounds right.....And, if true, it's another revealing insight into the Mind of Fidelity.
  
  
• And now, the obligatory cheap shot at Warren Isabelle: This month's guest shot comes from the aforementioned Charles Jaffe who, while awarding a lump of coal to the much-travelled Isabelle, offered this sage advice:
  "Do not ask for whom Isabelle toils. It's not for thee."
  
  

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FundAlarm © Roy Weitz, 1998