Mutual Fund Breaking News

Mayday Mayday...Sequoia Fund To Reopen

April 25, 2008

The last time investors could buy shares of the Sequoia Fund (SEWUX), Olivia Newton-John was at the top of the charts. The longest closed-to-new-investors period in mutual fund history ends May 1st:

The Sequoia Fund, after experiencing selling by investors, is reopening its doors May 1 to new investors for the first time since 1982.

The $3.5 billion value fund is celebrated for outperforming the broader market during much of its 38-year history. For years, it was run by legendary stock picker William Ruane, who followed the same approach as Benjamin Graham and Warren Buffett.

In recent years, however, Sequoia has a mixed performance record, lagging the Standard & Poor's 500-stock index in three of the past five calendar years.

Selling by investors caused assets to fall to a level lower than it was a decade ago, the funds' managers wrote in a report for the quarter ending March 31. If that were to continue at that rate, it could 'cause us to have to sell stocks that we didn't want to,' said co-manager Robert Goldfarb, 63 years old, in a telephone interview Wednesday."

Fund investors are bailing out of the fund in part because of its relatively ho-hum performance in recent years, but mostly because of demographics - you close a fund to new investors long enough eventually asset levels will go down.

We've never given the Sequoia Fund much thought for our private management clients or Powerfund Portfolios, mostly because we couldn't have bought shares if we had wanted to - but now that it is set to reopen we still wont be first in line to invest. The fund was too large to outperform and with a ginormous 25% stake in Berkshire Hathaway and a low turnover portfolio, investors could almost rebuild the fund stock by stock. That said, we give the fund kudos for being one of the few value funds to pass on banks and other financials even though they looked cheap relative to the market.

We're also wary because funds with low cost basis holdings are not good places for new investors if other investors are leaving. Newbies could see big piles of other peoples tax liabilities distributed to them at the end of the year (something the fund company notes in their last report). The reopening should partially alleviate this problem as inflows will counter outflows, but fund investors are pretty cool on domestic stock funds with so-so records in recent years so inflows could be limited. Investors who have tax deferred accounts (and who hence don't have to worry about potential tax liabilities) that want to lock in shares of the fund in case it closes again may want to do so with the fund's $2,500 IRA minimum ($5,000 regular accounts).


Homes Sink Stocks

July 26, 2007

Yikes! Lately it seems like it takes something along the line of a big drop in the Chinese market or an exotic macro problem to make the market fall fast and furious. Not this time.

Stocks plummeted on Thursday, with the Dow industrials tumbling more than 300 points, on signs of further weakness in the housing market and deteriorating conditions for corporate buyouts....

...The daily drumbeat of bad news on housing on Thursday came from two of the largest home builders, as D.R. Horton Inc and Beazer Homes posted quarterly losses.

Financial shares took a beating on growing evidence that problems in the subprime mortgage market are spreading, making financing the corporate buyouts that drove the market's spring rally more difficult."

This drop was all about the American dream - your house. Apparently all those billions of dollars in loans to people with no money down and questionable finances wasn't such a good idea after all. What will turn a bad situation into a near crisis is the fact that the homes backing up these loans aren't worth anywhere near the housing boom peak.

This past week marked the point where even the economic optimists realized this problem isn't just about subprime loans, and it probably won't stay neatly contained in the housing sector.


Is Your Bond Fund a Ticking Sub-Prime Time Bomb?

July 13, 2007

Investors buy bond funds because of their safety, but if your bond fund manager has taken significant positions in sketchy sub-prime bonds (the kind backed by questionable mortgage loans), your bond fund could be anything but. Worst case: as these sub-prime bonds continue to be downgraded by rating agencies, fund managers could be forced to unload them - which could lead to the bond fund equivalent of a good old-fashioned bank run:

Some funds have rules that require them to invest only in relatively safe bonds. So if bond credit rating firms lower ratings, pensions and mutual funds might have to sell large quantities of bonds. That can set off a dangerous spiral for mutual funds, (Morningstar bond analyst Lawrence Jones) said. If there is a rush to sell any security, the price can fall. And if mutual funds sell a large portion of their portfolio, the fund can take a loss. If investors then become jittery and want to bail out, the fund manager needs to come up with cash for investors. If the fund manager sells good securities to generate cash, more losses can occur."

The problem is it is very difficult to determine if your fund has significant sub-prime exposure until after the performance damage has been done. You can call the fund and ask, but they aren't required to reveal portfolio holding details, even to current investors.

Perhaps the best way to determine if something is fishy – as the article notes – is to check its performance during a rough patch for higher risk debt, like this past June. If your bond fund fell significantly more than a total bond index fund, figure out why (it could simply be a longer duration bond fund or an ordinary high yield bond fund) or throw in the towel.


