Watch Out
Death Spiral In Risky Stocks Takes Spotlight From....Death Spiral In Safe Bonds
With the Dow falling a few hundred points every single stinking day, you may not have noticed the carnage in almost all bond categories other than U.S. Government bonds. The nightly news doesn't show bond prices. Our guess is that this is what is really keeping some investors up at night.
Sure, the 40%+ drop from the peak in major market indexes is stunning, as is the performance of so many 'value' funds that seem to be falling faster than 'growth' funds did in the last bear market. Case in point Vanguard Capital Value Fund (VCVLX) is now down over 50% since the begining of 2008 after a manager change led to increased stakes in Russian stocks - the stock market than now routinely is shut down from panic selling - and energy picks, snapped up at pre-commodity bubble crash prices of course. Wellington Management Company was founded in 1928 so would think they would have learned their lesson about crashes...
But stocks are stocks, and investors almost have to expect 20%, 30%, even 40% drops every few decades - given the long-term upside and potential for one-year double-digit gains, it would be foolish to expect only big upside and no downside.
Bonds, on the other hand, are for adding diversification, stability, and regular income. You'll never get rich, but you wont lose much either. That is, until the great debt panic of 2008, which in its most recent form has hit safe debt categories like commercial paper (short term corporate borrowing), investment grade bonds, convertible bonds, and perhaps most stunningly - municipal bonds.
Municipal bonds are bonds issued by state and local governments. Some bonds not backed by the full taxing authority of the state are higher risk, but between the power to tax and the insurance that is frequently behind muni bonds, actually losing money by default is a fairly rare event. Muni bonds are typically sold to wealthier risk-averse investors who want steady, tax exempt income.
This is why the 10%-40% hits in muni bond funds in recent weeks is so startling. Over the last thirty days or so a conservative unleveaged fund like Vanguard Insured Long-Term Tax-Exempt Fund Investor Shares (VILPX), which "Invests primarily in high-quality municipal securities." and "Holds bonds covered by insurance guaranteeing the timely payment of principal and interest." is down 10%. Take a gander at more aggressive leveraged closed end muni bond funds - popular with brokers who sell them at IPO - and you'll find dozens in which the underlying holdings of the fund are down 20%-30% - which when you add in the widening discount to fund price means investors are seeing hits of around 50%. Recently some of these funds are moving up and down (mostly down) 10%-20% per day, much like leveraged junk bond funds have done of late. California muni bonds are acting like emerging market bonds.
It's bad enough when Internet fund drops like a rock but when 'safe' assets like your house and muni bonds start to act like Pets.com stock,well you can see why investors have become a little unnerved of late.
Your Stocks Are Down More Than The S&P 500. Admit It.
The stock market is having its worst stretch since the 1930s, but as bad as it is, foreign markets across the board are faring much worse.
Those who have viewed MAXfunds' fund data pages or Our Favorite Funds lists from time to time over the last year may have wondered why most emerging market funds have negative forecasts for future performance and lousy metrics (or why we sold our emerging market fund picks from our Powerfund Portfolios in recent years).
Long time MAXfunds.com readers will remember we had similar negative ratings on most tech funds in 2000. The rationale then and today was the same.
Our fund metrics are designed to help fund investors avoid funds that are likely to fall - the very funds attracting the most money after posting big returns. Most fund ratings and rankings only direct attention to the overvalued - they encourage performance chasing.
The reason we have used this anti-performance chasing methodology is to help you avoid the inevitable result of buying into popular funds and categories: below-market returns.
An article that appeared this week in the Wall Street Journal describes the carnage experienced by the throngs of fund investors who flocked into international markets in recent years. The only difference between this after-the-fact article and the ones published in 2002 is then it was tech and growth funds that were falling faster than the S&P 500 - the very funds that brought in the most money before the drop.
The average diversified foreign stock fund, which invests primarily in developed markets, is down 33% since the start of the year through Friday, versus a 25.5% decline for the average diversified U.S. stock fund, according to Morningstar Inc.
It's even worse in less-established foreign markets. The average emerging-markets stock fund, which includes funds dedicated to China, India and Latin America, is down 42.5% so far this year.
This is a sharp reversal from the heady gains of recent years. In 2007, the average emerging-market fund gained 40%, while the average foreign developed-market fund gained 12%.
