Stable Value – Good Or Bad for 401(k)s?
Stable Value funds are low risk choices in many 401(k)s. The funds create the illusion of stability by owning bonds and getting some big insurance company to eat any fluctuations in the fund’s price that result from bond prices changing when interest rates move.
Stable value funds tend to benefit investors over more traditional bond funds when interest rates rise sharply, but underperform when rates fall. But creating the illusion of stability isn't free, and you can expect stable value funds to underperform low fee bond funds over long periods of time.
The insurance industry has done a good job of getting this product into 401(k)s (where they now represent around 10% of all plan assets). Unfortunately for the insurance business, stable value funds are not going to be allowed in new automatic enrollment choices – the plan to opt in employees to their 401(k) as if they actively took steps to save. Apparently the labor department would rather see young investors splurging on stocks with a traditional bond chaser than use the nervous nelly stable value choice. Looks like the fund lobby beat the insurance lobby on this one.
A recent WSJ article notes the usefulness of stable value funds in 401(k)s:
But others say these funds, which are hybrids of fixed-income investments and insurance policies and are found in 401(k) plans and other retirement accounts, can have a place in a portfolio's conservative corner. They offer a good parking place for money that may be needed soon and may also work as a substitute for cash or as a holding for extremely risk-averse investors…
In some ways, they are similar to bank certificates of deposit. They aim to protect an investor's principal, and offer a yield that's typically at least a percentage point higher than that of a money-market fund with less volatility than a short-term bond fund….
We’re not so sure the portfolios of stable value funds are as rock solid as everyone thinks. Some of them might have invested in some once top investment grade mortgage debt that has suddenly fallen far down the bond quality totem pole. Unlike CDs, they are not guaranteed by the U.S. government.
In general we prefer low fee short term bond funds or money market funds for the safe yield allocation in a 401(k). Unfortunately sometimes stable value is the only safe choice in a 401(k) plan, or the bond or money market fund choices are expensive and crappy.
One oddity – why are ordinary super safe bank CD’s not in 401(k)s for a similar deliverable: no volatility and no risk?
Perplexed about ETFs?
According to InvestmentNews, most investors don't know the difference between a mutual fund and an exchange traded fund.
a recent survey of 500 individual investors by Rydex Investments of Rockville, Md., found that 53% did not know the difference between an ETF and a mutual fund. Thirty-eight percent of those surveyed didn't know what an ETF is."
Well here's the short answer: the key difference between an ETF and a mutual fund is that it can be bought and sold throughout the day (and can change in value throughout the day), like a stock. A mutual fund is priced just once, at the end of each day.
There are other differences between ETFs and mutual funds - like ETFs are not actively manged unlike most mutual funds. Some of the features investors find attractive about exchange traded funds are their low fees and a fund market price that, because of a complex arbitrage system, doesn't vary much from the actual fund NAV (or net asset value), a key shortfall of the other exchange traded funds: closed end funds.
Go Big Or Go Index?
The largest funds (in terms of investor assets) are often the ones with the best track records – they don’t get big by accident. These monster funds deliver huge profits to the companies that run them, so they can afford to hire the best managers. Giant funds also tend to have lower fees because they have so many shareholders to cover fund operating costs. Sounds like a recipe for continued success.
So what is the better investment – a big successful actively managed fund or an index fund?
Morningstar takes a look back at how the ten biggest funds of 1997 in the large cap blend category did in the ensuing ten years.
Of the 10 biggest large-blend funds back in 1997, six have outperformed the majority of their rivals since October 1997. We recommended five of those funds for purchase at that time….The other four funds in that group of 10 have underperformed their typical large-blend rival since 1997. True, we did recommend all four funds at the time…"
The takeaway from this article appears to be that big funds do well (and that Morningstar seems likes recommending big funds…). But a 60% success rate is not particularly impressive.
