An article on TheStreet.com notes that many funds launched right before the Great Depression have stood the test of time:

Don't be impressed. Fund companies buy and sell funds and flip managers throughout the years. It's irrelevant how a fund did decades ago when it was run by a different fund company with different managers, often with a different strategies. What we don't see on this list is all the funds launched in the late 1920s that went bust. The real takeaway is funds tend to launch tons of new funds shortly before markets tank. Someday we'll look back at funds launched in 1999 and 2000 that stood the test of time.

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Closed-end funds often use leverage aggressively. The essentially fixed portfolio size allow closed-end fund managers to perform tricks that funds with daily in and outflows would find difficult. A closed-end fund with $1 billion in actual shareholder capital can, for example, borrow another $500 million and buy a total of $1.5 billion in investments for the portfolio - money the closed end fund generally invests in bonds and other higher yield securities.

One reason this strategy can pass the laugh test (why borrow money and pay interest only to buy other bonds?) is the funds can borrow at very low interest rates (far lower than rates charged to retail investors using margin in their brokerage accounts) by issuing "auction rate preferred" securities.

Preferred securities means the payments of interest are senior to mere fund shareholders. Basically a fund with $1 billion says we want to borrow $500 million and we are using the fund holdings as collateral. Institutional investors bid on the preferred securities. These auctions are held frequently - weekly even - so the securities themselves are essentially floating rate investment grade bonds.

Big time institutional investors love investment grade floating rate debt. They don't have to worry about defaults or interest rates spiking - the two main fears of bond investors. This meant closed-end funds could borrow at ultra-low interest rates, then buy higher-risk, higher-yield bonds in their portfolios.

Apparently this love affair ended rather dramatically sometime around Valentines Day:

Now many closed-end funds are finding their borrowing costs increasing right around the time when what they bought with the borrowed money - higher-risk debt - is having problems. Coming soon: lawsuits against brokers who sold (with built in sales commissions) to yield-hungry investors supposedly safer closed-end funds at $20 a share a couple of years ago; funds that are now tipping the scales at around $13 (and falling).

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MAXfunds is all about avoiding overheated fund categories and sniffing around for out of favor fund categories. Our category rating system looks at fund flows and past performance across all funds in a category to find attractive areas. Funds that invest in financial stocks appear to be attractive as the mortgage meltdown has led to tens of billions in losses and big stock price declines for banks and other financial companies and the funds investing heavily in these stocks. Unfortunately for true contrarians, everybody else is looking to make the same bet:

This means more money has been going into financial sector funds trying to catch the supposedly big buying opportunity than left during the financials crash last year.

We've seen this phenomenon with the Select Sector SPDRs Exchange Traded Funds. You'd think the Financial Select Sector SPDR ETF (XLF) would be hemorrhaging cash with its stakes in many troubled financial stocks. However, today this sector ETF has more money in it ($5.5 billion) than any of the other nine sector SPDRs - even the popular and hot-performing Energy Select Sector SPDR ETF (XLE). At the end of January (during peak bottom fishing optimism in financials) the ETF had $6.7 billion in assets - way up from the roughly $5 billion at the end of December.

We're going to need to see some of this money leave the sector before we see a true buying opportunity. It's not a true buying opportunity until only a few people want to buy.

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We all remember the infamous "Let's light this candle!" ad for an online broker in 1999. The day-trader-era focused ads made riches seem available to all who clicked buy. We all know what happened: pain and suffering as the Nasdaq declined about 80% top to bottom.

To those watching the Superbowl yesterday, you may have noticed a sort of retro dot com era ad flashback. Not only were many of the multi-million dollar ads run by dot-coms (just like the old days), but ads for online brokers were making the rounds again.

Check out E*Trades current slew of ads. Our favorite is the one that touts E*Trade's new feature where customers can buy shares directly in foreign markets. In the ad, one customer is particularly enamored by his ability to load up on Chinese stocks. This of course doesn't bode well for the future of Chinese stocks. This is the E*Trade (ETFC) that moved heavy into mortgage lending right before well... just check out their stock price.

