David Snowball's
New-Fund Page for January, 2008


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


Dear friends,

Welcome to the New Year. Good news: 2008 marks "The Year of the Rat" in the Chinese zodiac. The year of the rat is auspicious both because rats are protectors of material prosperity but also because the rat year marks the beginning of a new twelve year zodiacal cycle. Akio Hayashida, deputy economic news editor of Japan's The Yomiuri Shimbun newspaper reports,

According to various sayings and lessons regarding stock transactions, the Year of the Rat is considered the year of prosperity, when stock prices mark a dramatic surge. This is good news for the year. Due to its strong propagating power, the rat is considered a symbol of "prosperity of one's posterity" and "increasing one's assets." The average rate of increase in [Japanese] stock prices in the Year of the Rat topped the list at 40 percent, far higher than the 29 percent figure recorded in the Years of the Dragon.

The BBC, under the headline "Rat craze grips Russia," (1/1/08) reports a Russian rat shortage as folks snap up the cuddly little furballs as presents, with the unscrupulous (or merely desperate) trying to sneak in mice, hamsters or gerbils.

How to profit from the ratty year ahead? In addition to considering specialty investments (hmmm . . . under-the-hedge funds? CROs -- collateralized rodent obligations?), astrologers claim "long-term investments could show favourable returns, since the earth components of the year prefers conservatism and practicability." Even if your interest in the Chinese zodiac is limited to reading the placemats at Chinese restaurants, you're faced with the interesting prospect that some of Asia's hundreds of millions of stock investors might keep this prediction at the backs of their minds in considering the year ahead. Since the Chinese New Year doesn't begin until February 7th, you have plenty of time to . . . uh, ferret out? some of the possibilities.

"Bend over and grab your ankles, please."

Men of a certain age and draft status doubtless remember the kind ministrations of the Army’s medical corps. Their avuncular request (see above) rarely came to mind when writing with mutual funds.

And then I met the Boston Company International Small Cap (SDISX) fund. SDISX paid a capital gains distribution in December of $23.17 per share against a pre-distribution NAV of $24.70, resulting in a post-distribution NAV of $1.23. That figures out to a taxable distribution equivalent to 94% of the fund’s assets, which surely sets a new intergalactic tax-hit record. The Boston Company, International Core Equity (SDIEX) showed a relatively modest payout of about 43% of assets.

Let's say that your diligence wasn't particularly "due" this year and you chose -- based on its 29% annual returns over the past five years and four-star rating -- to invest the minimum, $100,000, in SDISX on December 1st. By mid-December, you'd have noticed a small decline in the value of your account as the market fluctuated. Then on December 17th, the fund would have returned approximately $94,000 of your original investment to you in a check -- perhaps with a note reminding you that the taxable distribution means that you just inherited a $15,000 tax bill, payable by April 15th. All for an account that had lost you money.

How did they manage that feat? Folks on the FundAlarm board (a discussion started by "DlphcOracl" and joined by "Vegomatic," among others) initially speculated that this might be a data-reporting problem.

No such luck. The story seems to be this: the funds’ highly successful, long-time managers resigned in the first week of August.  According to a rep for the fund company, "they didn’t say why they were leaving."  One week later they were announced as the managers of the brand new Munder International Small Cap fund which follows a strikingly-similar investment discipline.  In the weeks following their departure, something like $800 million was pulled from the fund which had less than a billion to begin with (as of mid-December, they have $163 million left in the hard-hit Small Cap fund). Those redemptions forced the new manager to liquidate much of the portfolio, which realized over a hundred million in taxable gains that then had to be distributed to the remaining shareholders. I’m guessing that had to be a handful of enormous institutional accounts (the fund is institutional but the minimum is only $100,000).  The result was a devastating tax surprise for any poor fool who stayed loyal to the fund and didn’t have a tax shelter. 

In the normal course of events (that is, without the manager change) this year’s tax burden would have been trivial.  

I’m not sure where, exactly, the $800 million went.  Munder says the new fund has $189 million across all its share classes (though the rep is oddly uncertain about whether that meant "all" or "all retail").  Representatives for Munder’s public relations group allows that Munder runs separate accounts but that they don’t publicize the amount of assets in those accounts.

What’s a poor investor to do, other than follow my headlined advice? That’s one heck of a question for which I have no easy answer. "Ira", a FundAlarm reader who has written about the distribution, offered his strategy which is to accept all distributions in cash rather than having them automatically reinvested. He uses the resulting distribution as cash for rebalancing between accounts and is, mostly, stoic about the short-term tax hit. Others, me for example, might be tempted to use the check to buy an LCD TV – which probably doesn’t have quite the same long-term return. The facile answer is to "do your due diligence." Check for pending distributions and, when in doubt, avoid investing in taxable accounts anywhere before their ex-div dates.