Throwing darts at large blend funds in 1997 and falling asleep at the wheel for ten years should lead to a 50% success rate – odds are half of the dartboard funds would be in the top half of the performance curve... ...read the rest of this article»
Janus Fund Manager To Step Down
Marketwatch reports that Janus Fund (JANSX) is getting a new manager:
David Corkins, a 12-year veteran of Janus and manager of its flagship Janus Fund (JANSX) and other large-cap growth stock-fund vehicles, will leave the Denver-based company effective Nov. 1."
The Janus fund has posted better returns than a large cap growth index and similar funds since early 2006 when Corkins took over management, so his departure is not due to unsatisfactory performance, but rather that old Janus internal management turmoil that we used to know and hate (Janus recently announced that Scott Schoelzel, manager of Janus Twenty's [JAVLX], will be leaving at the end of the year). Maybe Corkins has his eye on a big hedge fund salary.
It's a good idea for owners of a fund that has changed management to keep a close eye on their investment. Bringing in a new manager to a mutual fund is kind of like starting a new quarterback in the NFL: investors are hoping for a hall-of-famer like Tom Brady, but they might end up with a washout like Ryan Leaf. New fund management can bring a entirely different investment approach, so much so that you could look at the Janus Fund after November 1st as an entirely different investment than the one it was under Corkins.
In this case we don’t think there is going to be a change for the worse here – we like the new managers and have other funds they manage in our MAXadvisor Powerfund Portfolios - but you can expect our ratings for the Janus Fund ratings to change slightly here in coming months (fund manager turnover generally hurts our custom quantitative ratings).
Like Funds, Newsletters That Sink Can Swim
Mark Hulbert has been tracking financial newsletter performance (via the Hulbert Financial Digest) longer than anyone else.
Judging financial newsletters by their past performance is just about as useless as judging mutual funds by their past performance. Top performing financial newsletters one year can be at the bottom of the heap the next.
As we’re coming up on the 20th anniversary of the greatest one day drop in stock market history, Hulbert took a look at some of the best and worst performing newsletters during the 1987 crash, and how they did afterwards:
On the whole, the best performers during the 1987 Crash have been below-average performers ever since, and vice versa. As an example, consider one of the newsletters with the best performances during the month of October 1987: Bernie Schaeffer's Option Advisor, with a gain of 61.5%, according to the Hulbert Financial Digest, in contrast to a 24.5% loss that month for the Dow Jones Industrial Average Since then, according to the HFD's calculations, it has produced a 3.4% annualized loss, and is very near the bottom of the HFD's performance rankings for performance over the past 20 years."
This means that doing well in a crash environment can mean crummy performance in a non-crash environment. Conversely, newsletters portfolios that fall hardest in down markets can perform very well post crash. The Prudent Speculator, a financial newsletter that performed poorly during the crash, has posted “… an annualized gain of 21.5%..[since 1987].”
It’s also interesting to note that Bernie Schaeffer’s newsletter has a negative twenty year track record (while the S&P 500 climbed more than 600% with dividends including the crash of 1987), but he still has a vibrant newsletter business and is sought after for market opinions and analysis.
Only four mutual funds have posted a worse performance than Shaeffer’s newsletter in the last twenty years. They are either gold funds, bear funds, or sky high expense ratio funds with no assets.
Fidelity's New Funds Give You Your Money Back
Last week we told you about three new 'managed payout' mutual funds from Vanguard, which promise an up-to 7% yearly payout with minimal reduction of initial investment principle. The funds will be marketed to retirees who want a steady stream of income.
The Wall Street Journal reports on eleven new funds from Fidelity aimed at those same investors.
Fidelity's new funds build on the success of the company's target-date funds, says Boyce Greer, president of asset allocation at the company. The Income Replacement funds are also portfolios of Fidelity stock and bond funds, with a mix that grows more conservative over time.
But instead of building toward a target date -- like retirement -- these funds make payments to you until a date you choose. The 11 funds range from Income Replacement 2016 to 2036.
How much do you get? That changes every year. The company will figure your monthly payments as a percentage of your annual account balance. If your portfolio grows, so will your payments.
