Dear friends,

"The winter of our discontent" indeed! A simple one-year chart of Vanguard’s Total Stock Market Index fund explains a lot about why people of good will and good sense are stocking up on strong drink and other survival essentials:

It’s not just you.

In case you’ve checked your portfolio lately, noticed nasty red numbers everywhere and asked, "is it me? Am I just stupid" the answer is "No, it’s not just you." Despite all of the smug babble at the beginning of the year about "a stock picker’s market," the stock pickers have uniformly had their clocks cleaned.

There are 930 mutual funds in the black YTD (as of 2/25/08). It’s not surprising that the top 25 funds are all bear market specialists (Direxion NASDAQ-100 Bear 2.5X leads the bear brigade with a gain of 43%), gold funds (Evergreen Precious Metals leads with a 15% gain) or natural resources funds or commodity funds whose portfolios are laden with bonds and futures contracts (PIMCO Commodity RealReturn Strategy is up 17%).

If we limit our search to diversified domestic retail stock funds, the number plummets to 15. That’s 15 out of 2600. One-half of one percent of the funds. Those few brave souls include a half dozen five-star funds: the consistently excellent Fairholme Fund (FAIRX), tiny and inconsistent Neiman Large Cap Value (NEIMX), Hennessy Focus 30 (HFTFX)and Royce Value (RYVFX).

The most interesting JHancock Large Cap Equity A (TAGRX) which has been around for nearly 60 years. Its management team is led by Tim Keefe, who ran the fund in the late 90s, left to work for Thomas Weisel Partners, then returned in 2004. In theory the portfolio discipline is undistinguished. "The management team seeks companies that are selling at what appear to be substantial discounts to their long-term intrinsic values and/or offer the potential for above-average earnings growth" (www.jhfunds.com). In practice, it benefits from intense sector concentrations: holds 30% in energy stocks (a tiny bit of coal and a lot of oil & gas) and 20% in metals (10% gold, 5% silver, 5% mining stocks). Not surprising, it tracks the S&P500 poorly but natural resources indexes well.

On the other hand, hedging helps.

Despite Morningstar’s well-publicized aversion to the high expenses charged by most of the hedge-like mutual funds (heck Vanguard’s Market Neutral fund charges 2.67%), a wide variety of them have substantially outperformed the stock market in both 2007 and 2008. Among the more promising performers:

Of the 20 or so hedged mutual funds that I track, only two trail the Total Stock Market YTD (Penn Ave Event-Driven and Icon Long/Short) while the vast majority have returned between (1.0) and 2.6 for the year through 2/28. While expenses range from 1.0 – 2.5%, in part because of the dividend expense of maintaining short positions, such funds might well be worth the price if they help keep you from doing something really unfortunate (investments involving the underside of mattresses, holes in the backyard, or mayonnaise jars).

Not yet time to write off Fidelity’s new funds

Dan Lefkovitz, editor of Morningstar’s Fidelity Fund Family Report, recently asked "Are New Fidelity Funds Worth Your Money?" (2/15/08). Dan brings a healthy skepticism to the world of fund marketing, noting that fund launches are often driven by "what’s hot and saleable rather than what makes sense for long-term investors." He notes Jim Lowell’s case for buying new Fidelity funds but finally concludes that there’s a pretty good chance that the funds are going to "sizzle then fizzle."

Mr. Lefkovitz defends his conclusion by running two studies of the performance of new Fidelity funds. The first study compares the funds to their peer groups. As a group, the Fidelity funds spanked their peers across a variety of time frames. 64% beat their peers in the year after launch. 63% beat their peers for the three years after launch and 68% were ahead after five years. At this point, Fidelity fans might be cheering lustily since durn few systems offer anything like the prospect of a two out of three chance of winning.

Unsatisfied, Lefkovitz conducts a second study "to truly determine whether new funds held long-term merit." At this point, I’m afraid, we part company. (I know, I know, many see that as a cause for celebration.) The second study compares the returns of all funds holding any stocks of any variety to the S&P 500 while comparing all bond funds to the Lehman Aggregate for bond funds. Here he finds "the absolute case for new funds is weaker." While 52% outperformed their benchmark after one year, only 40% did so after three and 37% over five years.

That’s silly. If an investor were to say, "I’m worried because my fund (which holds 23% bonds, 31% foreign stocks, 23% US stocks and 12% cash) is trailing the S&P500," we’d conclude that the person needed to attach training wheels to his clue-wagon. And yet that’s exactly the comparison that the study makes in dismissing Fidelity Global Balanced, International Discovery, Pacific Basin and 130/30 for their failure to beat the S&P.

