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Mayday Mayday...Sequoia Fund To Reopen

April 25, 2008

The last time investors could buy shares of the Sequoia Fund (SEWUX), Olivia Newton-John was at the top of the charts. The longest closed-to-new-investors period in mutual fund history ends May 1st:

The Sequoia Fund, after experiencing selling by investors, is reopening its doors May 1 to new investors for the first time since 1982.

The $3.5 billion value fund is celebrated for outperforming the broader market during much of its 38-year history. For years, it was run by legendary stock picker William Ruane, who followed the same approach as Benjamin Graham and Warren Buffett.

In recent years, however, Sequoia has a mixed performance record, lagging the Standard & Poor's 500-stock index in three of the past five calendar years.

Selling by investors caused assets to fall to a level lower than it was a decade ago, the funds' managers wrote in a report for the quarter ending March 31. If that were to continue at that rate, it could 'cause us to have to sell stocks that we didn't want to,' said co-manager Robert Goldfarb, 63 years old, in a telephone interview Wednesday."

Fund investors are bailing out of the fund in part because of its relatively ho-hum performance in recent years, but mostly because of demographics - you close a fund to new investors long enough eventually asset levels will go down.

We've never given the Sequoia Fund much thought for our private management clients or Powerfund Portfolios, mostly because we couldn't have bought shares if we had wanted to - but now that it is set to reopen we still wont be first in line to invest. The fund was too large to outperform and with a ginormous 25% stake in Berkshire Hathaway and a low turnover portfolio, investors could almost rebuild the fund stock by stock. That said, we give the fund kudos for being one of the few value funds to pass on banks and other financials even though they looked cheap relative to the market.

We're also wary because funds with low cost basis holdings are not good places for new investors if other investors are leaving. Newbies could see big piles of other peoples tax liabilities distributed to them at the end of the year (something the fund company notes in their last report). The reopening should partially alleviate this problem as inflows will counter outflows, but fund investors are pretty cool on domestic stock funds with so-so records in recent years so inflows could be limited. Investors who have tax deferred accounts (and who hence don't have to worry about potential tax liabilities) that want to lock in shares of the fund in case it closes again may want to do so with the fund's $2,500 IRA minimum ($5,000 regular accounts).


The Ups And Downs Of Target Funds

April 23, 2008

Target date funds make investing easy by offering a complete portfolio of funds in a one-stop package to match your risk profile. But like how a multi-entre frozen TV dinner offers a complete meal, there are positives and negatives. In a Marketwatch.com article Jennifer Openshaw lays out the positives and negatives:

The advantages

  • Autopilot for your investments.
  • Diversification for less.
  • Safety.

The disadvantages

  • Bland investments.
  • Diversification question.
  • Potential for bad timing.

And offers some tips when investing in target date funds:

  • Study their investments.
  • Understand the mix.
  • Find out whether allocations are fixed.
  • Focus on the target fund.


Sarcastically-Toned New ETF Launch Review

April 18, 2008

The great new ETF (exchange traded fund) stamped continues unabated. Who'd have thought there was so many wonderful investment opportunities that hadheretofore been ignored? This past week alone we've seen:

Claymore launch the Claymore/MAC Global Solar Energy Index ETF (Ticker 'TAN' - ha ha ha), which owns around 25 solar related stocks. Because frankly investing in the dozen or so existing alternative energy funds is just too darn diversified. This fund offers a hedge against Birkenstock-wearing 'no nukes' politicians screwing up your investment in the recently launched PowerShares Nuclear ETF (PKN) or Market Vectors Nuclear Energy ETF (NLR). Alternatively consider the ELEMENTS Credit Suisse Global Warming Index ETN (GWO) as a hedge against do-gooders.

Northern Trust launch the NETS™ TOPIX ETF (TYI) based on the Topix Japanese stock index, in addition to a smattering of other country funds. Hey at least they got the nerve to launch an ETF for the down and out Japanese market, most ETFs chase trends.

The debut of DB Agriculture Double Short ETN (AGA), DB Agriculture Double Long ETN (DAG), DB Agriculture Short ETN (ADZ), DB Agriculture Long ETN (AGF). Nothin says laissez-faire capitalist like four new ways to gamble on agriculture while residents of other countries riot over food shortages.

Yep, what a week. There hasn't been this many ETFs launched since...well since the week before last.

401(k) Flubs

April 15, 2008

Good article on Zacks.com today that reviews five common 401(k) mistakes that could cost you a bundle over the long haul:

Not funding a 401(k)

About a third of eligible participants fail to enroll in a retirement plan. A huge majority of these people are younger workers. Of those who are making contributions, a large number are playing catch-up because they did not start saving for retirement until later in life. Why is this? The solution is as simple as picking up the phone and talking to your human resources group."

Not Contributing Enough

It is critical to sit down with a financial planner, or at the very least access a retirement calculator, to figure out how much you need to save in order to draw out a certain income after retirement. Here's a basic guideline. If you are making $50,000 annually, multiply that by 25. This means you will need to have saved $1,250,000 in your retirement account."

