Investing Tips
The Bigger The CEO’s House, The Smaller The Shareholder’s Returns
A new study on executive stock sales and ensuing stock performance, summarized on Marc Andreessen’s blog, has discovered that the more house an executive buys with the proceeds of selling company stock, the crummier the future company stock returns:
When a CEO buys real estate, future company performance is inversely related to the CEO’s liquidation of company shares and options for financing the transaction. We also find that, regardless of the source of finance, future company performance deteriorates when CEOs acquire extremely large or costly mansions and estates. ...
We look first at whether the CEO sells shares of company stock to finance the home purchase. Although buying a house appears to offer a prima facie personal liquidity reason for CEOs to sell their own shares, most are wealthy enough to acquire homes with other sources of finance."
This should be expected. If a top exec already owns stock in their company, it’s not illegal to hang on if they know next year’s earnings are looking pretty good. Therefore, why would a rational executive cash out of a near-sure thing to buy a historically ho-hum investment with high maintenance costs?
Motley Fool's 'Best Funds' List Is Really Dumb
When you spot an article titled 'The Market's 10 Best Funds', you might be tempted to think that if you'd read it you'd get a list of ten great mutual funds that are set to produce market beating returns in the years ahead. Not so for readers of a recent posting on The Motley Fool. Readers who clicked on that snappy headline were treated not to a list of inexpensive, high-quality funds in undervalued categories, but merely a list of the top performing funds of the last ten years:
- Wasatch Micro Cap (WMICX)
- Kinetics Internet (WWWFX)
- Bjurman, Barry Micro-Cap Growth (BMCFX)
- Bridgeway Ultra-Small Company (BRUSX)
- FMI Focus (FMIOX)
- Bruce Fund (BRUFX)
- CGM Realty (CGMRX)
- Bridgeway Aggressive Investors 1 (BRAGX)
- T. Rowe Price Media & Telecom (PRMTX)
- Quaker Strategic Growth (QUAGX)
As we are sure the decidedly un-foolish readers of MAXfunds.com know, one way to all but guarantee poor returns going forward is to buy funds based on past performance. Of the funds that topped the ten-year performance charts back in 2000 (Invesco Technology II [FTCHX], T. Rowe Price Science & Tech [PRSCX], Spectra [SPECX], RS Emerging Growth [RSEGX], Janus Twenty [JAVLX], Managers Captl Appreciation [MGCAX], Dreyfus Founders Discovery F [FDISX], Janus Venture [JAVTX], American Cent Ultra Inv [TWCUX], Fidelity Growth Company [FDGRX]) none have since performed better than the S&P 500.
The Motley Fool's list of 'Best Funds' is actually more likely to under perform the market going forward than funds chosen at random. That's not just foolish, it's stupid. ...read the rest of this article»
Prep Your Portfolio
Marketwatch lists five no-load mutual funds experts say will be good vehicles for saving for a child's private high school tuition. The criteria they've chosen for the list are low fee, high performing funds suitable for investors with a relatively short investment horizon.
- Vanguard Intermediate Term Bond Fund
- Loomis Sayles Bond Fund
- Oakmark Global Fund
- Dodge & Cox International Stock Fund
- Vanguard LifeStrategy Conservative Growth Fund
Our take: Investing 100% of a portfolio that needs to be tapped within ten years in stocks is a bad idea. Two of the funds on this list – Dodge & Cox International Stock and Oakmark Global can fall up to 50% in a very bad market for stocks, with 25% pullbacks relatively common.
Another word of caution: today it is fashionable to point to international and global funds as the top choices for a portfolio. A few years ago, most would have gone with U.S. large cap growth or tech funds. Dodge & Cox International Stock has been on our favorite funds list (part of our Powerfund Portfolios service) for international funds since 2002 – when we started the list. However, with such widespread popularity today (and tens of billions in relatively recent new assets) resulting from a five year return of around 150%, investors looking to move money to such a fund could be making a similar mistake investors made in 2000 piling into hot Janus funds.
