Watch Out
The Mutual Fund Industry Says They Are Doing a Terrific Job
A report released by the mutual fund industry's trade association (the ICI or Investment Company Institute) last week trumpets a decades' worth of changes made by fund companies designed to benefit shareholders - changes that include creating independent boards and audit committees tasked with protecting shareholder interests. But Chuck Jaffe (who has been writing about funds for much longer than one decade) says that fund companies still have plenty of work to do before earning a self-congratulatory pat on the back.
What you haven't seen in the last decade is those boards standing up regularly to management practices that are bad for investors. Plenty of funds have retained mediocre or lousy managers year after year, have pushed through fee increases or have failed to push management to close a fund to new cash after passing the ideal size for the strategy that is employed.
On the governance front, you have seen no steps by the big fund firms to set up multiple boards so that a director serves no more than, say, 25 funds. A director can only be so "independent" working for dozens of funds run by the same firm.
While boards have been marginally more active in dismissing subadvisers - outside hired guns brought in to run money - they appear no more interested in jettisoning in-house managers. They may be independent, but boards aren't firing insiders."
Seven Habits of Highly Defective Funds
Yesterday we noted a high yield bond fund that has seen its fund price (NAV) fall about 40% since early June. Higher risk bond funds follow a pattern of feast and famine – the key to investing in such funds is to identify the types of bond funds that can tank 40%, and either avoid them completely or consider a speculative investment near the bottom of a famine cycle.
The trouble is that these bond funds tend to look the best at exactly the wrong time. They have the best reviews and ratings, and the performance figures smash the competition.
But remember, for most types of bond funds, performance comes largely from just two things: the fund’s expense ratio and the quality of bonds the funds hold. A much smaller part of the performance can be attributed clever bond selecting.
Here then, dear reader, is the MAXfunds “Seven Habits of Highly Defective Bond Funds”, our step by step instructions for lousy managers to destroy their perfectly good bond fund... ...read the rest of this article»
Motley Fool’s Orwellian Moment
In Animal Farm, George Orwell describes a Utopian society that slowly morphs into the evil farm that its founders initially rose up against. The Motley Fool’s latest advertisement, touting "255% Gains in Six Months," is perhaps their "four legs good, two legs better" moment.
This pattern of closing mutual funds that fall on hard times in order to focus on the good stuff looks strangely familiar. That's because it's the same strategy used by the very mutual funds that the Motley Fool used to ridicule. With mutual funds, this cleansing process is called survivorship bias. This trick-of-the-trade is why many fund companies appear to hold only decent funds in their roster. The Merrill Lynch Internet Strategies Funds of the world are effectively deleted from history.
One thing the Motley Fool does today that mutual funds are not allowed to do is cherry pick performance information in order to market their wares. Of course, the Motley Fool is not alone here. Virtually all investment newsletters tout their spectacular returns through methodologies that would make a mutual fund marketer blush. But because everybody is doing it, selling an investment newsletter without such circus barker-grade promotion is nearly impossible... ...read the rest of this article»
Sneaky Mutual Fund Tricks
If we didn't think mutual funds were the best investment option for the vast majority of people, we wouldn't have started MAXfunds.com way back in 1999. But that doesn't mean we love everything about them. Author Ric Edelmen exposes three sneaky mutual fund industry tricks fund companies use to confuse and confound fund investors (all of which MAXfunds has written about at one time or another) in this article for the Maryland Gazette.
Confusing share classes
Retail mutual funds are now available with a dizzying array of pricing models. In many cases, a single fund might offer a half dozen share classes, and the only difference among them is the cost. If you select the wrong share class, you could pay more than necessary.
Talk about opening Pandora's box. Today, fund investors must choose among Class A, B, C, D, F, I, J, K, M, N, R, S, T, X, Y and Z shares. Depending on the share class you purchase, you might incur a load when you buy, when you sell or annually. The load might disappear after a time, or it might remain forever. In some cases, you might enjoy a lower load, but incur higher annual expenses, or vice versa. And in some instances, you might buy one share class only to have your shares automatically converted to another share class in the future!"
