Investing Tips

New SEC Fund Online Research Tools Hits The Internet Super Highway

April 8, 2008

The Securities and Exchange Commission (SEC) just launched their new Mutual Fund Reader, an online tool that lets fund investors review data provided by fund companies to the SEC:

The Mutual Fund Reader enables fund investors to read, analyze and compare mutual fund information concerning cost, risk, investment objectives and strategies, as well as historical performance.

The SEC adopted a new rule in June 2007 enabling mutual funds to submit risk/return summary information voluntarily from their prospectuses using XBRL, a computer software language that labels company financial and business data so investors and analysts can more easily find what they’re looking for and use the information for comparisons.

Twenty mutual funds so far are using the XBRL system, and additional filers are expected to participate in the coming months, the SEC wrote in a press release."

With such a small sampling of mutual funds contributing to the system at launch, there's not a heck of a lot data to compare at the moment - but down the road this could be a useful tool.

B Class Funds - Designed To Deceive

January 24, 2008

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:

While the bulk of mutual fund investors wisely choose no-load funds — 73 percent in 2006, according to the Investment Company Institute — $37 billion went into funds with loads.... One message comes through loud and clear from a trip through the analyzer: There is no such thing as the right share class for all investors. Indeed, one of the most intriguing findings is that Class A shares, the most commonly sold class today and the one usually characterized as the best value for individual investors, are often more expensive than B and C shares.... Class A shares are typically viewed as cheaper because their lower operating expenses are thought to offset their upfront sales loads, which can run to 5.75 percent. In 2006, such shares accounted for 51 percent of all load fund sales, versus 13 percent in 2002. Finra’s fee analyzer shows how wrong this conventional wisdom can be."

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

Focus On: Asia Funds

January 3, 2008

From early 2002 until mid-2006, we rated Asian funds a (Interesting - should outperform the market over the next 1 to 3 years). After investors began investing in emerging markets with somewhat irrational exuberance, we downgraded this category to a (Neutral) in 2006. In the fall of 2007, after a very hot 12-month span, we finally went with a negative rating (Weak - should underperform the market) in our most recent favorite funds ratings update. Now, at the end of 2007, we’re giving the Asian offerings our lowest rating of (Least attractive).

There are many signs that the best days are now behind us in this category. Four of our five favorite Asian funds have accumulated over $4 billion dollars in assets. Fidelity Southeast Asia (FSEAX) was up roughly 60% for the year at the end of November in spite of an 11% drop in November. Its five year annualized return is just over 35%. T. Rowe Price Asia (PRASX) posted similar returns. the rest of this article»

Capital Gains Questions?

November 5, 2007

Mutual fund coverage at The Motely Fool is, to put it mildly, hit or miss - but today they post a nice explanation of what is a confusing issue for many fund investors: capital gains distributions.

When a capital gains distribution is made, the fund's value is adjusted downward accordingly. If you buy just before the distribution, you'll face taxes on an investment you didn't own for very long -- and in many cases, one you never owned. Funds often wait nearly the entire year before paying out gains from a sale early in the year."

The article lists several legitimate techniques you can use to minimize your capital gains exposure, including buying funds with high capital gains potential through non-taxable accounts like your IRA and investing in ETFs (which aren't subject to capital gains distributions).

One note: unlike most fund reporters and analysts (including the author of The Motley Fool's article) we are not big fans of reinvesting dividends in funds held in taxable accounts unless the fees to buy other funds with the distributions are excessive (loads, commissions). It can be very difficult to determine your cost basis later when selling after random reinvest points determined by fund distributions. We prefer putting the cash from various fund distributions into new funds, or to rebalance your current stock / bond / cash stake.


Sneaky Mutual Fund Tricks

September 24, 2007

If we didn't think mutual funds were the best investment option for the vast majority of people, we wouldn't have started 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.'"


Too Much Fund Focus – A Bad Thing?

September 12, 2007

An article in the Chicago Tribune warns of the risks of mutual funds with too few holdings:

No equity-fund manager has made a clearer confession than William Nygren, co-manager of the Chicago-based Oakmark Select Fund, a so-called focus fund holding stocks in just 24 companies at the end of June. Fourteen percent of the fund was in mortgage lender Washington Mutual.