Note that Oakmark Global has a 2% redemption fee if sold within 60 days. For new investors, Oakmark Global can only be purchased directly from the fund company.
No Fat Funds
We've been singing this song for years: asset bloat is one of the leading causes of fund underperformance. But does anybody listen? Of course now that Mr. Big-Time-Bloomberg-Mutual-Fund-Columnist Chet Currier follows our lead , everybody will think it's a brilliant concept:
It's one thing to rack up nice returns when a strategy is new and the amount under management is small. The job may prove different after those early gains attract heaps of additional money from investors, and the fund that used to maneuver like a sports car comes more and more to resemble a dump truck.
'Asset bloat' is the term analysts at the Chicago firm of Morningstar Inc. use in their mutual-fund research.
'The worst effect of the asset bloat phenomenon is simple,' Morningstar says. 'The more money a fund has in it, the less nimble it becomes. If a fund's asset base increases too much, its character necessarily changes.'
Some fast-growing funds close to new investors to try to mitigate this effect. Others resist any such move, insisting they can handle the extra load.
Closings don't always solve the problem anyway, especially if a fund leaves its doors open to additional investments by retirement-plan members or to all clients of brokers and advisers who have existing accounts. The damage may not be immediately visible to the casual onlooker."
It would be great if some mutual fund research website would come up with a simple data point that would reveal how bloated with assets each mutual fund was. Call it a 'Fat Fund Index', if you will. Hey, we've been doing that since 1999!
MAXfund's Fat Fund Index lets you know if a fund is weighted down by its own heft. A FFI of 1 means a fund is lean a mean and will suffer no drag on performance because of asset bloat. A fund with an FFI of 5 is fatter than Homer Simpson and could suffer serious performance issues in the months ahead. You'll find each fund's Fat Fund Index on MAXfunds' recently redesigned data pages.
Resist the Urges
Morningstar's Fund Spy lists three critical investing mistakes to avoid:
Don't read too much into the recent past - Instead of doing the necessary and possibly tedious homework to research a potential investment, investors "anchor" their expectations for the future in the recent past.
The problem, of course, is that yesterday doesn't always tell you what tomorrow will bring. If you don't believe us, just ask investors who swarmed red-hot technology- and Internet-focused stocks in 1999 and 2000 expecting the good times to continue. They didn't, and most folks ended up suffering huge losses.
You don't know as much as you think - We think we're more capable and smarter than we really are. As an investor, you should check your excessive optimism at the door. You might believe you're more likely than the next guy to spot the next Microsoft, but the odds are you're not.
Keep winners longer and dump losers sooner - (Behavioral-finance) noticed that investors would rather accept smaller but certain gains than take their chances to make more money. On the flip side, investors are reluctant to admit defeat and sell stocks that are underwater in hopes of a rebound. As a result, investors tend to sell their winners too early and hang on to their losers for too long."
And as long as you're in an investing-rules-list-reading kind of mood, take a gander at our oldy but goodie (circa 2000) Seven Golden Rules of Mutual Fund Investing. Note that fund data pages have changed since then - please review current definitions of metrics by rolling over the terms on our new data pages.
12b-1 Fees Gone Wild
John Waggoner at USA Today looks at the wacky past and current state of affairs of the oddly-named mutual fund 12b-1 fee.
The American Funds' Growth Fund of America A, for example, which is the nation's largest fund, weighing in at $85 billion in assets, doesn't exactly need to jack up its marketing efforts to attract more assets. Yet that fund charges a 12b-1 fee of 0.25% — nearly as much as its other fees combined. The American Funds says the fee goes to servicing accounts.
The 12b-1 fee is also at the heart of the bewildering multishare class system we have today. In many cases, 12b-1 fees have morphed into a way to indirectly pay a broker's commission.
Funds discovered that people don't like to pay commissions on mutual funds. So they used the 12b-1 fee to make the brokerage charges more palatable and less transparent.
