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Small Stake, Big Break

02/12/07 -

Steve Butler at the Contra Costa Times describes the value of adding a small stake in a high-risk emerging market fund to his conservative portfolio.

Beginning with a quick lesson in calculating a "weighted average return," I will assume that I have a $100 portfolio and that $5 will be invested in an aggressive fund or combination of funds.

If the $5 doubles in value in a two-year period, I will have $5 of earnings.

If the remaining $95 invested conservatively averages 10 percent per year for two years, that portion will earn $9.50 per year for a total of $19. On the entire portfolio, I have earned $24 in two years.

This works out to be $12 per year, or a 12 percent average annual return. (I have ignored compounding because the time is so short.)

Some would argue that investing only 5 percent of a portfolio aggressively is not enough to "move the needle," but this simple example shows that it can be worth it when the high-risk investment is successful.

On the flip side, what happens if the high risk investment on 5 percent of our money drops by 50 percent in two years?

On $5, we just lost $2.50, or $1.25 per year. On the remaining $95 we still made $19, or $9.50 per year. Our total annual earnings on the entire $100 works out to be $8.25 -- or 8.25 percent. We haven't lost everything. We just had two years where our return was about 2 percent less than it otherwise would have been. Overseas funds of all types are being swamped with new money.”

He ended up investing in T. Rowe Price Emerging Markets Stock (PRMSX), to which our newly overhauled Fund-O-Matic gives a MAXrating of 80. The fund with the highest MAXrating in the category is currently the DFA Emerging Markets Value (DFEVX), but with a $1 million minimum that choice might be a little rich for most people's blood. Our top MAXadvisor Favorite Fund in the category is SSgA Emerging Markets I (SSEMX)


Invest in Mutual Funds Like a Hedge Funder

02/11/07 -

No, not the part where you hand over millions of dollars to (largely unregulated) hedge fund managers who can do pretty much whatever they want with your money. And not the part where you pay them both management AND performance fees. The part where you aren’t allowed to sell for two or three years.

Following complex strategies requires some stability in assets, so hedge funds -- which have a limited number of investors -- don't allow willy-nilly trading. Instead, most operate with a "lock-up," a time period when the investor agrees to stay put. Most often, the lock-up period is 12 months, although some funds are now going out for two and three years. When the lock opens, a hedge fund investor either agrees to another year, or pulls out.

It's the lock-up that ordinary fund investors should lock down and make part of their investment criteria. The lock-up requires the investor to answer one basic question: "Do I like this fund enough to be locked into it for another year or two?"

More than 5 percent of all hedge funds have been liquidated each year for several years, with the attrition owing to investors deciding that they don't want to lock their cash up with the same fund again. A hedge fund manager who sees a bunch of shareholders making a no-confidence vote when it's time to re-up for another year may simply pull the plug before most of the cash heads for the exits.

Mutual funds not only have no lock-up, they practically encourage inertia and mediocrity. With no pressure to make a hold or sell decision -- and with management free from worry that investors will rush the exits -- shareholders often settle for mediocrity.”


Fund Supermarket Gets a Little Less Super

02/10/07 -

We new it was coming. Discount broker Firstrade recently notified us that they are changing their mutual fund policy.

Starting February 15th (or March 15th if you have an account), Firstrade moves to a more traditional commission structure for buying and selling mutual funds in brokerage accounts – a.k.a. mutual fund supermarkets.

Customers will now have to pay to buy and sell no-load funds unless those funds kick back 12b-1 fees to the broker to be on the brokers “no transaction fee” (NTF) list.

In an effort to land new accounts, Firstrade had allowed buying and selling of ANY fund on their list of thousands for no fee - even cheapo funds like Vanguard 500 (VFINX), so long as investors didn’t sell for 180 days.

Low fee funds don’t skim enough fees from shareholders to pay a kickback and are usually not on NTF lists. This loss leader was a boon to fund investors who want the convenience of owning all of their funds in one place, yet the costs of buying funds directly from fund companies.

We’ve been recommending Firstrade as the best choice for fund investors because of this deal –though we knew it had to end someday. The last broker we recommended for the same deal (Scottrade) eventually stopped offering free fund trading as well.

Like Scottrade, those who loaded up on Vanguard and other low fee funds (like say, me) for no transaction fee, will soon have to pay a transaction fee to sell. (Why the FTC isn’t cracking down on this is a mystery – what if they started charging $5,000 to sell after you got in on “free trades”?)

That said, Firstrade’s new fee structure - $9.95 to buy or sell a non-NTF fund is still lower than anybody else – Scottrade charges $17, E*Trade $20, Schwab – you don’t even want to know… Plus Firstrade shortened the short-term redemption fee period to 90 days and now has over 10,000 funds available.

Miller Time

One of the big stories in mutual funds last year was the end to the famous  Bill Miller’s streak. In 2006 Legg Mason Value Trust (LMVTX) – the flagship fund managed by Miller – scored an unimpressive 5.9% return, missing the S&P 500 by a country mile (10%) and ended Miller’s impressive, unmatched, 15 calendar year streak of beating the most-benchmarked of indices. 

December 2006 performance review

In December, the S&P500 climbed 1.40% and the Dow 2.11%, while the NASDAQ slipped 0.68%. Small cap stocks rose, but only 0.34% (as measured by the Russell 2000 index), and bonds were weak as interest rates inched back up. The Lehman Brothers Long Term Treasury Index was down 2.14%, while the Vanguard Total Bond Index, which is less sensitive to interest rate shocks, fell by just 0.48%.

New fund launches: too much of a good thing

We’re always looking for signs of overly exuberant fund investors to guide our investing decisions. When fund investors get very excited about a specific fund, a category of fund, or even investing in general, it often pays to do the opposite, or at least ease up on whatever is catching their fancy. New fund launches—their volume and relative asset-gathering success—are tops on our list of contrarian indicators.

Better Than a Dartboard… But Worse Than An Index

12/22/06 -

Picking mutual funds is tricky business. That’s why most individual fund investors underperform the S&P 500 index. But in theory it should be easier than choosing stocks. The expert fund managers are doing the difficult work of picking the stocks to buy and sell. Investors just have to pick the right pickers.

There are dozens of reasons a mutual fund that had been a top performer can suddenly stop performing well. Professional fund analysts exist to look beyond the mere data and do actual fund manager interviews and additional research. Morningstar, the world’s premier mutual fund research company, has a sea of analysts keeping tabs on the growing (and growing….) list of funds. The job of these analysts is to choose the cream of the fund crop.

Morningstar recently updated the performance of their fund analyst picks. At first blush, the results look quite good.

As their director of mutual fund research concluded, “I'm pleased to see that our picks delivered superior returns.” The test was relatively simple: “Basically, we compare each fund with its peer group and ask whether it outperformed its peer group during the time when it was a pick.” In other words, if a fund analyst picks Super Duper Large Cap Value Fund as a large-cap value fund pick, does it beat the returns of most of the large-cap value funds going forward?

“For the trailing five years, it's 65%.” Not bad. That is, until you compare Morningstar analysts’ performance to some alternatives.

November 2006 performance review

Now that most funds have released year-end capital gains estimates and record dates, we have been able to create our <a href="http://maxadvisor.com/newsletter/reports/MAX.2006.distribution.pdf">annual year-end tax report</a> for all the funds in our model portfolios. Please download the PDF for estimates (and dates) of the distributions. Also, check out our guide to year-end tax issues for advice, tips, and tricks related to year end fund distributions.