John and Regina Baker checked with their financial adviser to make sure their funds were scandal free.
On the surface, 2003 was an excellent year for mutual funds. Virtually every fund category posted gains—the first time that’s happened since 1996. The fund categories that held the most money (those emphasizing large-cap domestic stocks) averaged gains of 28%. However, a stream of scandals rocked the industry in the second half of the year, leading to high-profile resignations, costly settlements with regulators, and huge cash outflows from certain fund families.
What was all the fuss about? In essence, some fund families allowed selected investors to benefit from market timing and after-hours trading—taking advantage of loopholes in the mutual fund rules—to make a quick buck. (See “How Do the Mutual Fund Scandals Affect You?” Moneywise, Feb. 2004 or www.black enterprise.com/ExclusivesEKOpen.asp?id=649.) Ivory Johnson, who is a chartered financial consultant and founder of Delancey & Associates L.L.C. in Annapolis, Maryland, says, “Those profits diluted the returns of long-term investors and increased fund expenses.”
But the actual losses may not have been so great. Marc Singer, CFP, a partner with Singer Xenos Wealth Management in Coral Gables, Florida, estimates that an investor with $20,000 in a mutual fund might have lost only $20 or $30 to such practices. Christine Benz, associate director of fund analysis at Morningstar Inc., agrees: “It’s true that the dollar amounts were small,” she says. “What’s more, this type of improper trading probably has been stopped. However, investors in fund families that have been named in serious trading abuses should think hard about making changes.”
Morningstar, the Chicago-based mutual fund research firm, has recommended that shareholders consider selling funds from Alger, Alliance, Bank One, Bank of America’s Nations Funds, Invesco, Janus, PBHG, and Strong. What about Putnam, which has been charged with misconduct and has suffered billions of dollars of investor outflows? “Putnam’s new management has a history of strengthening mutual fund companies,” says Benz. “We’re not saying sell, but we have told investors not to put any more money into Putnam funds, the same as we’re recommending for funds from Federated Investors.”
ENCOURAGING WORDS
John Baker, for one, is happy that his funds aren’t on that list. “The news has been worrisome,” says Baker, 37, a manager with a high-tech company in Colorado
“These funds are defensive; they don’t make as much money as some funds during bull markets. But they don’t decline as much either when the stock market is weak,” explains Richard J. Peace, CFP, the Bakers’ financial planner. “In fact, these funds have performed well over the past decade.”
The Bakers also have some money in SunAmerica focused portfolios. “These are mutual funds that ask three different managers to name their 10 best ideas in terms of stocks,” says Peace. “They tend to be more aggressive than American Funds. Again, the company has a good reputation and performance has been strong.” Peace says he is satisfied with the ethical behavior of these families, as he is with Van Kampen funds, which are held by some of his other clients.
RESPONSIBILITY KNOCKS
Just as Baker is comfortable with the fund families he holds, so is Charles M. Adams, 42, president of Adams Communications & Engineering Technology, an IT consulting firm in Waldorf, Maryland. “All the bad news doesn’t scare me unless it affects my funds,” says Adams. “So far that hasn’t been the case. I do most of my investing through my company’s 401(k) plan, which has funds such as Fidelity Magellan (FMAGX) and Fidelity Dividend Growth (FDGFX). Fidelity hasn’t been named in these scandals.”
Ivory Johnson, Adams’ financial planner, concurs that Fidelity and its funds have not been implicated in the ongoing scandals. “Charles also holds some Vanguard funds, and Vanguard has an excellent reputation,” says Johnson. “I’d be surprised if it’s found out that those companies permitted improper trading.” Johnson does feel, however, that the mutual fund scandals have presented business owners, such as Adams, with other burdens to bear. “If you sponsor a
retirement plan that includes employees,” says Johnson, “you have a fiduciary responsibility to them. Your employees might sue you in the future if their retirement accounts don’t do well, and having funds from families that have been named in scandals could hurt your defense.”If that’s the case, what steps should business owners take to reduce this risk? “Bring in a reputable financial professional,” says Johnson. “This adviser can look at the funds in your plan and attest—on paper—that they appear to be well-managed and from respected fund families. If necessary, your adviser can recommend new funds to replace ones that should be removed from your plan. An advisor also can determine whether you’re participating in a good mix of funds and can help your employees put together well-balanced portfolios.”
LEARNING CURVE
Looking at this issue from the employee’s point of view is Carl E. Peoples, 38, a manager with Wachovia Wealth Management in Atlanta. “I do most of my investing through my employer’s 401(k) plan,” he says. “I expect [my employer] to review all the funds now in the plan and to replace any that are inappropriate for my investing.”
