Sell High

July 13, 2006

The top of the great emerging markets run will likely be very close to the levels hit on May 16, 2006. That’s the day Dreyfus filed with the Securities and Exchange Commission to launch another emerging market stock fund – to be named Dreyfus Emerging Markets Opportunity Fund.

With billions of new money flooding into emerging markets funds (after a massive three-year rally that has seen most funds in the category triple in value), Dreyfus is getting tired of sitting on the sidelines while competitors bring in all the loot.

Can you blame ‘em? Emerging market funds are about the last area where a fund company can make an honest buck. Management fees for your typical emerging market stock fund are double domestic stock funds – even the ETFs in this area have high expenses. iShares MSCI Emerging Markets Index (EEM) charges 0.75% a year. As this ETF recently peaked at around $14 billion in assets, Barclays Global Investors (the company behind the popular ETFs) rakes in more money from this fund than any other they run.

They funny thing is, Dreyfus already has an emerging markets fund – the solid Dreyfus Emerging Markets Fund (DRFMX for class A), which has been in a couple of our higher-risk model portfolios back when it was a no-load fund (converted to load 11/02 – we switched to SSgA Emerging Markets SSEMX but sold that a couple of months ago as the whole category is overblown at this point).

Trouble is, the old Dreyfus fund is closed to new investors (as it should be at around $1.5 billion in assets) and is a bit too conservative to attract hot fund seekers, who gravitate to the top performers in up markets more than down.

The even funnier thing is that Dreyfus closed a “redundant’ emerging market fund by merging it into Dreyfus Emerging Markets Fund. Who needs two emerging market funds in the fund lineup in early 2003 when few were buying? As it often turns out with fund closings, this marked (almost to a T) the end of the fall for emerging market stocks and the start of the big move up.

This whole escapade smacks of Vanguard’s decisions to effectively close by changing their excellent Vanguard Utility Income fund (which we owned) right before the great utility stock rally of recent years. Vanguard then launched a new utility ETF (Vanguard Utilities VIPER – VPU) in early 2004, when utilities became a little more saleable to the average consumer.

Want more proof? Dreyfus has been known to launch and close funds right around the top and bottom of market cycles. Remember Dreyfus Premier NexTech Fund (DPNTX)?

Dreyfus filed with the SEC to launch this fund in March 2000 – the very top of the Nasdaq bubble, when the tech and telecom-fueled index was around 5,000. Everybody was launching tech funds – that’s were billions of new shareholder money was flowing and unlimited profit potential abounds.

In what would be funny if it didn’t cost shareholders dearly, the company noted,

“Specific high-tech sectors that will be evaluated for the [NexTech Fund] include
Internet products and services or e-commerce companies; optical communications components; wired and wireless communications services, equipment and component suppliers; storage devices and networks; computer hardware and software; and semiconductors. The Fund will also seek to participate in the initial public offerings of companies in these sectors.”

The Dreyfus president went on to say,

"Innovative new technologies can continue to fuel the growth and success
of this sector ....We will strive to provide our shareholders with the types of investments that are of most interest and benefit to them."

Unfortunately, the types of investments that are “of the most interest to shareholders” one year are often the same ones that perform the worst the next. This particular fund promptly fell 85% in the bear market. The only thing that kept the fund from falling even more was that the market already turned south between when the fund was filed with the SEC and when it was actually cleared for takeoff with the SEC – in May, 2000.

Dreyfus merged the fund into their Premier Technology Growth Fund on December 17, 2003 and buried this embarrassment and case study in bad investment timing from the public eye forever. Apparently this time around Dreyfus should be trusted to know opportunity when it strikes.

When a certain type of fund is saleable, you should pass. When I launched an emerging market stock fund back in 1998 – right after the Asian financial crisis – we literally couldn’t give away fund shares. At the recent peak in emering markets, the fund was up over 1,000%. I can assure you, investors are more likely to lose 30 to 60% on this new Dreyfus fund than make even 1/10 as much as emerging market investors made in what seemed like a very stupid investment in late 1998.