The case to be made for adding a new Fidelity fund . . . heck, for adding any fund . . . to your portfolio is based on the way its constellation of risk, return and diversification characteristics benefit the overall portfolio. It may well be that a low volatility fund that never beats the S&P500 has an important role to play in a portfolio. Likewise, a fund with a very low correlation to the S&P – which is to say, a fund which might well lag the S&P badly for years and then clobber it for years – is an equally legitimate contender for a spot in the portfolio. It would be great if we could all invest in the one fund representing the one asset class which will do best over the next three to five years, but if we don’t know what that asset class is going to be, we add asset classes that give us the best shot of being in the right place (with at least some of our money) at the right time.

As a Fidelity marketer or investor, I’d take considerable comfort in Mr. Lefvokitz’s peer analysis. As for the other half, the kindest judgment would be a "Scotch verdict": case not proved.

Lipstick, meet Corpse.

Deck chairs, meet Titanic.

Funds, meet Reorganization Plan.

We’ve all had that sickly moment when we finally realize what we should have done, but didn’t do. Sometimes the moment comes when you awake after a first heart attack. Sometimes when a loved one leaves for the last time. And sometimes it occurs after you’ve lost three or four billion dollars of other people’s money.

The Van Wagoner funds seem to be having just such a moment. Garrett van Wagoner, enfant terrible in the 1990s, turned just terrible in the present decade. He made a reputation for himself as manager of Govett Smaller Companies, where he averaged 51% annual returns from 1993 through 1995. He left at the end of 1995 to start his own management company. In the late ‘90s he produced returns that were eye-popping even by the jaded standards of the day: a $10,000 investment at the start of 1998 in his flagship Van Wagoner Emerging Growth fund was worth over $40,000 by the end of 1999. By the end of 1999 he was managing nearly $4 billion.

And then he crashed. His funds posted catastrophic and continuing losses. The Post-Venture fund lost 60% in the first three months of 2001. Emerging Growth lost 60% in 2001 and another 66% in 2002. Investors fled. Van Wagoner shuttered three funds while opening others. He proposed and then abandoned a private partnership for rich investors. In 2003, he received Forbes magazine’s "Mutual Fund Booby Prize" award. Whether from hubris or desperation, he got hit with multiple lawsuits from shareholders for manipulating stock prices, which also got unwanted attention from the SEC.

In February 2008, I highlighted Van Wagoner’s funds as stars of "the race-to-the-bottom derby:

In an SEC filing on February 11^th, 2008, Van Wagoner’s board proposed to change all that. The board presented a reorganization plan that would, in essence, dismiss the firm’s founder.

The firm's founder
(in front)

Here’s how it would work. There are currently six Van Wagoner funds (the three noted above, and three that were liquidated in 2003). As it turns out, the liquidated funds weren’t actually liquidated. Van Wagoner canceled his advisory contract with the funds. The Van Wagoner board sold all of the funds’ holdings and turned them into high cost, money-losing money market funds. The funds’ marketing director believes that a lawsuit against the funds, which wasn’t resolved until mid-2007, made final closing impossible. Every six months, Van Wagoner warned investors in the liquidating funds that they were being stupid:

Despite all of this, despite losing money year after year and have no prospect of ever recovering it, some poor benighted souls – possibly dead people – have remained invested in the funds.

Under the board’s new plan, and pending shareholder approval, every fund will change its name, objective, management and – likely – expense structure.

Who are these new managers? How did this happen? Should you care?

Insight and Husic are private money managers located, like Van Wagoner, in the San Francisco Bay Area. Both firms have splendid records managing separate accounts. Despite that, Husic’s attempt at managing a mutual fund (Vanguard Capital Opportunity in 1997-98) was a failure, and Vanguard ended up firing Husic. Jay Jacobs is a member of Van Wagoner’s board, the founder and portfolio manager for a long/short hedge fund, and a founding partner of Thomas Weisel Partners. Nice resume, I suppose, but why does he deserve to run your money?

And where was Van Wagoner’s board while all of this was going on? Mostly they were assiduously avoiding entrusting their money to Van Wagoner. During much of the time, the board was virtually non-existent: it was comprised of Van Wagoner and just two independent directors. At the SEC’s behest, the board was expanded to include an anesthesiologist and a guy who ran a chain of scrapbook stores. In 2006 that board announced a proxy vote which would elect an entirely new board. According to the proxy, "Each nominee has consented to . . . serve if elected. Each of the current directors will resign . . . immediately following the election of the new directors." Lest you think that the directors were signaling the existence of a problem at the funds, they hastened to add: "None of the current directors as a disagreement with the Company on any matter relating to its operations, policies or practices."