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The trouble with fund share classes is even the experts don't understand them. God help the rest of us. Gretchen Morgenson at The New York Times wrote an article about fund share classes that tells us fund investors are wise about avoiding sales loads and that the poor B class fund is much maligned, but often the best choice:

The article then proves this point by running a few load funds through an online fund fee calculator available by the newly re-branded Finra, aka NASD, available here. Unfortunately, in this case conventional wisdom was true: B class funds are for clients of questionable brokers and often the worst class to chose. This should come as no surprise because brokers looking to dupe clients is exactly who B class funds were designed for in the first place. The B class load was created to hide the obvious 5.75% front end sales commission that is whisked away from your account when you buy a load fund. People tend to notice when $575 of their $10,000 investment goes poof by their first statement. With the threat of no-load funds growing, the mutual fund industrial complex invented a load fund that looked like a no load fund. Of course, the fund companies where not going to build a cheaper fund class that paid brokers less in commissions, so they hid the 5.75% commission in a high yearly "distribution" charge of 1% on top of the ordinary annual fund costs. But how, pray tell, do fund companies prevent a shareholder from selling in a few years and avoiding the full 5.75% commission? With a contingent deferred sales load, or CDSC. This fee often starts at 5% and falls as the years roll by. At no time are you going to get out and save that much over an A class fund. Then how come some funds are cheaper to own as B class funds than A class funds as the article claims? Simple: the example funds are not typical load funds. Every load fund family has a slightly different way of levying the loads. Whether a B class is better than an A class for a particular fund often breaks down to the spread between the 12b-1 fees. Normally A class load funds have 0.25% 12b-1 fees and B class funds have 1.00% fees. In such a case the A class is almost always the better class when your time horizon is more than a couple of years. When the 12b-1 fee is 0.35% on the A class it is possible for a few years the B class will be the better class - and often not by much. If you review the largest load funds out there, it is clear the typical spread makes the A class the better choice. The prospectus fee table confirms this. American, PIMCO, Legg Mason, Davis, Van Kampen, and Franklin funds typically have the 0.25/1.00 12b-1 split. When you factor in that larger investments - either in a single fund or across the same fund family - can qualify for reductions in A class sales loads, the A class becomes the far superior choice. Crooked brokers use B class funds to avoid giving wealthier clients A class discounts in addition to hiding the loads from sight. We have no hard numbers on this, but from our own discussions and emails with hundreds of fund investors, most have no idea they are in a load fund when they are in a B class fund - which was the original purpose of the invention. Success! If you must go load, most of the time C class funds are best for very short term investments of under three years, and A class shares are better for longer term investments over three years. Occasionally (rarely) a B class is better for around 3-6 years if the CDSC is low (under 5% to start) and/or the 12b-1 is higher than 0.25 on the A class or lower than 1% on the B class. LINK

Following the recent steep drop in foreign markets, today the U.S. stock market opened way down - in early trading we saw a 4% fall. Since the market peak in October 2007, stocks have been weak around the world. While the market has come back in the afternoon, we just about saw the most indexed and benchmarked of U.S. stock indexes down 20% from the highs hit just over three months ago.

A 20% drop is a measure often used to denote a bear market. We haven't had a 20% fall since the great bubble pop of 2000-2002. Unlike the last bear market, this one is proving hard to dodge.

In the late 1990s we didn't have across-the-board asset price booms. Real estate was relatively cheap, as was natural resources and commodities, small cap stocks, and value stocks in general.

Back in 1999 the entire Russian stock market had a combined market cap less than any individual major stock in the Nasdaq or S&P 500. Even safe U.S. Government bonds had a decent yield. The bubble was in tech, telecom, U.S. large cap and growth stocks. Anyone who was "properly" diversified across multiple asset classes at least partially avoided the market meltdown that eventually took the S&P 500 down almost 50% and the Nasdaq almost 80%.