Taking Loans or Cashing Out

Don't do this! Many people take out loans while they are still employed with their firm and this is a very bad idea. Yes, when you take out a loan, you do pay yourself back with interest. However, when you take out the loan, your borrowed money is not working for you."

Putting all your contributions into company stock

Sometimes, disasters such as what happened at Enron or Worldcom can occur and wipe out your whole retirement savings plan in a heartbeat. What if you own a stock in a hot sector and you are about to retire? What if the sector turns cold and your savings of $1,000,000 turn into $500,000? All of a sudden you have to change gears and take less out of your savings or continue working into your 70s."

Allocation, Allocation, Allocation!

I’ve seen too many people piled into the hottest sector funds or hottest areas in the market only to get burned. These days this mistake commonly happens with commodity and energy funds. Don’t try to “get rich quick” because in all likelihood you will lose money very fast."

Shameless plug: If you think your 401(k) could use a little professional help, try MAXadvisor's 401(k) Planner. You tell us the mutual funds in your 401(k) plan, the MAXadvisor 401(k) Planner will tell you which funds you should consider, and the percentage of your company-sponsored retirement plan's contribution you should allocate to each fund. So we'll tell you how much to allocate to what, and we generally avoid company stock - thus eliminating two of the five problems mentioned above!


New Fidelity Long Short Fund

April 10, 2008

While most of the new fund launches are ETFs these days, certain categories of mutual funds are popular breeding grounds for new old-fashioned funds. Funds that ‘short’ stock (borrow shares and sell them with the hope of buying them back at a lower price in future) are becoming increasingly popular with investors, and therefore fund companies are lining up with new offerings.

So far this category of ‘long-short’ funds is riddled with expensive but mediocre funds. Fidelity hopes to change all that with their new Fidelity 130/30 Large Cap Fund (FOTTX), launched this past week:

The main differences between a 130/30 fund structure and other funds is the use of leverage and shorting. 130/30 Funds employ a strategy of holding investments both "long" (or bought with the expectation that the stock will outperform the market) and "short" (or those borrowed and sold with the expectation that they will under-perform the market). This gives the fund manager the ability to further capitalize on stock selection skill by allowing him to fully express both positive and negative views on stocks...…Fidelity has a 15-year history of shorting stocks, mainly in institutional market-neutral portfolios.”

The fund’s minimum is an above average $10,000 for regular accounts, $2,500 for IRA’s and for purchases made through an investment advisor.

Keep in mind such a fund is NOT safer than a stock fund that is invested 100% in stocks. The core fees include management fees of 0.86% and other expenses of 0.37% for a 1.23% expense ratio BEFORE considering dividends owed on shorted stocks and other expenses related to shorting. With these fees total expenses are 1.89%. Note that dividends earned buying stocks with short proceeds is not deducted from quoted expenses so the 1.89% in some cases is a bit of an overstatement.

If this fund were to short stocks and invest the proceeds in say, government T-bills, investors could see some risk reduction as their overall portfolio would have net exposure to the stock market of under 100% (though there would still be risk the shorts would go up while and the longs down resulting in a risk profile of 100% long).

However, this fund and many like it take the proceeds of the shorts and buy more stock. This is even riskier than borrowing the 30% to buy more stocks (130% long) like many closed end funds do because there is a risk that both the shorts and the longs will lose money – in some cases an investor could have the risk profile of being 160% in stocks if the longs and shorts picks by the fund manager both perform poorly. In fact, since an investor can lose more than 100% of their money on a short, in theory this fund could approach the risk profile of being 200% in stocks, though I’m sure Fidelity would disagree with this assessment.

Risk warnings aside, this and other similar funds have a key advantage over individuals shorting stocks: use of short proceeds. Most investors not only have to keep the proceeds of the short with the broker, they may have to pay margin interest or put some of their own cash up against the short to cover the risk to the broker. Funds get to invest the proceeds of the short and put up the rest of the portfolio as collateral.

We expect this fund to perform in the top 20% of similar funds over the next year because the fees are lower than many others and Fidelity will be doing everything in its power to make sure this new small fund performs well.

For more on this new fund check out Fidelity’s website.

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.

A Taxing Test

April 3, 2008

The Wall Street Journal asks (and answers) ten surprising questions related to mutual funds and taxes - the biggest surprise being that ten questions about mutual funds and taxes can actually be pretty interesting.

Take for example the quiz's last question, about a recent Supreme Court case concerning muni bonds:

10) The Supreme Court recently heard a case involving muni bonds. What is it about?

A. Whether muni bonds can be subject to the alternative minimum tax

B. Whether a state can tax interest on most out-of-state muni bonds while exempting interest on its own

C. Whether muni bonds may "guarantee" returns to out-of-state investors

ANSWER: B. The justices were asked to reverse a Kentucky court ruling that said the state couldn't favor its own bonds, in a case being closely watched by other states with similar laws.

The argument largely comes down to whether munis are akin to milk -- or trash. The lawyer challenging the Kentucky law argued that preferential treatment is unconstitutional because the court has ruled that states cannot put up protectionist barriers around their dairy industries. But Kentucky's lawyer cited a ruling that allowed two New York counties to discriminate on their own behalf by requiring trash haulers to deliver waste to publicly owned disposal facilities when cheaper private-sector alternatives existed.