Incubation strategy
This is one of the retail mutual-fund industry's most devious ploys. Here's how it works: Create a whole bunch of mutual funds. Wait three years. Then evaluate the results of each fund.
The results of each fund will either be good or bad. If a fund's performance was bad, close it before anybody hears about it. But if a fund posts good results, send the data to Morningstar, which will award a five-star rating (Morningstar won't rate funds that are less than 3 years old.)"
Fund seeding
When a company issues stock, it offers a limited number of shares. A given retail mutual fund company buys as many shares as it can, and when it does, it doesn't say which of its individual funds is doing the buying.
Later, if the initial public offering (IPO) proves to be successful, the fund company disproportionately allocates the shares to its newer, smaller funds. Result: the IPO artificially boosts the return of these funds, supporting the Incubation Strategy (see above). The investors who buy seeded funds are in for a rude surprise when the fund proves to be incapable of repeating its earlier 'success.'"
There's No Such Thing as a Free Lunch
Investing seminars marketed to seniors as educational get-togethers are often nothing more than crooked high-pressure sales pitches for questionable products, the SEC says.
The Securities and Exchange Commission held a 'seniors summit' on investment fraud and abusive sales practices with the North American Securities Administrators Association, which represents state securities regulators; AARP, the advocacy group for seniors; and the Financial Industry Regulatory Authority, the securities industry's self-policing organization.
While their promoters paint the 'free lunch' seminars as educational sessions, sometimes promising that nothing will be sold, 'they are designed to sell -- either at the seminar itself or later,' said Lori Richards, director of the SEC's Office of Compliance Inspections and Examinations. 'They're not educational events.'
The investigation conducted by the SEC, state regulators and FINRA found the use of scare tactics to get seniors to question their current investments, claims of fantastic returns with no risk, and "ringers" in the audience who would stand up and offer testimonials of how much they had earned."
Why You Should Worry About Your Bond Funds
Today’s mutual fund investor is offered a broad range of choices covering every imaginable risk level - everything from essentially no-risk money market funds to leveraged sector short funds that can fall 10% or more in a single day.
As long as an investor understands the risks, investing in a risky fund in not inherently any better or worse than investing in a safe fund. With more risk comes more reward.
A risky fund tends to rise faster but fall harder. By researching a fund’s potential upside and downside an investor can make an informed decision whether or not they should invest in that fund... ...read the rest of this article»
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Can Money Market Funds Fail?
Got money? Then there's a good chance some of it's in money market funds. Investors now own over $3 trillion in these buck-per-share mutual funds that offer the liquidity of cash, the yield of Treasury bills, and the safety of …. well, that’s the part that's now in question.
Money market funds have only been around for about three decades, making them the young'ns of a mutual fund business that's existed in one form or another since before the Great Depression. Whenever we suffer a credit crisis of some sort, the same question comes up – are money market funds safe?
The number of articles written about the money fund industry's current troubles has been climbing in lockstep with the number of financial institutions taking multi-billion dollar write-offs related to mortgage “investments” (and we use the term loosely).
In last week’s Wall Street Journal, for example:
The risk to money-market funds is that a decline in the value of a single investment can cause them to "break the buck," or allow their net asset value to fall below the $1 level the funds are required to maintain.
FAF Advisors [a unit of U.S. Bancorp] is the latest in a string of about a half-dozen financial institutions that have taken steps to protect their money-market funds. The others include Bank of America Corp.'s Columbia Management Group, Credit Suisse Group's Credit Suisse Asset Management and Wachovia Corp.'s Evergreen Investments. No money-market fund has broken the buck in the recent turmoil.”
Like a top-40 radio station, the (mortgage) hits just keep on coming. This latest evolution of the mortgage disaster is now placing even the safest category of mutual funds in jeopardy. But just how risky are these funds?... ...read the rest of this article»