Well, at least no one else has quit lately . . .

Over the past several months I’ve highlighted the on-going and lamentable exodus of Janus managers that began in 2006. It’s not exactly great news, but at least they’ve now gone a month without further defections. At the same time, Janus announced just before Christmas its plan to close immediately Janus Overseas (JAOSX) and its various clones. Like last month’s decision to merge away the five-star Fundamental Equities fund, this looks like an organization still struggling to balance its fiduciary responsibilities with sharply diminished staff resources.

Have I been picking on the Spectra Funds?

God forfend! Admittedly, in the December essay, I criticized Spectra’s most recent advertising campaign as being wildly optimistic, at best, and noticeably misleading, at worst. The ads preened about the fact that "back when the bubble was bursting, we knew it wasn’t all hot air." They went on: "Talk about a no-brainer . . . with bottom-up research, careful analysis, and a little creative independence, we aim high and look to get in early." I merely pointed out that fact that Spectra skipped the "and lose our shirts" part.

A number of folks wrote to express concern about my discussion. Their very thoughtful commentaries focused on two points which I didn’t discuss in the essay. First, Fred Alger Management – with its offices high in the World Trade Center – was virtually destroyed in the attacks of September 11th. The only survivors of the attack were folks attending meetings elsewhere that day. Their loss was terrible and the decisions made by a number of former Alger employees to quit their then-current positions in order to return and rebuild was very moving. Surely those losses had an effect on the firm’s subsequent performance. Second, Spectra – the fund I chose to illustrate the "lose our shirts" performance – has performed spectacularly over the past five years under manager Patrick Kelly.

So why not mention it?  Three factors were on my mind:

  1. I was trying to criticize an advertising strategy and wasn’t trying to pick on the Spectra fund. Mr. Kelly has produced exceedingly strong, consistent returns for Spectra investors (22.4% annually, which places the fund in the top percentile for large growth offerings) in his three years with the fund. My concern was with Alger’s advertising strategy which leads its readers toward the impression that Alger brought some special merit to investing during the meltdown ("others saw a bubble, we knew it wasn’t all hot air, so we got there early and . . .").  In reality, they got taken to the cleaners, both with Spectra and Alger Capital Appreciation and trailed 90-some percent of their peers.  Since then, they’ve cleaned up their act and rebuilt the talent pool.  Those are both admirable and advertisable.  Pretending that 2000-02 didn’t happen strikes me as problematic and might help make a larger point.   

    2. We're in a sort of marketing sweet spot for large-growth funds right now. Those funds took often-devastating losses from 2000 - 02, but those losses have now left the five-year return figures. For funds which don't have ten-year records yet, that means that those losses disappear entirely from the figures provided (in ads and elsewhere) for the standard 1-, 3- 5- and 10-year standard reporting periods. That makes it harder for investors who rely on star-ratings and consistent reported results to recognize the considerable risks, as well as substantially advertised returns, that such funds offer. 

  2. The performance issues actually bracketed 2001, which is to say that the funds’ old management team crashed hard in 2000 (Alger Cap App trailed 94% of its peers, Spectra trailed 98%), recovered in 2001, then crashed again in 2002 under the new management team (trailing 89% and 93%, respectively).  In each case, the fund lost between 25 – 35% of its investors’ money annually.  Some fraction of the ’02 losses are certainly attributable to the deaths in ’01 but it also seems clear that a large fraction of it is attributable to Alger’s investment discipline.


  3. Finally, if I began the narrative of destruction and rebirth, I would have felt compelled to include the subsequent betrayal. While Alger managers worked to rebuild the company and regain their investors' confidence, at least one of Alger's executives worked to betray those investors by allowing hedge funds to engage in late trading and market timing (late trading involves buying shares of a fund at that day's NAV but after the close of the day's trading, so that the hedge fund could benefit from market moving news when other investors couldn't; market timing involves rapid trading in and out of funds, triggering tax liabilities and higher expenses for long-term investors while enriching the hedge funds). Typically, in exchange for such access, the hedge funds agreed to invest large amounts into other mutual funds in the family. Some of the details are available on the SEC Web site (Alger cease and desist order), as well as the "Legal Proceedings" section of the various Spectra fund prospectuses. The prospectus reports that "The Manager has responded to inquiries, document requests and/or subpoenas from various regulatory authorities in connection with their investigations of practices in the mutual fund industry identified as ‘market timing’ and ‘late trading’ . . .without admitting of denying liability," in 2007 the firm coughed up $40 million and undertook "certain other remedial measures." The firm belatedly committed itself to a ban on such behaviors.
In recognition of the considerable talent that Alger/Spectra's managers bring to growth investing, I've profiled their new (but still seven-year-old) Spectra Technology fund as this month's "Star in the Shadows."

Has growth topped out already?