On Monday, some European markets had their worst decline in 20 years. Britain's FTSE 100 index fell 8%, while France's benchmark CAC-40 index fell 9%, the largest one-day declines for both markets at least since 1987. Also on Monday, stock trading was halted repeatedly in Russia and in Brazil, where shares registered declines of 19% and 5.4%, respectively. Asian markets fell as much as 6%, but they have been hit worse than European markets since the start of the year.
Mutual-fund investors have piled into foreign markets in recent years partly to diversify their portfolios. Some $463 billion in net contributions poured into these funds from 2003 to 2007, boosting assets to $1.48 trillion at the end of 2007, according to Morningstar."
The more things change, the more they stay the same...
Money Market Fund(s) Fails
The dominoes are falling fast on Wall Street. It's not just a bunch of hedge funds that lent money to semi-defunct Lehman Brothers - mom and pop mutual funds are owed billions. On Tuesday the first money market mutual fund in over a decade announced it has 'broke the buck'. This collateral damage from Lehman is likely why Uncle Sam is now writing blank checks to AIG.
You may want to refill your Ambien prescription before you read this New York Times article about the mess:
The announcement was made by the Primary Fund, which had almost $65 billion in assets at the end of May. It is part of the Reserve Fund, a group whose founder helped invent the money market fund more than 30 years ago.
The fund said that because the value of some investments had fallen, customers now have only 97 cents for each dollar they had invested.
This is only the second time in history that a money market fund has 'broken the buck' — that is, reported a share’s value was less than a dollar.
This year alone, big banks and fund management companies have pledged more than $10 billion to rescue affiliated money funds that were caught holding mortgage market securities that were deteriorating rapidly in value...
The Primary Fund reported that, until further notice, it would delay paying redemptions to customers for up to seven days, as permitted under mutual fund law. That delay will not apply to debit card transactions, automated clearinghouse transactions or checks written against the assets of the Primary Fund, provided that the transactions do not exceed $10,000 from single or affiliated investors...
Several industry analysts said on Tuesday, however, that the Reserve Fund’s action came after its Primary Fund was hit by heavy redemption demands that intensified the impact of the Lehman losses."
Of course, the fund company trade association assures us that money market funds are sound...
The Seven Percent Dissolution
The Wall Street Journal reports that Vanguard's so-called managed payout funds, which promise a 7% of principle distribution per year to investors, are delivering mostly phantom income.
..just four months after Vanguard's funds launched, their performance reveals one very big problem with how such funds are structured: to meet their payout obligations, the funds are dipping into principal.
Seventy-seven percent of the payouts from Distribution Focus Fund this year will actually come from the fund's capital, and it's a similar story for Vanguard's other two managed payout funds. For Growth and Distribution Fund that figure is 71%, while 63% of distributions from Growth Focus Fund have been taken from capital.
'People are getting their money back as a distribution,' said Dan Wiener, editor of The Independent Adviser for Vanguard Investors. 'These aren't coming from dividends or interest from holdings, or even short-term capital gains. These funds just haven't been making money.'"
The problem of course is that during rough market conditions these funds simply don't perform well enough to keep making payments without eating into principle. Since these fund's monthly payouts are set based on expected long term returns of the fund,when underlying investment performance doesn't live up to the payout goals, you are dipping into principal to 'earn' your 7%. Investors who bought into these Vanguard funds thinking they would be getting a steady, predictable stream of income have so far achieved this goal, but at the expense of their actual investment declining in value along the way - much like taking out 7% a year from your own portfolio as it sinks with the market.
Next year we expect Vanguard to lower the distribution to be 7% of the new lower fund price (which means those who bought in at launch will no longer be receiving 7% on their original investment). The current artificial yield is actual around 7.8% to those buying today because the fund price has fallen but the payout is fixed for now.
Bottom line, the only true yields above 7% are in distressed or non investment grade debt. The real yield on Vanguard Managed Payout Growth Focus Fund Investor Shares (VPGFX) is around 2.5%. Anything else - even higher yield stocks and REITs - will require some sort of liquidation of assets to generate that yield - hopefully after a capital gain but lately that as not been the case.
We (of course) predicted this outcome ("It’s unlikely Vanguard can create a fund delivering big 7% payouts with principal preservation and stability.") before the fund was launched.
Buy High, Sell Low, Repeat Until Nausea Sets In
Throughout the years we've written many articles and highlighted scholarly research showing how investors often buy high after big runs in a fund (or stock) only to sell after a sharp drop. This pattern is why fund investors tend to underperform the market and is the foundation of our contrarian rating system and methodology that tries to focus attention away from the hot and towards the not.