Over much of the last few years investors have been piling into foreign stock funds. Today the iShares MSCI EAFE Index (EFA) exchange traded fund or ETF tips the scales at around $50 billion - second only to the oldest ETF, the SPDR S&P 500 ETF (SPY) exchange traded fund with $85 billion. Heck iShares MSCI Emerging Markets Index (EEM) has $24 billion - more than the $19 billion in the Nasdaq 100 ETF or QQQ (the ticker is now QQQQ).

Unfortunately in this down market all this diversification is hurting, not helping. The Dow and S&P 500 are among the relatively best performing areas to invest - many foreign markets have fallen over 10% in the last two days alone. Most of the big foreign stock markets are already down more than the U.S. market during this downturn. Real Estate Investment Trusts or REITs - a favorite to the diversification crowd - are now down near 40% from the peak in February 2007.

Bottom line, diversification helps when investors are adding cheap out-of-favor asset classes. Adding expensive asset classes - even ones that have been historically less correlated to U.S. stocks - can increase portfolio downside in a bear market. Going forward, we expect U.S. stocks to continue to outperform essentially all the hot categories of recent years. Our fund category rating system rewards categories that have underperformed and seen a lack of interest by investors in recent years.

Fidelity investments announced yesterday morning that it was re-opening its flagship Magellan fund (FMAGX) to new investors for the first time in nearly a decade.

Steven Syre at the Boston Globe thinks its a perfect time for investors to dive in:

The fund that has been closed to new investors for a decade is in the right place at the right time, favoring large growth stocks at a time when the market pendulum has swung into that category after years of preference for value-oriented equities. It moves easily around the world, investing 26 cents of every dollar under management outside the United States, at a time when a global perspective is necessary for superior performance (Finnish cellphone maker Nokia Corp. is Magellan's single largest holding).

There's more: Lange has managed Magellan for just two years, but he has a long record as a superior stock picker. Fidelity has stayed off Lange's back and let him pull together an eclectic portfolio, about 260 stocks of all sizes from all over the world. His big picture view of the global economy emphasizes information technology stocks (nearly 29 percent of the portfolio) and underweights financial investments (11.6 percent)."

Syre's logic is wrong on several counts.

First, while Magellan is about half the size it was in 2000 it is by no means svelt. The fund still has around $50 billion in investor assets.

Second, we've been harping on the comeback of large cap growth for awhile now (and upgraded large cap growth funds to our highest category rating in 2006). We've recommended funds like Vanguard Growth Index (VIGRX) and the ETF version Vanguard Large Cap Growth (VUG). In 2007 these funds were up around 12.5% while iShares Russell 2000 Value Index (IWN) was DOWN 10.3% and Vanguard Small Cap Value Index (VISVX) was DOWN 7.1%. That's a pretty big performance gap, which means you're getting in a little late to the resurgence of large cap growth party.

Lastly, and worst of all, is the statement "at a time when a global perspective is necessary for superior performance". What little solid performance this giant fund has delivered in 2007 has largely been because of a large foreign stock position - a relatively recent increase. This foreign stock allocation is going to drag on returns over the next 1 - 3 years and will be the main reason Magellan will continue to underperform the S&P 500. As long time readers of MAXfunds know, we're contrarian investors. This means we don't think foreign stocks are necessary for superior performance, even though about every domestic fund manager and fund analyst thinks so.

Bottom line, the best thing Magellan has going for it is low fees and a size and diversification that will prevent a major collapse relative to the market. Your chance of matching much less beating the S&P 500 over longer periods of time in this fund remains slim, which is what we've been saying since 2000.

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Michael Lewis tells a wonderful story in the new Portfolio magazine – a coming of age piece if you will – of a successful stock broker who slowly realizes the (ahem…) shortcomings of his business.

The story first attacks the notion of beating the market with stock picks then moves on to picking wining mutual funds:

Eventually our hero moves his clients and his conscience to Dimensional, proprietors of the successful DFA (which stands for Dimensional Fund Advisors) funds.