Within his 401(k) plan, says Peoples, most of his assets are in Dodge & Cox Stock Fund (DODGX). “This fund has done very well. That family hasn’t been charged with anything, as far as I know.”
Osmond Baptist, a certified financial planner in Decatur, Georgia, who advises Peoples, says, “I don’t like to see clients have too much of their portfolio in one stock or one fund. For 2004, I’ll try to convince Carl to spread his investments around to some other funds.” Peoples, in the meanwhile, has another issue to discuss with Baptist at their next meeting. “Our children’s 529 college savings accounts are in a plan run by Putnam, which is a matter of concern,” he says. “When we sit down together, I’ll ask [Osmond] about moving to another 529 plan.”
Whether you hold funds from dysfunctional families in a 529 plan, a retirement plan, or a personal account, there are reasons to bail out as well as reasons to stay put. Here’s why you might want to stay:
The fund might have been a top performer. For example, Strong Advisor Small Cap Value Fund (SSMVX) has returned more than
22% per year for the past five years, among the best of all mutual funds. If you currently hold this fund (which is closed to new investors), would you want to pull your money out and try to find another small-cap fund that will perform as well, just because the parent company has had problems?You might owe taxes. Leaving a fund from which you gained a profit will trigger a capital gains tax, assuming it’s not in a retirement account, says Baptist: “If you’ve owned the fund less than a year, you’ll have a short-term gain taxed at your highest rate.” If you move out of a top fund, such as the Strong entry mentioned above, th
e tax bill could be enormous.
You might owe fees. “Some investors don’t realize they own B shares of a mutual fund,” says Baptist. “If that’s the case, you might owe a deferred sales charge if you move to another fund family in less than two years time.”
There may also be fees to pay and paperwork to fill out if you want to move from one 529 savings plan to another. “Unless there is a strong desire to switch right away, I may advise investors to wait for a while,” says Peace. “I’ll keep an eye on events and let clients know if they should act.”
Here’s why you might want to switch:
Possible manager distraction: “If the managers at your fund are thinking about defending themselves against lawsuits,” says Johnson, “they’re not thinking about picking the best stocks for you.”
Possible manager departures: Top-performing managers at tarnished families may get better offers elsewhere. “It’s probably not much fun working for some [scandal-ridden] companies these days,” says Benz. “We’ve seen manager defections from some fund families.”
Greater caution, lower returns: Money is already flowing out of families named in the scandals. “If managers expect heavy redemptions, they may hold more cash than they normally do,” says Johnson. Low-yielding cash is likely to reduce returns for long-term investors. Alternatively, if the manager stays in stocks but eventually has to sell some holdings to meet redemptions, there’s a chance those stock prices will be depressed by the selling pressure.
Fewer investors, higher expenses: “There may be a ‘run on the bank’ at accused fund families,” says Baptist. “If that happens, remaining investors might have to carry a greater share of the fund’s expenses.”
Repeat offenses: Singer is advising clients to change 401(k) selections in some cases and move away from fund families that have been charged with improper behavior. “Everybody is entitled to a few mistakes,” he says, “especially if steps are taken to correct them. However, repeated errors may be a sign that the fund company is not well-managed. It may lack good controls. There are many fund families to choose from, so why invest with a company that has misbehaved frequently?”
If the reasons for switching seem convincing, you must next decide where to reinvest. There’s not much point in moving from a confessed wrongdoer to another fund family that is soon revealed to be the latest target of regulators. “There’s no way to know for certain where problems will be,” says Don Cassidy, senior research analyst at Lipper Inc., a mutual fund research firm. “However, we have found two factors to be good forecasters of funds [involved in] improper trading.”
First, says Cassidy, mutual fund investors can compare the number of purchases and redemptions a fund has undergone. Both numbers can be found in the fund’s annual report or proxy statement. If those two numbers are about equal, it may be a sign of a lot of in-and-out, round-trip activity.
The second number to look at is what Cassidy calls the churn ratio—the relationship of a fund’s redemptions in a given year to its average net assets. “A fund with a billion dollars of net assets might expect to have $400 million worth of redemptions in a year, for a 40% ratio,” he says. “If a fund has $3 billion or $4 billion in redemptions, for a 300% or 400% ratio, that’s another sign of short-term activity. From our calculations, the fund families that have been charged with serious misbehavior are among those ranking highest on those two factors.”