Statistics aside, a graphical depiction of the "mind of an investor" is making the rounds on the internet. It may not be something you will find in the Wall Street Journal (or impress Edward Tufte...), but it is well worth a peak for a humorous look into the actual thinking that may go on in the head of a performance-chasing investor.
The Gods Must Be Crazy
If you're one of the small-potato investors Janus exploited to make their big-time clients a bundle in the the great fund timing scandal of 2004, we've got some good news. The Securities and Exchange Commission has given the go-ahead for the Denver-based behemoth to begin disbursement of $100 million of settlement money.
"The payment of nearly $18.23 million is the first disbursement of $100 million Denver-based Janus set aside to settle a market timing case.
The SEC directed the funds be transferred to Deutsche Bank to be distributed to 'injured investors.'
Investors in Janus have been waiting since 2004 to recoup some of their losses. The SEC estimates investors lost $20.9 million because of market timing arrangements with certain large investment companies.
The SEC said Janus benefited from market timing agreements because the investors agreed to make long-term investments in certain Janus mutual funds. But the prospectuses for the funds being timed stated, or strongly implied, that Janus did not permit frequent trading or market timing, according to the SEC."
Too bad they didn't just say in the prospectus "we favor certain clients to the possible detriment of other clients" and everything may have been honky-dory for Janus. Why Janus would risk a multi-billion dollar money machine over a few million dollars remains a mystery.
Investors in seven Janus funds during specific months of 2002 and 2003 are eligible for a piece of the pie. Read this FAQ for more info.
Socially Responsible Fund Family Fined For Buying Socially Irresponsible Stocks
Apparently the tree huggers at the Securities and Exchange Commission were a little annoyed when they noticed that holdings in certain Pax Word socially responsible funds didn't seem up to the touchy-feely earth-friendly marketing hoopla on Pax World's site, according to this Wall Street Journal article:
"Pax World Management Corp., one of the best-known 'socially responsible' investment firms, settled Securities and Exchange Commission charges that it violated its own rules against purchasing shares in companies involved in such businesses as defense, alcohol, tobacco and gambling.
The settlement -- in which Pax agreed to pay a $500,000 fine -- marks the first time the SEC has taken action against a purportedly socially responsible fund for failing to live up to its mission. The SEC said it uncovered the problems in a routine examination.
...The SEC alleged that, from 2001 through 2005, Pax World Growth Fund and Pax World High Yield Bond Fund failed to screen 41 stocks and bonds at all to see if they met socially responsible criteria.
Of those securities, 10 violated the funds' written restrictions. Regulators didn't reveal the securities' names, but Portsmouth, N.H.-based Pax said they included Anadarko Petroleum Corp., an oil and natural-gas exploration company; Darden Restaurants Inc., which operates a chain with its own micro-brewed beer; and Jacobs Engineering Group Inc., a defense contractor."
We've complained in the past about some socially responsible fund portfolios being anything but, and while there are certainly higher crimes and misdemeanors in the world of investing, we're glad to see the marketing fluff produced by socially responsible funds finally come under under some scrutiny. Call us old fashioned, but when Pax world says their investment philosophy include so-called sustainable investing, "the full integration of environmental, social and governance (ESG) factors into investment analysis and decision making", we don't expect to see the number one holding on 6/30/08 of the Pax World Value Fund (PAXVX) to be Whiting Petroleum Corp (WLL), a company involved in "exploration, development, exploitation, and production of oil and gas primarily in the Permian Basin, Rocky Mountains, Mid-Continent, Gulf Coast, and Michigan regions of the United States" that was busted by the EPA and had to pay a fine under the clean water act for spilling oil into an tributary of Whitetail Creek in North Dakota.
Some Load Funds Don't Know Their ABCs
Find load fund's multiple share classes confusing? Turns out so do the fund companies themselves. The New York Times examined a selection of prospectuses from several sales load-bearing mutual funds and found that sometimes the information about a fund's share classes printed in them was misleading or just plain wrong:
It’s hard enough to make sense of load funds’ expenses when the documents describing them are accurate. But an informal survey revealed surprising errors in prospectuses. Some arose when a fund company ignored the shift in the cost structure of a B share to that of an A share after a certain period. Other funds applied inaccurate back-end sales charges or misstated the amount that a brokerage firm receives to recommend the shares.