The percentage of money you get also rises closer to your horizon date.
At 20 years out, you get 6.4% of your balance spread over 12 monthly payments; by the time you're 10 years away, you'll be getting 10%. In the last year, the fund pays 100% of what's left."
The Fidelity funds are structured to behave more like annuities than the new Vanguard funds in that Fidelity's funds are basically giving investors back their own money over a period of time (along with the underlying investment returns). The payouts of the new Fidelity funds are more aggressive than the Vanguard funds but can erode the principal more aggressively as well.
See also: Vanguard’s 7% Forever Funds
Seven Habits of Highly Defective Funds
Yesterday we noted a high yield bond fund that has seen its fund price (NAV) fall about 40% since early June. Higher risk bond funds follow a pattern of feast and famine – the key to investing in such funds is to identify the types of bond funds that can tank 40%, and either avoid them completely or consider a speculative investment near the bottom of a famine cycle.
The trouble is that these bond funds tend to look the best at exactly the wrong time. They have the best reviews and ratings, and the performance figures smash the competition.
But remember, for most types of bond funds, performance comes largely from just two things: the fund’s expense ratio and the quality of bonds the funds hold. A much smaller part of the performance can be attributed clever bond selecting.
Here then, dear reader, is the MAXfunds “Seven Habits of Highly Defective Bond Funds”, our step by step instructions for lousy managers to destroy their perfectly good bond fund... ...read the rest of this article»
Funds Keep Singin’ The Subprime Blues
Every few years there is a mini bond crisis. Each time the same thing happens: bond funds that looked great by beating their peers, fall precipitously. Same goes for 2007.
The [Regions Morgan Keegan Select High Income Fund (MKHIX)] is down about 35% this year, and is at the bottom of the junk-bond fund category for the one-, three- and five-year annual performance periods, illustrating how recent events are starting to tarnish even manager Jim Kelsoe's impressive long-term record."
Lord knows how much investors would have lost in these high flying RMK bond funds if the giant financial firm behind the funds didn’t step in (RMK funds are owned by Regions Financial RF):
The annual report that covers these funds also outlines some important steps taken by the funds' adviser and affiliates to help cope with recent losses. These include stepping in to buy about $55.2 million in shares of the High Income Fund and $30 million in the Intermediate Bond Fund [MKIBX] from the beginning of July to the end of August to help provide liquidity."
The takeaway is that you shouldn't mix mutual funds with thinly-traded higher-risk investments, or you could end up singing the subprime blues:
I went to the bond market, fell down on my knees
I went to the bond market, fell down on my knees
Asked the Lord above, have mercy now, save my poor bonds if you please
Standin' at the bond market, tried to flag a buy
Whee-hee, I tried to flag a buy
Didn't nobody seem to know me, everybody pass me by
Standin' at the bond market, risin' sun goin' down
Standin' at the bond market baby, the risin' sun goin' down
I believe to my soul now, my po' bonds is sinkin' down
You can run, you can run, tell my friend Bennie B
You can run, you can run, tell my friend Bennie B
That I got the bond market blues this mornin', Lord, baby my bonds are sinkin' down
(To the music of Crossroads Blues / Robert Johnson 1936)
Ask MAX: A Fund with an 18% Yield?
Mike asks:
I recently received an email solicitation for the 'High Yield Investing Newsletter,' featuring a mysterious diversified fund called The Korea Fund (KF) which sports a whopping 18.4% dividend with a 34 .4% projected yield! Is this even possible?"
It is, in fact, possible for a diversified fund to yield 18.4%. But of course, there is a catch. This kind of yield is best avoided. The income newsletter's marketing department has clearly opted to transform lemons into lemonade. So let’s get to the bottom of this allegedly attractive investment opportunity.
There really is no such thing as a free lunch when it comes to investing. When stocks pay dividends that beat the S&P 500 (which is currently yielding under 2%) by such a large margin, there is always a reason... ...read the rest of this article»
Capital Gains Questions?
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.
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