Such ratios may or may not be signs of improper behavior. “They do indicate high trading costs. And, over time, high costs work against fund investors,” says Cassidy. “If you’re looking for top-performing funds from well-run companies, you might start with those that pay attention to people living within a family budget.
|
B.E.’S TOP MUTUAL FUND PERFORMERS |
||||||
| FUND NAME | TICKER | 1-YR RETURN % |
3-YR RETURN % |
5-YR RETURN % |
MINIMUM INITIAL PURCHASE |
PHONE |
| LARGE GROWTH | ||||||
| Fidelity Sel Leisure | FDLSX | 41.85 | 4.92 | 2.99 | $2,500 | 800-544-8888 |
| Fidelity Capital Apprec | FDCAX | 51.68 | 3.35 | 5.69 | 2,500 | 800-544-8888 |
| Marsico 21st Century | MXXIX | 48.79 | 2.23 | NA | 2,500 | 888-860-8686 |
| Jensen | JENSX | 16.58 | 1.26 | 7.78 | 2,500 | 800-992-4144 |
| Chesapeake Core Growth | CHCGX | 42.42 | -1.84 | 8.23 | 2,500 | 800-430-3863 |
| MID-CAP GROWTH | ||||||
| Meridian Growth | MERDX | 47.90 | 11.73 | 15.17 | 1,000 | 800-446-6662 |
| First Focus Gr Opp Ins | FOGRX | 33.41 | 4.28 | 6.38 | 500 | 800-662-4203 |
| Papp Small & Mid-Cap Gro | PAPPX | 30.18 | 2.46 | 9.81 | 5,000 | 800-421-4004 |
| Accessor Sm to Mid Adv | ASMCX | 44.06 | 1.81 | 1.89 | 5,000 | 800-882-9612 |
| valign=”middle”>Westcore Midco Growth | WTMGX | 41.19 | 1.23 | 6.45 | 1,000 | 800-392-2673 |
| SMALL GROWTH | ||||||
| 1st Source Special Eqty | FMSPX | 41.08 | 9.80 | 11.68 | 1,000 | 800-766-8938 |
| Baron Small Cap | BSCFX | 38.82 | 9.67 | 13.19 | 2,000 | 800-992-2766 |
| Henlopen | HENLX | 64.98 | 9.57 | 11.68 | 2,000 | 866-880-0032 |
| Fidelity Small Cap Stock | FSLCX | 45.04 | 9.17 | 15.73 | 2,500 | 800-544-8888 |
| Oberweis Emerging Growth | OBEGX | 67.70 | 8.48 | 11.80 | 1,000 | 800-245-7311 |
| LARGE BLEND | ||||||
| Matrix Advisors Value | MAVFX | 44.59 | 8.79 | 13.05 | 500 | 800-366-6223 |
| Thompson Plumb Growth | THPGX | 31.86 | 7.73 | 10.83 | 2,500 | 800-999-0887 |
| Mairs & Power Growth | MPGFX | 27.67 | 7.69 | 11.13 | 2,500 | 800-304-7404 |
| Parnassus Equity Inc | PRBLX | 15.69 | 7.01 | 9.86 | 2,000 | 800-999-3505 |
| Neuberger Ber Soc Res In | NBSRX | 34.48 | 3.88 | 3.62 | 1,000 | 800-877-9700 |
| MID-CAP BLEND | ||||||
| Hussman Strategic Growth | HSGFX | 21.09 | 16.55 | NA | 1,000 | 800-487-7626 |
| Matthew 25 | MXXVX | 32.05 | 12.98 | 8.60 | 1,000 | 888-625-3863 |
| ICON Leis&Consum Staples | ICLEX | 27.33 | 12.87 | 9.45 | 1,000 | 800-764-0442 |
| TCW Galileo Val Opport N | TGVNX | 48.35 | 12.71 | NA | 2,000 | 800-386-3829 |
| FMI Common Stock | FMIMX | 24.07 | 11.53 | 11.96 | 1,000 | 800-811-5311 |
| SMALL BLEND | ||||||
| CGM Focus | CGMFX | 66.46 | 26.42 | 27.53 | 2,500 | 800-345-4048 |
| Babson Enterprise | BABEX | 50.64 | 23.51 | 14.46 | 1,000 | 800-422-2766 |