In some cases, prospectuses steered investors away from Class B or Class C shares, calling them more expensive, even though for the typical fund transaction — less than $50,000 invested for around four years — B and C shares can be cheapest.
Prospectus errors seemed to favor Class A shares. Consider an error in the statement of the Lord Abbett Affiliated Fund, dated March 1, 2008. In a table showing average annual returns for 1-, 5- and 10-year periods for all share classes, it assigned an annual return of 7.26 percent for A shares over 10 years, versus 7.2 percent for B shares.
But these figures overlook the B share compensation change in the eighth year, when its fees are the same as those of the A shares. According to the Finra calculator, a holder of B shares would wind up with slightly more in his account over 10 years than an A share investor. Using a 5 percent annual return on $10,000 invested, the calculator says an A share holder would have $14,162, versus $14,273 held by a B share investor.
So what's an investor to do? Simple: avoid load funds like the plague. There are thousands of low-cost, high quality no-load funds out there that have just one straightforward easy-to-assess retail share class.
Schwab YieldPlus Investors Run After Fund Goes PriceNegative
Ultra short-term bond funds have been collapsing since early July 2007, and the carnage is going from bad to worse. Apparently investors in these funds - billed as slightly higher risk alternatives to money market funds - are liquidating in droves:
Ultra-short bond fund Schwab YieldPlus (SWYPX) is the latest victim of the credit crisis. It has fallen 16.8% for the year to date through March 26, ranking dead last in its category, and as a result, investors have been fleeing the fund. Assets have fallen precipitously from a high of $13.5 billion in June 2007 to just $2.5 billion as of March 20.
The fund's sizeable loss in recent months is certainly shocking, as ultra short-term fixed-income securities are generally perceived to be safe investments with minimal interest-rate and credit risks..."
Schwab YieldPlus has fallen almost 20% since late January 2008 - four times more than the Nasdaq drop during the same period - which is particularly troubling because the upside of the fund was slim - perhaps 1% more than an investor would get in a traditional low-fee money market fund. As Schwab's website notes, "the fund’s objective is to seek high current income with minimal changes in share price. " This is the type of fund an investor might park some cash they need in a few months to pay for college tuition or to buy a house - or just to avoid the risk of the stock market or even longer-term bond funds.
Ultra short-term bond funds' trouble started last year. The adjustable rate mortgage and corporate debt these funds invested in was far riskier than the investment grade ratings would lead one to believe. The current trouble has as much to do with the open-end fund structure itself as with continuing home-loan and other adjustable debt mark downs: when investors panic sell all at once the fund manager has no choice but to sell portfolio holdings at the same time to raise cash - often at lower prices than the fund thought the holdings were worth.
Sudden increased selling by fund shareholders leads to lower security prices of the fund holdings which drives the fund price or NAV down even more, which in turn leads to more fund investors selling. As many of these types of funds have "Free, unlimited checkwriting" and all have no redemption fees, there is nothing standing in the way of nervous shareholders getting out. Selling at large funds like Schwab YieldPlus can drive prices down for other funds that own the same or similar securities as well. Mutual funds in such a death spiral will not come back to their original price even if the hard hit portfolio holdings rebound in price.
See also:
Why You Should Worry About Your Bond Funds
Is Your Bond Fund a Ticking Sub-Prime Time Bomb?
Eighth Annual Mutual Fund Turkey Awards
It's Not an Honor Just to be Nominated.
Not exactly a rare breed even in the best of times, the Fund Turkey multiplies exponentially when the market turns south.
A bear market is a high-powered headlight bar across the top of your fund research pickup truck, shining a spotlight on bull market excess. Tis the season to hunt Fund Turkeys (squawking all the way about investing abroad or in commodities), and thin this breed.
So without further ado, it's high time for our 8th annual Fund Turkey Awards!
The "Audacity of Hope" Award
Winner: Bear Stearns
At the top of the list of suckers for the real estate bubble is was Bear Stearns, the century-old Wall Street investment bank that collapsed well before the other leveraged "Masters of the Universe” suffered similar fates. What started innocuously enough with leveraged mortgage debt hedge funds didn’t end until the entire firm lay in ruins.
But failure's no reason to give up! You have to give Bear props for launching the first actively managed ETF, Bear Stearns Current Yield ETF (YYY). So what did this innovative new fund invest in? Mortgage securities. Naturally.
Bear's final hurrah didn’t last long. In September , the fund's Board of Trustees unanimously approved its liquidation "in the best interests of the Fund and its shareholders.” ...read the rest of this article»