Another Hedge Fund Wrist Slap

July 12, 2007

If you get caught walking out of a Wal-Mart with a carton of smokes that you didn’t pay for, it’s unlikely that you would be allowed to refuse to admit or deny the wrongdoing, simply return the cigarettes to their rightful owner along with the interest on their value, and pay a fine of about $10. This is a good thing. Otherwise, the price of cigarettes would surely rise to compensate for the increase in thefts.

Fortunately for investors in London-based hedge fund giant GLG Partners, the punishment just doled out by the SEC was pretty toothless.

The crime was "multiple violations of Rule 105 of Regulation M of the Securities Exchange Act of 1934. Rule 105, designed to prevent manipulative short selling, prohibits covering certain short sales with securities obtained in a public offering."

That sure sounds complex and boring. No wonder the recent articles about this fine avoid explaining the scheme in depth. If only Paris Hilton crime coverage was so shallow. Here goes:

GLG Partners may sound shady, but they are actually a good hedge fund. Good hedge funds make risk-free or nearly risk-free trades. This is what investors are really paying 2% per year, plus 20% (or more) of their profits, for. If you want predictions, trading, stock picks, and market gyrations, watch CNBC or buy a mutual fund that charges 1% a year (with no cut of profits).

Truly bad hedge funds, which are a fast-growing population, charge GLG Partner-grade fees, but aren’t quite so clever in delivering low-risk returns. They just charge a lot more for their guesses and are open to just about anybody.

Most publicly traded corporations have a few large investors who own big swaths of the stocks – some are founders of the company. When these big fish want to sell a few million shares here or there, they often seek professional help. Rather than selling shares on the open market through their E*TRADE account, they enlist Goldman Sachs to put together a "secondary offering" of stock. This is sort of like an IPO, but the company whose stock is being sold doesn’t get any money – the selling shareholders do.

In 2003, electronics giant Philips decided to sell 100 million shares (American Depositary Shares or ADSs) in Taiwan Semiconductor Manufacturing Company (Ticker TSM) – about a billion dollars worth. For a few million bucks, Goldman and Merrill Lynch helped with the sale.

Normally, these investment banks would have to drum up demand for the stock. It has been frowned upon for an investment bank to issue favorable recommendations for stocks that they are selling ever since the 2000 bubble crash, so this would mean a lot of pavement pounding, which slows down deals.

Instead, the investment bankers apparently found some hedge funds to take big chunks of the stock off their hands. But why would a hedge fund want to speculate on the day-to-day gyrations of a tech stock?

They wouldn’t, which is why the hedge fund shorts the stock in the days before they buy the stock in the offering. ‘Shorting a stock’ means borrowing shares from other investors (probably clients of Goldman Sachs and Merrill Lynch), and then selling them with the hopes of buying the shares back at a lower price.

It’s the Wimpy from Popeye trade: I’ll gladly give you your shares back Tuesday if you give them to me today, and it has risks – big risks. If the stock takes off, the short seller loses money. The short sellers can even lose more money than they earned selling the stock because, although a stock can only fall to zero, it can also triple in price.

But what if a hedge fund knew they could get, say, 7 million shares in the TSM offering at the guaranteed price of $10.77 per share? Well then, selling some shares short at $11.50 two days before you buy the shares for $10.77 from Goldman isn’t so risky after all…they just hand off the $10.77 shares to the person they borrowed them from to cover the short, so to speak.

What about the poor saps who bought TSM shares at $11.50 from the hedge fund, not knowing the offering price was going to be at $10.77 in the very near future? Maybe they should quit whining and start paying the high hedge fund fees to join the "in" crowd.

The securities rule in question is sort of a vague catch-all to try to weed out these sorts of tricks, but it doesn’t really do the job, hence the lame settlements. Frankly, being effectively both short and long, any one stock (directly or through various derivatives or contractual pre-sales) is questionable and is likely a tax avoidance scheme at best and flat-out securities fraud at worst.

But what’s so bad about a hedge fund essentially acting as a stock underwriter anyway? If GLG was genuinely taking on risk by shorting the stock, and if they had no pre-arranged deal to find out what price they were getting the stock at and to thereby cover the short, then no muss no fuss. In reality, somewhere between a 100% risk-free trade and a normal trade took place. Arbitraging the price gap between the outsider and insider price can be as questionable as insider trading.

What’s so bad about a risk-free trade? Nothing, for GLG investors. Remember the great mutual fund timing scandal? The result of hedge funds skimming near risk-free profits from ordinary mutual funds was lower rewards for mutual fund investors.

Risk-free trades effectively skim profits off the market – leaving the same risk but lower returns for everybody else. The market as a whole only has so much profit. This profit comes at a cost, and that cost is risk. Skimming the profit while leaving the risk means less reward for everybody else.