A particular mutual fund might have three share classes. Each share class represents the same portfolio but has a different expense structure."
For those looking for a brief history into the nature and causes of mutual fund 12b-1 Fees, it’s a must read.
An interesting factoid from the article: the entire mutual fund business had less money in total assets in 1980 than in 1972. Now THAT’S a rough market environment. No wonder everybody was buying gold – they plum gave up on stocks ( gold is still down from 1980 and stocks are up well over 20-fold). Today total mutual fund assets are much higher than the market peak of 2000 - even though the S&P 500 just broke its old record set in 2000. Fund investors are just more forgiving these days.
More startling, American Funds Growth Fund Of America Class A (AGTHX) alone has more money in it today than the entire fund business was managing back in 1980.
Fantastic Fund Freebies
Chuck Jaffe at Marketwatch periodically contacts mutual fund companies and asks for educational materials and says that while these freebies usually come with a healthy does of promotional material, a lot of what he gets is surprisingly useful. Here are some highlights:
- Handheld "slide-rule calculators." I love old-fashioned, cardboard hand-held gadgets that let you slide your way through inputs and outcomes. You practically can't stop playing with them, learning something with each move. They're simplistic, but still a good jumping-off point.
- AllianceBernstein's "College Debt Crunch." This calculator is one of the most interesting I have seen in a long time because it is designed to show the long-term impact of education debt on college graduates. A few minutes playing around -- or letting your kids use it if they are responsible for tuition -- and you're likely to increase your college set-asides immediately. You can get the calculator by calling AllianceBernstein at 800-227-4618. You also can order versions online or use an electronic version at www.collegedebtcrunch.com.
- College savings. Of course, it helps to know how much money you will need to save and the college savings slide-rule from American Century's Learning Quest program gives you a quick-and dirty estimate of how much you will need -- and how much to invest monthly based on your child's age -- in order to pay for a public or private education. You can get the calculator by calling 1-800-579-2203.
- Allocation models. The asset allocation calculator from Franklin Templeton Investments (1-800-342-5236) remains one of my all-time favorites, providing five sample allocations and allowing you to track how money invested that way would have performed over the five- to 20-year periods ending Dec. 31, 2006. This lets you measure your current strategy against others, letting you know if you want to stay the course or need to consider a change.
- Putnam Investments' "retirement calculator." This slide-rule -- available at 800-225-1581 -- is a two-sided, dual-purpose keeper. On one side, it allows you to determine the future value of systematic investments; it's a great way to show not only how $50 a month adds up over time, but how doubling that number -- or going even bigger -- will turn small monthly dollars into lifetime money. On the flip side, the calculator helps determine the future value of your current savings, which will help you see how much $10,000 will have grown to when you reach retirement, based on various rates of return and your current age.
- Organizers. T. Rowe Price recently created a new "family records organizer" that is a terrific tool for anyone trying to get a handle on their finances. The freebie in this case is actually a CD-ROM -- available by calling 1-800-538-2706 -- that does a great job of helping a family gather and manage its records in one single place. Having looked at fund freebies for years, this is one of the best I have ever seen.
- Mixing it up. As long as you are calling T. Rowe Price, ask for the company's "asset mix worksheet," as it could be a very good tool for deciding how to best position your money.
Pay Less, Make More
When it comes to mutual fund performance, you don't get what you pay for. In fact, according to a recent study by Morningstar, the less you pay for your fund, that better that fund is likely to perform.
Of domestic stock funds, 47% in the cheapest quintile succeeded in beating the category average over a ten year period, 33% in the next quintile, 30% in the following quintile, 27% in the next and just 19% in the costliest quintile. Or in other words, you are over twice more likely to beat the category average if you are in a low cost fund than in an expensive fund. The success disparity was also similar for other fund categories. For foreign stocks the probability of category out-performance between the low cost funds versus high cost funds was 40% to 18%, for taxable bond funds this was 48% and 7%; 49% and 9% in municipal bonds."