| Safeco Small-Cap Value I | SFSCX | 43.10 | 17.63 | 11.42 | 2,500 | 800-624-5711 |
| ABN AMRO/TAMRO Sm Cap N | ATASX | 56.86 | 16.57 | NA | 2,500 | 800-992-8151 |
| Hennessy Cornerstone Gr | HFCGX | 45.82 | 15.93 | 17.71 | 2,500 | 800-966-4354 |
| LARGE VALUE | ||||||
| Memorial Value Eq Inst | MVEIX | 33.76 | 10.22 | 6.43 | 1,000 | 888-263-5593 |
| Auxier Focus | AUXFX | 26.75 | 10.00 | NA | 2,000 | 877-328-9437 |
| Oakmark I | OAKMX | 25.30 | 8.26 | 4.89 | 1,000 | 800-625-6275 |
| Masters’ Select Value | MSVFX | 32.42 | 7.61 | NA | 5,000 | 800-960-0188 |
| PIMCO PEA Value D | PVLDX | 43.99 | 7.51 | 11.02 | 5,000 | 888-877-4626 |
| MID-CAP VALUE | ||||||
| Yacktman Focused | YAFFX | 31.79 | 21.08 | 8.09 | 2,500 | 800-525-8258 |
| Yacktman | YACKX | 33.03 | 20.98 | 10.79 | 2,500 | 800-525-8258 |
| Fidelity Sel Constr&Hous | FSHOX | 44.09 | 16.52 | 8.54 | 2,500 | 800-544-8888 |
| T. Rowe Price Mid Val | TRMCX | 39.00 | 13.76 | 13.35 | 2,500 | 800-638-5660 |
| Marshall Mid-Cap Val Inv | MRVEX | 35.87 | 13.62 | 12.80 | 1,000 | 800-236-8560 |
| SMALL VALUE | ||||||
| Heartland Value Plus | HRVIX | 53.56 | 25.80 | 13.04 | 1,000 | 800-432-7856 |
| Royce Special Equity | RYSEX | 27.64 | 24.39 | 15.13 | 2,000 | 800-221-4268 |
| Berwyn | BERWX | 50.01 | 21.67 | 11.90 | 3,000 | 800-992-6757 |
| American AAdv SmCpVl Pln | AVPAX | 51.28 | 21.46 | NA | 2,500 | 800-388-3344 |
| Delafield | DEFIX | 40.13 | 19.68 | 16.19 | 5,000 | Â 800-221-3079 |
| WORLD STOCK | ||||||
| Oakmark Global I | OAKGX | 48.98 | 20.52 | NA | $1,000 | 800-625-6275 |
| Polaris Global Value | PGVFX | 47.06 | 15.99 | 11.36 | 2,500 | 888-263-5594 |
| Pearl Total Return | PFTRX | 40.02 | 8.82 | 10.69 | 1,000 | 866-747-9030 |
| Fidelity Worldwide | FWWFX | 38.41 | 1.76 | 4.86 | 2,500 | 800-544-8888 |
| Portfolio 21 | PORTX | 32.68 | 0.42 | NA | 5,000 | 877-351-4115 |
| LONG GOVERNMENT | ||||||
| AmCent Target 2010 Inv | BTTNX | 3.19 | 8.37 | 6.59 | 2,500 | 800-345-2021 |
| AmCent Target 2015 Inv | BTFTX | 3.96 | 8.27 | 6.54 | 2,500 | 800-345-2021 |
| Vanguard Long-Tm US Try | VUSTX | 2.68 | 7.71 | 6.44 | 3,000 | 800-662-7447 |
| AmCent Target 2020 Inv | BTTTX | 3.52 | 7.39 | 5.73 | 2,500 | 800-345-2021 |
| Wasatch-Hoisington US Tr | WHOSX | 1.31 | 6.80 | 5.43 | 2,000 | 800-551-1700 |
| INTERMEDIATE GOVERNMENT | ||||||
| PIMCO Real Ret D | PRRDX | 8.03 | 10.87 | 10.15 | 5,000 | 888-877-4626 |
| Vanguard Infl-Prot Secs | VIPSX | 8.00 | 10.70 | NA | 3,000 | 800-662-7447 |
| AmCent Inf-Adj Bond Inv | ACITX | 7.27 | 9.82 | 8.55 | 2,500 | 800-345-2021 |
| Vanguard Int-Tm US Trs | VFITX | 2.37 | 7.91 | 6.69 | 3,000 | 800-662-7447 |
| PIMCO Total Ret Mtg D | PTMDX | 3.80 | 7.43 | 7.17 | 5,000 | 888-877-4626 |