The fund's performance has been 'dreadful,' Nygren wrote to shareholders last month. So far in the quarter, the fund is down nearly 9 percent….Ed Maracinni, co-manager of the JohnsonFamily Large Cap Fund in Racine, Wis., said the pessimism in stocks has been overdone, apart from financial and real-estate-related stocks. The fund is down nearly 5 percent in the current quarter….This summer's concentrated disasters prove the risk of narrow bets on a few stocks or a few sectors..."

We’d counter with "Too much diversification spells mediocrity for most stock funds".

While it is true that diversification lowers risk, it also reduces upside. At MAXfunds we tend to prefer more focused funds with fewer than 100 holdings (in fact it has been a component of our ratings and is highlighted on each funds data page). While these funds can fall the hardest in down markets, they tend to outperform in up markets. Why is this a good thing?... the rest of this article»

Don't Forget the Little Guy

September 4, 2007

Jonathan Burton at Marketwatch says that when shopping for mutual funds, don't just go with the big boys like Janus and Vanguard. Smaller fund firms tend to deliver better returns than industry giants:

The best-performing small firms often do better than similarly high-ranking large firms, regardless of whether they own small-cap, midcap or large-cap stocks or follow a value or growth investment style. Forty percent of money managers in the top 25% of their peers have less than $2 billion in total assets under wraps, according to research from financial-services firm Northern Trust Corp.

For investors, the message is that giving money exclusively to industry giants shuts out a large group of talented stock pickers. Broadening horizons to include small firms boosts the odds of finding innovative managers with results in the top 25% of their peers, says Ted Krum, a vice president at Northern Trust who helps institutional clients with money-manager searches.

New research Krum expects to release this fall looked at results over five years through 2006 for managers investing in small-cap and midcap stocks. It found that among firms in the top 25% of their class, the smallest players, handling less than $1.4 billion, delivered returns almost two percentage points better than the giants.

Tiny investment shops returned 16.5% annualized on average in the period, which covered both bull and bear markets, while firms of $1.4 billion to $17.9 billion in size averaged competitive 16% gains, the forthcoming research says.

Performance slipped as assets grew, the study reports. Midsize firms with $17.9 billion to $66.5 billion gained 15.6% on average, while the biggest outfits, managing $66.5 billion to $785.4 billion, posted average gains of 14.7%."

Funds from smaller fund companies mentioned in the article:

Auxier Focus Fund (AUXFX)

Al Frank Asset Management (VALUX)

Berwyn Fund (BERWX)

Berwyn Income Fund (BERIX)

Amana Trust Growth Fund (AMAGX)

Amana Trust Income Fund (AMANX)

Sextant International Fund (SSIFX)


Obvious Advice of the Week

August 29, 2007

Scott Burns at MSN Money meets this week's article quota by telling us that when shopping for mutual funds, you're better off going with cheap rather than expensive:

The least expensive one-eighth of large-blend funds had an expense ratio of 0.50% or less and provided an average return of 6.90%. More important, 49 of the 69 funds in the group provided superior returns, so you had a 71% chance of superior performance simply by selecting the least expensive funds."

While this advice might be a bit on the "duh" side for savvy MAXfunds readers, we reckon it never hurts to get a reminder every now and then.


Backdoor Men

August 3, 2007

Some fund managers are the financial equivalent of rock stars - investing idols that pack their famous funds like Springsteen fills Giant Stadium. But as anyone who's ever been stuck in the nosebleeds when attending a concert at a mega-arena can tell you, sometimes smaller is better. Same goes with mutual funds. Rob Wherry at Smartmoney
points out
that investors can get more intimate access to some of the biggest names in fund management by investing in their lesser-known offerings... the rest of this article»

Ahhh…That New Fund Smell

July 25, 2007

New funds have some advantages over larger, older funds, as noted in a recent Fortune article about interesting young funds:

Some of the rookies, though, have genuine all-star potential, whether because of a smart strategy, proven management, or - as you'll find in the funds that follow - a combination of both. Adding to their appeal, new funds can actually have some advantages over their more established counterparts. They tend to be smaller, for example, allowing managers to invest more nimbly."

But while new funds do offer real competitive advantages over their old-fogey counterparts, there is one critical downside for being a Ponce de Leon investor: new funds are often launched to meet ill-timed investor demand. We saw new tech and internet funds launched when fund investors were infected with dot-com mania, new commodity oriented funds after a hot run in oil and gold, and a flurry of international funds after a run of foreign stocks beating the U.S.

A winning fund investor should be open to new and small funds, but ask themselves: is this just a fund being launched to satisfy performance chasing investors...or is this a genuinely good time to buy this type of fund from this manager or company?

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