It’s like ordering a $25 porterhouse steak at a restaurant, noticing that the filet mignon part was missing, and being informed by the waiter that a hedge fund patron cut it off your steak on its way from the kitchen.

We’ll leave you with one funny line from the secondary stock offering documents, "...we are not aware of any plans by any major shareholders to dispose of significant numbers of common shares…"

Of course not, they disposed of them before the offering.

The Future for Stocks and Bonds? Like The Past. Only Not Nearly As Good

July 5, 2007

Investment pros at Morningstar’s recent annual investment conference seem to be in agreement on one thing: future returns for investors will be a mere fraction of the golden era of the last two decades or so.

'If we are to rely on history as a predictor of future returns, we are likely to be intensely disappointed. Because the future is simply unlikely to be anywhere near the recent or even historical past,' Ranji Nagaswami, chief investment officer of AllianceBernstein Investments, told the conference.

'Bonds are not likely to have returns in double digits. And relative to their long-term history, equities, too, are likely to return a lot less,' she said. AllianceBernstein estimated that in the past two decades, equities returned a compounded 12.5 percent in U.S. dollar terms."

While here at MAXfunds we also have tepid estimates on future stock and bond returns, some of these fund managers motives for setting shareholders expectations so low are suspect. Many of these managers have seen billions of new money hit their hot funds. This makes their job harder, because they have to find more and more compelling investments in which to invest all that cash. The lower the expectations of investors are, the better these managers look when they exceed them – and the less likely those investors are to look for better returns elsewhere. None of these managers, of course, recommended going with a low fee, near zero risk money market fund, of course.


2006 Was A Cheaper Year

June 20, 2007

Here's some good mutual fund news: a new study finds that fund fees in 2006 were the lowest in more than a quarter century.

A study going back to 1980 found that mutual fund fees and expenses haven't been lower than they were last year.

Fees declined again in 2006, continuing a multiyear trend, as ever-larger investor portfolios triggered reduced load fees and as funds continued to tamp down expenses to boost their competitiveness. Many growing portfolios had smaller fees taken out because their size enabled them to receive discounts on large purchases as well as fee waivers. Overall, it seems investors had much to cheer about in 2006.

The Investment Company Institute, the mutual fund trade group, found that investors in stock funds paid fees, including both loads and expense ratios, that averaged about 1.1 percent, a decline of .04 percent from 2005."

Fund fees are going down for two big reasons: 1) More money is being invested in funds. Fund operating costs do not go up proportionally with more assets under management, so rising assets should lower fees. 2) Investors are paying more attention to fund fees, and investing in lower cost funds.

The study is quiet about 12b-1 fees, which have been rising as a percentage of the total rake over the last two decades, as well as commissions to buy mutual funds at brokers, which have been jumping across the board in recent years. But it seems that more and more mutual fund investors are picking funds based on cost - and mutual fund companies, ever looking for ways to attract investor assets, are trying to give investors what they want. Let's give ourselves a round of applause.


Who's Your Mutual Fund Voting For?

June 7, 2007

Is your mutual fund supporting CEO pay raises, even when the CEO doesn't deserve it? reports on a new study which shows that fund managers back compensation proposals by company management more than 75% of the time:

A study of the proxy voting records of 29 mutual fund families by the American Federation of State, County and Municipal Employees, the Corporate Library and the Shareowner Education Group indicates that between July 2005 and June 2006, fund managers backed management-sponsored proposals on executive compensation just over three-quarters, or 75.8%, of the time.

That represents a slight uptick from 75.6% during the year-earlier period.

'These mutual funds are failing to protect the assets of their clients,' says Gerald W. McEntee, president of AFSCME. 'CEOs should be paid for performance. Investors in these mutual funds should be outraged that their assets are being used to prop up undeserved CEO pay.'"

That pay is undeserved, the study says, because higher pay for company management doesn't generally lead to more profitable companies:

...authors of the report cite research showing that among S&P 500 companies, the largest increases in total compensation actually correlated poorly with improvements in long-term corporate performance."


Do You Know Something the Pros Don't?

May 10, 2007

Your fund returns are through the roof. The market is smashing records on a daily basis. So why aren't you more excited? Recent studies have shown that most investors are expecting rough economic seas ahead.

Clearly there is a disconnect here because strong market activity typically isn't met with widespread pessimism.

'The market's move is dollar-weighted, it's being fueled by the big institutions but retail investors have, for the most part, not participated,' says Jack Ablin, chief investment officer for Harris Private Bank in Chicago. 'Fewer and fewer people are participating in the market's prosperity.'

Some of that situation is hangover from the last bear market. Investors who became euphoric in the late 1990s got hammered when the market turned in 2000 and they're not anxious to repeat the experience. They discount the market's performance because of all the negative factors they see out there and don't want to get caught up in any euphoria because that was a big reason they got tripped up the last time.