| SHORT GOVERNMENT | ||||||
| AmCent Target 2005 Inv | BTFIX | 2.17 | 6.89 | 5.43 | 2,500 | valign=”middle”>800-345-2021 |
| Managers Interm Dur Gov | MGIDX | 3.40 | 6.71 | 6.14 | 2,000 | 800-835-3879 |
| Northern U.S. Government | NOUGX | 1.77 | 6.28 | 5.69 | 2,500 | 800-595-9111 |
| Marshall Govt Inc Inv | MRGIX | 3.08 | 6.03 | 5.60 | 1,000 | 800-236-8560 |
| Vanguard Short-Tm Trs | VFISX | 2.38 | 6.03 | 5.73 | 3,000 | 800-662-7447 |
| FOREIGN STOCK | ||||||
| Oakmark Intl Small Cap I | OAKEX | 52.41 | 17.78 | 18.02 | 1,000 | 800-625-6275 |
| Tocqueville Intl Value | TIVFX | 54.79 | 12.32 | 8.32 | 1,000 | 800-697-3863 |
| Fidelity Canada | FICDX | 51.91 | 9.54 | 15.71 | 2,500 | 800-544-8888 |
| BlackRock Intl Opp Instl | BISIX | 49.29 | 6.24 | 22.62 | 5,000 | 800-441-7762 |
| Oakmark International I | OAKIX | 38.04 | 6.23 | 13.47 | 1,000 | 800-625-6275 |
| CORPORATE BONDS | ||||||
| Managers Bond | MGFIX | 10.77 | 10.46 | 8.86 | 2,000 | 800-835-3879 |
| Vanguard Long-Tm Corp Bd | VWESX | 6.26 | 9.65 | 6.68 | 3,000 | 800-662-7447 |
| Parnassus Fixed-Inc | PRFIX | 5.30 | 9.56 | 5.59 | 2,000 | 800-999-3505 |
| Columbia Income Z | SRINX | 11.97 | 9.40 | 7.81 | 1,000 | 800-338-2550 |
| Vanguard LongTm Bd Idx | VBLTX | 5.50 | 9.28 | 7.00 | 3,000 | 800-662-7447 |
| MUNI NATIONAL | ||||||
| Harris Ins Tax-Ex Bond N | HXBAX | 5.55 | 7.45 | 6.48 | 1,000 | 800-982-8782 |
| Eaton Vance Muni Bd I | EVMBX | 7.38 | 7.44 | 5.54 | 1,000 | 800-225-6265 |
| Safeco Municipal Bond Inv | SFCOX | 5.95 | 7.16 | 5.67 | 2,500 | 800-624-5711 |
| TIAA-CREF Tax-Exempt Bd | TCTEX | 5.87 | 7.16 | NA | 2,500 | 800-223-1200 |
| Fidelity Adv Muni Inc I | FMPIX | 5.84 | 7.00 | 5.96 | 2,500 | 800-221-5207 |
| DOMESTIC BALANCED FUNDS | ||||||
| FPA Crescent | FPACX | 26.15 | 21.22 | 11.57 | 1,500 | 800-982-4372 |
| Oakmark Equity & Inc I | OAKBX | 23.21 | 12.47 | 12.98 | 1,000 | 800-625-6275 |
| Greenspring | GRSPX | 31.34 | 10.82 | 10.07 | 2,000 | 800-366-3863 |
| Dodge & Cox Balanced | DODBX | 24.44 | 9.95 | 11.39 | 2,500 | 800-621-3979 |
| Franklin Income A | FKINX | 30.96 | 9.26 | 9.32 | 1,000 | 800-342-5236 |
| MONEY MARKETS | ||||||
| CitiFunds Inst Liq Res | CILXX | 1.02 | 2.38 | 3.75 | 1,000,000 | 800-721-1899 |
| Harris Money Market Inst | HACXX | 1.10 | 2.37 | 3.75 | 250,000 | 800-982-8782 |
| Nations Cash Resrvs Cap | CPMXX | 1.09 | 2.36 | 3.74 | 1,000,000 | 800-321-7854 |
| SEI Daily Money Market A | TCMXX | 1.07 | 2.26 | 3.66 | 100,000 | 800-342-5734 |
| Nations Govt Resrvs Cap | CGCXX | 1.04 | 2.24 | 3.60 | 1,000,000 | 800-321-7854 |
| SOURCE: MORNINGSTAR INC. MORNINGSTAR MAKES EVERY EFFORT TO ENSURE ACCURACY OF THIS DATA BUT CANNOT GUARANTEE COMPLETENESS AND ACCURACY.DATA THROUGH 12/31/03. | ||||||