DFA, an early pioneer of low fee index funds, has $152 billion under management. Unlike Vanguard, DFA does not have actively managed funds or ETFs. DFA indexes are not just market cap weighted or based on well known indexes like the S&P 500, Nasdaq, or Russell 2000, but involve custom screens that remove some individual holdings that would ordinarily show up in a straight market cap screen.

DFA funds are institutional funds sold though advisors, who tag their own fees on top of the underlying fund fees.

In addition to learning some great sales techniques used to con prospective brokerage clients into paying full service commissions for stock bad stock picks, the article focuses on the benefits of low fee indexing over more expensive and inconsistent active management. What the article doesn’t do is question the logic of dozens of different asset classes – too much of a good thing perhaps.

If a broker’s stock picks tend to underperform broad indexes, why won’t an advisor’s sector or style picks using DFA funds do the same?

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Chuck Jaffe looks back at eight mutual funds that closed their doors in 2007, and for good reason. It's a roll-call of weird, expensive, or just plain lousy funds run by managers with a deadly combination of hubris and incompetence. None of these funds will be missed, least of all the Ameritor Investment fund, which was quite possibly the worst mutual fund (from perhaps the worst fund family) of all time:

The Ameritor funds started life in the 1950s as the Steadman funds. They were nicknamed the 'Dead Man funds,' because they finished dead last in their peer group, losing money all the way, for years. Ultimately, Steadman Oceanographic — which was supposed to profit from companies that were farming and building communities at the bottom of the sea — and Steadman Technology ran through almost all of their money.

When Charles Steadman died in the late 1990s, his daughter took over. The funds had no prospect for growth, but she had no reason to shut them; the double-digit management fee was like a personal annuity, up to the point where it bled the fund to death. When the Securities and Exchange Commission finally filed paperwork stating that the fund 'had ceased to be an investment,' the loss over the last 10 years was 98.98 percent, turning a $10,000 investment into $102. It took about four decades for the losses to drive shares down to less than a penny, but Ameritor got the job done, and then kicked the bucket.

It’s a lesson in just how bad mistakes can be if you insist in hanging on to them. Sadly, this fund is survived by a sister, Ameritor Security Trust (ASTRX), with performance that is 'better,' but only when compared to its all-time loser sibling."

The long life of the Ameritor Investment fund highlights an important point. While mutual funds are regulated by the Securities and Exchange Commission, it is possible for a fund to be operating within the letter of the law but still be an absolutely horrible scam-grade investments.

There is no law against high fund expense ratios - when a fund's assets fall below about $10 million and the management company stops caring about the shareholders, the sky's the limit on expenses because the minimum fixed costs of running a fund have to be paid by a small group of investors. We call these "free range" expense ratios - ones that are not capped by fund companies because frankly, my dear, they don't give a damn. As Jaffe notes, Ameritor Security Trust (ASTRX) still clings to life - with two million of investor assets and an expense ratio of 16.36%.

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Sure Chuck Jaffe's Christmas-themed 'Lump of Coal Awards' might not be as clever or insightful as our own Thanksgiving focused Turkey Awards, but they're an entertaining pre-holiday week read nonetheless.

We especially like his 'Inability to Recognize a Bad Fund When They See It' award giving to the directors of the Franklin Real Estate Securities Fund:

Of course, the real travesty with a poor performing giant fund is not with their boards (how many fund boards really care about lagging performance anyway?) nor the semi-blind shareholders, but with the brokers who sold it. No load funds almost always shed assets when performance slips – even long time winners will lose shareholders after a few bad quarters. Until absolute returns tank hard, load funds can maintain a healthy, commission paying, asset base in near perpetuity.

That said, this fund has recently seen mass shareholder redemptions, which should cause a huge taxable distribution to the remaining shareholders when the fund goes ex-dividend tonight. Talk about dammed if you do, dammed if you don’t – either sell the fund and possibly owe a back end sales load (C,B class shares), or stick around and get hit by some other investor’s taxable gains in a year the fund is down by double digits.

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