S&P 500 Index Secrets Revealed
Despite challenges from new-fangled upstarts, the good old Standard & Poor's 500 Index still reigns as the king of the stock indexes. It's the basis for such mutual fund giants as Vanguard 500 Index Fund (VFINX) and Fidelity's Spartan 500 Index Fund (FSMKX), and in all more than $4 trillion in investors dollars is tracking it (some of which is probably yours). Marketwatch reveals some fascinating facts about the S&P 500 index that you might not know:
- Some people see indexing as a static, sanitized investment strategy. To be sure, the S&P 500 represents about 75% of U.S. stocks by market value, but it's hardly monolithic. Just 86 of the original 500 companies are in the index today. The others were acquired, failed or dropped from the ranks.
- The S&P 500's strength -- ranking stocks by market value -- can be a weakness. In runaway bull markets especially, the index can become a poster child for speculative excesses. When investors ignore valuation and bid shares of the biggest companies to stratospheric heights, the index can become dangerously unbalanced.
- Today, about 18.5% of the S&P 500 is tied to technology and telecom stocks. That's second to financials, at 22% of the index's total value. Add the health-care sector, at 12%, and more than half of the index is represented.
- In the bear market that persisted through most of 2002, index-fund investors found no shelter as the S&P 500 lost half its value.
- To most investors, the S&P 500 is the stock market's apple pie, a uniquely American product. In fact, though the benchmark companies are U.S.-based, their customers are increasingly global. The S&P 500 has so much total international-sales exposure, your stock portfolio might not even need a separate international component for diversification.
Closed-End Funds – Better Than Open-End Funds?
Scott Burns writing for the Houston Chronicle makes a past performance case for closed-ends funds, mutual funds that issue a set amount of shares, which trade on an exchange like shares of a stock:
Here's an interesting factoid. Over the three years ending May 30, the average mutual fund that invested in domestic equities has provided an annual return of 13.30 percent.
Rather nice.
Until you compare it with another return. The average closed-end fund, mutual funds that has returned 17.03 percent annually over the same period."
Now before you run out and buy a closed-end fund, let’s think about a few issues specific to closed-end funds that may have played a role in this recent streak of outperformance:
1) Leverage. Most closed-end funds leverage their portfolios with borrowed money. And why not? They get paid a management fee based on total assets, including borrowed money. That can prove to be one heck of an incentive to borrow. How has this juiced returns? Through much of the last three years borrowing was very cheap. More important, stock markets have been very hot. A fund manager throwing darts at the stock page and investing in the ones he hits in a leveraged portfolio is going to beat an unleveraged portfolio if stocks in general are going up more than the cost of borrowing.
2) Discount Erosion. Closed-end funds can trade at a premium or discount to NAV, or net asset value. This means that when closed-end funds are out of favor (say when reporters are not writing about their streaks of outperformance…) they can trade at ninety cents on the dollar. After strong runs in stocks, investors may bid up these discounts away completely.
Why is this important? Imagine two S&P 500 index funds, one a regular open-end fund, the other a closed-end fund trading at a 10% discount to NAV. If the S&P 500 index climbs 10% one year and the closed-end fund discount goes from 10% to 5%, the closed end fund will be up over 16% compared to the 10% return of the open-end index fund. Add in leverage and the gap would grow even more.
Now that closed-end discounts are much lower, interest rates are higher, and stock markets are more expensive, what are the odds that a leveraged closed-end stock fund will beat a traditional open end fund over the next three years? What if stocks get weak and the wide discounts to NAV return, and the fund managers of closed-end funds keep the leverage (and therefore management fees) up?
There are other reasons closed-end funds can be decent investments – in fact we’ve picked some in our past MAXadvisor Powerfund Portfolios HotSheets. These include smaller portfolios sizes, more experienced managers, and no hot money (in and outflows of money that hurt open-end fund returns).
You can track these important variables for open-end funds right here at MAXfunds. And remember to look forward as well as backward when picking funds.
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