Another issue is inflation, particularly as it impacts regular costs and savings. This is where, for many people, rising gas prices figure in.

A recent study conducted for the Civil Society Institute's project showed that about half of all households, regardless of income level, will "definitely or probably" have to cut back on personal spending if gasoline hits $3.50 per gallon."

While the current somewhat low inflows of new money to stock funds (relative to money market and bond funds) is a mild positive for stocks (fund investors tend to be wrong), we have not seen fund investors pull big money out of stock funds. Such a move would be needed before there will be any real bargains in the stock market.

It is quite possible that individual investors are more accurately assessing stock market risk than professionals these days. The economy is slowing, but the stock market is speeding along. That can’t go on forever.


Another Mutual Fund Burglar Gets Off Easy

May 9, 2007

You don’t hear much about the great mutual fund rip-off these days. Maybe it’s all the record Dow closes. Maybe all the big cases seem to have been settled. Justice was doled out, and all that good stuff. Swiss insurance giant Zurich Financial just paid a not-so-whopping $16.8 million to settle up with the SEC.

Zurich Capital Markets, a U.S. subsidiary, helped four hedge funds disguise their identities to avoid detection when making frequent trades in mutual-fund shares, a practice called market timing, the SEC said in statement today.

By knowingly financing their hedge funds clients' deceptive market timing, ZCM reaped substantial fees at the expense of long-term mutual-fund shareholders,' Mark Schonfeld, director of the SEC's regional office in New York, said in the statement."

As a refresher, the fund timing scandal involved crooked banks and brokers working with crooked hedge funds and other institutional investors to systematically skim ordinary fund shareholders out.

Frequent trading in and out of mutual funds can allow the smart trader – or timer – near risk free profits by effectively taking advantage of pricing anomalies at mutual funds. One scheme involved trading funds that invest overseas, arbitraging the stale prices resulting from time zone issues. Another favorite allowed trading after hours in funds that would move the next day on big news released after the market closed.

As would be expected, such money moves increased ordinary fund investor’s exposure to downside, but decreased their exposure to upside. This in addition to increasing costs incurred by the fund (and therefore the shareholders) handling all the fast money flows.

While such fraud lacks the flash of absconding with an entire account, stealing small amounts from millions of people should be punished just as severely as stealing large amounts from a small amount of people. Apparently the SEC sees things a little differently.

The settlement includes a $4 million fine and forfeiture of $12.8 million in profits. The money will be distributed to mutual-fund investors harmed by the trading, the SEC said."

Keep in mind Zurich probably made $4 million investing that $12.8 million in illicit profits. The SEC can chalk up another "success" and the global financial industrial complex can rest assured that, as Bob Dylan once said, "Steel a little and they throw you in jail, steel a lot and they make you king."

O.K. maybe replace king with "give the money back"...


SEC Looks to Expose Hidden Fund Costs

April 4, 2007

You'd think when a mutual fund publishes its total expense ratio, you could be confident that number represented all the costs you'll pay to invest in the fund. Well, it doesn't. There are all sorts of hidden trading costs associated with mutual funds that don't show up in the total expense ratio, but do weight on the fund's returns. Two funds could have the exact same expense ratio, but one that trades frequently could be more expensive to own than one that trades very little because every time a fund buy or sells a stock they pay a commission, just like you do in your E*TRADE account. reports that the Securities and Exchange Commission hopes to require funds to more accurately account for true cost of fund ownership:

In an interview, Cox said companies that manage funds and retirement plans should be required to report 'one simple number that captures fees and expenses.' As traditional pensions disappear, more workers are relying on 401(k)s and individual retirement accounts. But excessive fees can jeopardize the financial security of retirees.

These costs are often hidden now — either buried in the fine print of a fund prospectus, or simply deducted from accounts without ever showing up as a line-item expense.

'It's our top regulatory priority,' said Cox, who wants to make it easier to compare funds. 'There are always technical concerns raised by someone, but the truth is that apples-to-apples comparisons are quite useful for consumers. The same should be possible for our retirement savings.'


Sounds like a good idea, but it won't be easy. The problem is that some trading costs are easy to hide, and others hard to measure. If a fund thinks investors are paying attention it is not difficult for them to obfuscate the amount they pay to brokers to buy and sell stocks. A fund could, for example, make a wink-wink nudge-nudge deal with a broker to pay very little in commissions per trade in exchange for paying a slightly higher price per share of a stock.

While the SEC will be grappling with this difficult issue for quite a while, MAXfunds is ahead of the curve. If you're looking for one simple number that captures fees and expenses (including an estimate of trading costs), we've got some good news for you. Our MAXrating: Expenses, found on each funds data page here on, does just that.

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