In general, "growth" and "value" styles of investing alternate as the dominant (i.e., most profitable) investment strategy, though most research suggests that value investing has greater long-run returns. In general, investors clue into these changes just a bit too late to benefit from them. In reality, Morningstar found that cash flows were a remarkably reliable contrarian indicator – money typically flowed away from the next year’s most profitable investment area and into less attractive realms.

For a long time, Morningstar had a "buy the unloved" portfolio which they released early each year. The portfolio featured the three sectors with the greatest investor outflows and, typically, that portfolio would beat the market over the following three years. They quietly killed (okay, revamped beyond all recognition) the strategy in 2006, apparently because sector fund flows were goofing up the system.

If contrarianism is your mantra, you might consider the fact that long-closed "value" funds are steadily reopening as a result of diminished (and, in some cases, negative) cash flows. Among the recent announcements are Third Avenue International Value (TAVIX), Tweedy Browne Global Value (TBGVX), Oakmark International (OAKIX), Oakmark International Small Cap (OAKEX), Diamond Hill Small Cap (DHSCX), and FPA Crescent (FPCAX). .

Answers to your questions about Wasatch Emerging Markets Small Cap

My December 2007 profile of the new Wasatch Emerging Markets Small Cap fund (WAEMX) raised questions for a number of folks, some of which were posted on FundAlarm’s discussion board while others reached me through our feedback link. The nice folks at Wasatch shared these thoughts:

Why does it seem that the fund’s NAV often goes days without changing? One likely factor was the relatively illiquidity of some of the smaller markets in which Wasatch invests. I noted, in writing about Africa’s frontier markets as part of my T. Rowe Price Africa and Middle East essay, that some of the African stock markets report average daily volumes in the range of hundreds of shares (against the US average in the billions) and some markets will have days with no trades at all. Wasatch add that the unchanged NAV "was a function of managers carefully investing the cash received into the fund resulting in higher cash levels close to the beginning of the fund launch.  Also, with a starting NAV of $2.00 it requires more to move the NAV even a penny."

Wasatch tends to close funds quickly and tightly. When will WAEMX close? Wasatch: " While we don’t have an exact target for total fund assets, the mangers feel comfortable managing assets in the range of $500 million." This struck me as odd, since they closed International Opportunities – a fund which can invest in both developing and developing markets – at around $50 million. Wasatch explained that "The international markets are drastically different in January ‘05 (launch of International Opportunities Fund) vs. October ’07 (launch of Emerging Markets Small Cap Fund). They’ve had such a huge run-up that, late last year MSCI increased the market cap for small cap from a max of $2.5 billion to a max of $5 billion. So, there are a lot more target companies in emerging small now than there were in micro non-emerging in ’05. Wasatch International Opportunities Fund whose focus is on micro cap companies remains a smaller investable universe, especially since many international markets do not have the transparency that we have in the U.S., so it’s harder to find micro companies that you can buy and feel comfortable with the numbers. That’s changing, but still limits it."

Is this apt to be appropriate for a taxable portfolio? In general, yes, as much as any international fund is appropriate there. They write, "In general we don’t manage the fund with a close eye on tax efficiency. I would say we are tax aware but not tax focused.  At the outset of the management of the Emerging Markets Small Cap Fund we don’t believe our turnover, dividend yields etc. will be significantly different that our international/global funds."

Did you even know you were hostage to invisible funds?

If, like me, you’re a Fidelity investor, you might be surprised to learn that you may be invested in dozens of funds whose existence you didn’t even suspect. The performance of those invisible funds can cause substantial discomfort to your portfolio.

Welcome to the world of the Fidelity Central Portfolios. Fidelity runs a set of about 40 mutual funds in which only its own mutual funds may invest. If, for example, your diversified large cap guy wants to increase his exposure to the energy sector, he’s got two choices. Research and buy some energy stocks, which will then show up individually in the portfolio holdings, or buy shares of the Fidelity Energy Central Fund. These funds, often but not always run by managers of Fidelity’s public funds, charge miniscule expenses – in Energy’s case, one-third of one percent – and have assets ranging from the hundreds of millions (Energy holds $760 million) to the tens of billions of dollars. Disclosure concerning the funds is minimal and their mere existence is unknown to most retail investors.

The fact that the funds are invisible, though, doesn’t make them inconsequential. Derek Young, who manages the Fidelity Strategic Real Return (FSRRX), reported in his most recent shareholder letter (dated 9/4/07, though it arrived in December) that:

[T]he commodities and inflation-protected securities subportfolios underperformed their individual benchmarks partly as a result of their investments in Fidelity Ultra-Short Central Fund, a diversified pool of short-term assets, which had sizable exposure to the beleaguered subprime mortgage market. . . meanwhile, our investment in floating-rate bank loans – primarily through Fidelity Floating Rate Central Fund – outperformed mainly due to solid security selection.