Dear God.

An entirely new board was elected on January 29^th, 2007. And, two days later, one of its members resigned. The remainder began planning either Van Wagoner’s demise or the firm’s resurrection, depending on your point of view.

That having been said, there remain several problems. The new managers haven’t run a successful mutual fund before. The existing shareholders, many apparently deceased, still have to vote in favor of the proxy. And the new funds will remain saddled with a horrendous reputation and, most likely, onerous expenses.

On the whole, not good. You know that liquidation idea? It’s looking better and better.

Garrett Van Wagoner Speaks (Part I)

Garrett Van Wagoner Speaks (Part II)

Life on the frontier might be gittin’ just a bit crowded

As I note below, Fidelity has registered to launch a new fund which might be a bit edgy: Fidelity Emerging Europe, Middle East and Africa. I let the cat out of the bag in a post on FundAlarm’s lively discussion board. "Investor" poked around the SEC’s website, figured out which fund I was alluding to, and posted a note of its existence. Inquiring minds (well, "msf" and "Investor") soon discovered, and debated, an identically-named Fidelity fund which is available only in markets outside of the U.S.

The question is, what guidance can you take about the prospects of an American Fidelity fund from the construction and performance of one of its offshore counterparts? The answer is: none at all.

Fidelity runs a number of funds offshore funds with names and mandates very similar or identical to its American funds. Nonetheless, the offshore versions do not track their American counterparts. The British version of Fidelity Europe is managed by Tim McCarron and has returned 21.9% over the past five years; the American version led by Trygve Toraasen (sounds like a native Midwesterner to me!) returned 27.8% annually over the same period. Fidelity Technology (British) trailed Fidelity Select Technology by almost 50% over the past five years – 7% versus 13% annually.

Even when the funds are run by the same managers, the portfolios and returns can be dramatically different. The American and British versions of Fidelity Japan have been run by the same manager, Rob Rowland, for about a year. In that time, the British version led the American one 15% to 11.6%. Over the longer term, the British version trailed the American by a third. Both versions of Fidelity Emerging Markets are managed by Robert Rekowsky (though in the U.S. he’s known as Robert B. von Rekowsky). The British version holds 360 stocks in its portfolio and returned 41.3% last year. The American version holds only 230 stocks and returned 45.1% for the same period.

Caveat, in short, emptor.

T. Rowe Price might be spending a bit less time on the frontier than advertised.

One of the attractions of Price’s recently launched Africa and Middle East fund (TRAMX) is its access to Africa’s unfollowed "frontier markets," which offer the prospect of greater diversification and substantial returns. After studying TRAMX’s most recent portfolio and chatting with Price analysts, Morningstar’s Gregg Wolper (2/26/08) tosses a bit of cold water on the party:

Price analysts argue that valuations are more attractive in the Middle East right now, but that they’re still looking hard in the sub-Saharan nations. Wolper suggests that you "ignore the name and think of it as a Middle East vehicle first." By whatever name, its 35% return since inception (September 07) and its 4.6% YTD (through 2/28/08) certainly warrants attention.

Maybe not so "Central" after all?

The Wall Street Journal picked up my February story on Fidelity’s Central funds (Eleanor Laise, "Mutual Funds Find an Enemy from Within," 2/16/08), though without mentioning its origin. (Sigh.) Her story got picked up by MutualFundWire.com. Laise correctly points out that finding out who uses the Central Funds is a major pain because Fidelity’s website lists each fund’s holdings "but these lists don't show which holdings are inside central funds." That is, you can’t tell whether a fund bought its listed shares of General Electric directly or if they own GE by virtue of owning a Central Fund which owns GE.

By far, the greatest response among FundAlarm readers was to the suggestion that their stock managers might be cutting corners by investing in Central stock funds rather than selecting their own securities. It appears that’s not the case. A painfully slow full-text search of SEC filings suggests that the equity central funds might only be held by the Asset Manager and Advisor Asset Manager series of funds. Many of the bond-oriented Central funds are also used in Fidelity’s balanced funds, as well as in Fidelity’s income funds. I’ve got a call into the folks at Fidelity to confirm my reading of the SEC record and, if true, why this seems slightly at-odds with their statements in the Journal’s piece. More to follow!

David

Augustana’s students are spending the next week on Spring break. Given the snow swirling around campus right now, I hope it’s somewhere warm. I’ll spend the week ahead preparing for next term’s classes (two sections of Advertising and Social Influence, just fyi) and talking with fund managers. I’ll let you know what I’ve learned in the April Annex, as I celebrate the completion of my second year writing on your behalf.

As ever,

David