Neither Fidelity’s website nor Morningstar’s offer any guidance on the Central Funds, which means an intrepid investigator (well, me) needs to turn to the SEC’s labyrinthine site. After digging a bit, you encounter the source of Mr. Young’s frustration:




One has to imagine that Mr. Young was dismayed by the sudden, 120-degree bend in Ultra-short's return line. His one advantage, unlike that of most of his investors, is that he at least knew that Strategic Real Return had placed nearly a billion dollars into each of the Fidelity Floating Rate Central and Ultra-short Central funds.

Welcome to a New Year! Both Roy and I hope that it will be both joyous and profitable for you. We’ll certainly do our part to help.

As ever,

David



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


NEW Discussed this month:
Satuit Capital Management Small Cap Y (SATSX) : What do you get when you cross a two-month old, three-star small cap fund which reports a five year record with a low-profile, load-bearing microcap fund? A pretty compelling opportunity for investors looking for a tested, tax-efficient small cap option.


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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.

American Trust Energy Alternatives Fund invests stocks of:  1) companies involved in the development of, or ownership of, alternative energy sources; 2) companies that supply key parts, materials, services or technologies to those companies that develop or own alternative energy sources; and 3) natural resource or other asset intensive companies (including utilities, energy companies and general industrial companies) whose value could increase with growing use of alternative energy technologies. Carey Callaghan and Paul H. Collins co-manage. The minimum initial investment in the Fund is $5,000 for regular accounts and $2,500 for IRAs. 1.85% e.r. after waivers. Likely February launch.


Anchor Multi-Strategy Growth fund seeks to invest in multiple quantitative strategies that, when combined, will provide enhanced risk-adjusted returns. The Fund will pursue its objective by allocating assets among a group of specialized quantitative and fundamental investment strategies. The adviser employs a proprietary quantitative approach to allocate assets and diversify across multiple asset classes and investment styles, which the adviser believes are complementary and have low correlation with each other and with major financial markets. The Fund is team managed and led by Chief Investment Officer Eric Leake. You might get a clearer notion of the fund’s investment strategies by consider Mr. Leake’s professional affiliations: he is a level II Chartered Market Technician, member of the Market Technicians Association (MTA), American Association of Professional Technical Analysts (AAPTA), National Association of Active Investment Managers (NAAIM),  and advisory board member to Rydex Financial Services, LLC.   Minimum investment is $2500.


Fidelity 130/30 Large Cap fund seeks long-term growth of capital by establishing both long and short positions in equity securities. Fido intends to maintain a net long exposure (the market value of long positions minus the market value of short positions) of approximately 100% by investing 130% in long positions and 30% in shorts. Keith Quinton is manager and also runs two four-star, quant-ish funds, Disciplined Equity and Tax-Managed Stock. Expenses capped at 1.3%. $10,000 minimum for regular accounts, $2500 for IRAs.


FundX Tactical Upgrader fund seeks long-term capital appreciation; capital preservation is a secondary consideration. It will invest in no-load and load waived mutual funds and ETFs. Here’s their official explanation of the upgrading regime: "When the Advisor believes that stock market conditions warrant a defensive posture, the Advisor may liquidate a substantial portion of the Upgrading Underlying Funds and invest in money market instruments and ETFs that short the market (perform inversely to broad market indexes), providing a hedge against the remaining long positions.  When the Advisor’s indicators turn positive, the portfolio will again be fully invested in Upgrading Underlying Funds. Consistent with the Fund’s investment objective, the Advisor uses an "upgrading" investment strategy to manage the Fund and to select the Upgrading Underlying Funds.  The Advisor believes that the best investment returns can be attained by continually upgrading the Fund’s investments into what it believes to be the top performing Upgrading Underlying Funds within a given risk class, and intends to remain invested in those funds as long as they continue to provide superior results." Team managed. Minimum not yet set. E.R. not yet set. Likely February launch.


Manning & Napier Target Funds (Income and 2010 – 2050) The Target Income Series, Target 2010 Series, Target 2020 Series, Target 2030 Series, Target 2040 Series, and Target 2050 Series (collectively, the "Series") seek to achieve their investment objectives by investing in a combination of other Manning & Napier mutual funds (referred to as the underlying funds) in order to meet their target asset allocations and investment style. These underlying funds will pursue asset allocation strategies, and will invest in a combination of stocks, bonds, and cash. The Series are designed to provide investors with investment management, asset allocation and ongoing reallocation over time. Not available at retail but worthy of serious consideration if they’re part of your retirement plan.


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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:
Spectra Technology (SPETX): Here's the latest in a series of encouraging developments for the no-load fund world. Following launchs by Dreman and Westwood, another first-rate loaded fund is migrating very quietly into the retail, no-load realm.


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