If the Kentucky court ruling stands, single-state muni funds would become irrelevant."


See also:

Capital Gains Questions?

Tougher Tax Times Ahead for Mutual Fund Investors

How Mutual Funds Work - Capital Gains

Six Mutual Fund Tax Tips

New Vanguard Global Index Fund - It's About Time

April 2, 2008

Everybody loves indexing, and indexing pioneer Vanguard certainly doesn't shut their yap about the benefits of indexing, but for some strange reason Vanguard has yet to deliver a global stock index fund. Vanguard offers dozens of index funds - now in ETF format as well as traditional open-end funds - to cover U.S. stocks and foreign markets, but they don't have a one stop product that lets a truly passive investor buy a single stock fund that invests in world equity markets.

Well, soon they will:

Vanguard filed a registration statement on Wednesday, April 2, 2008, with the U.S. Securities and Exchange Commission (SEC) to offer a global equity index fund—Vanguard Global Stock Index Fund. The fund will offer three share classes—Investor, Institutional, and ETFs—that are expected to be available in the second quarter of 2008. This will be Vanguard's first passively managed global index fund.

The new fund will seek to track the performance of the FTSE All-World Index, a float-adjusted, market capitalization-weighted index designed to measure equity market performance of large- and mid-capitalization stocks worldwide. The fund will invest in a broadly diversified sampling of securities from the target benchmark, which comprises more than 2,800 large- and mid-cap stocks of companies in 48 foreign countries. Approximately 55% of the index is made up of stocks from outside the U.S."

The index fund open-end version's 0.45% expense ratio is not as cheap as other Vanguard U.S. index funds, and is just 0.19% cheaper than Vanguards actively managed global stock fund, Vanguard Global Equity (VHGEX).

Vanguard is also adding purchase fees to buy the open-end version of this new index fund, along with the usual redemption fees:

To offset the transaction costs associated with global investing and to protect the interests of long-term fund shareholders, the fund will assess a 0.15% purchase fee on all non-ETF share purchases and a 2% redemption fee on all non-ETF assets redeemed within two months of purchase."

This front and back fee levy should lead to slightly better quoted performance of the open-end fund than the closed end fund, even factoring in higher fund expenses (the ETF costs 0.25%).

Vanguard is really just playing catch-up here. Barclays iShares unit just launched a global stock ETF, iShares MSCI ACWI Index Fund (ACWI), which started just last week. Barclay's fund owns 711 holdings to mimic an index of 2,884 stocks and comes with an 0.35% expense ratio - more than the Vanguard ETF but less than the Vanguard open-end fund.

Global indexing made more sense before foreign stocks outpaced U.S. stocks, as they have for the past several years. At this point we expect U.S. stocks to beat foreign stocks going forward. Our predictions aside, for those looking for a one stop stock fund they can buy and ignore for twenty years, this is it. No word on where the one stop global stock AND bond index fund is - we need that even more, especially in 401(k) plans.

Can Too Many Funds Spoil a Good Portfolio?

March 31, 2008

Chuck Jaffe at Marketwatch says that when it comes to building a mutual fund portfolio, less is usually more. Jaffe's point is that owning more than ten or so funds is at best unnecessary, and at worst can turn your holdings into an overpriced index fund.

With actively managed mutual funds, more is not necessarily better. Studies show that owning four funds in the same asset category is virtually certain to create a 'closet index fund,' which means that the combined performance of the funds winds up doing no better than the index for that asset class

Plus, that index-or-worse overall performance comes at a much higher cost than simply owning a mutual-fund or exchange-traded fund tracking the index.

...Ultimately, an investor can build a winning portfolio with no more than six funds covering domestic and foreign markets, large- and small stocks, bonds and money-markets. Sector funds and other issues can be used to flesh out the holdings and tilt the assets to areas the investor prefers, without creating massive overlap with the core holdings.

A portfolio that's a little more complicated is fine, but going much further -- with closer to 20 funds than a half-dozen, and with too many decisions to make -- is almost sure to leave you with an unmanaged mess."

While it is true that the more funds you own, the closer your portfolio becomes an overpriced index fund, it is also true that 10 cheap good funds are better than five expensive mediocre funds. There is also the risk of over-relying on an expert manager by focusing too much on a few funds - something investors in Bill Miller's Legg Mason Value (LMVTX) are finding out right now. Moreover, it can be impossible to own just a few funds when you consider many investors own funds in several accounts - 401(k)s, IRAs, etc and collectively owning 20 funds is all but unavoidable.

The article also features this dubious advice from a Morningstar exec.:

'It's a good time to check up and see if your fund is performing worse than you would have expected in a tumultuous environment,' said Christine Benz, director of personal finance at investment researcher Morningstar Inc. 'If performance is worse than you expected, then maybe the fund is a bad match for your risk tolerance.'"

But wouldn't such behavior lead to buying high and selling low? Don't most people buy funds after they perform better than expected? In fact isn't that how funds get highly rated in the first place? Weren't all the Janus funds performing better than expected in the late 1990s? By this logic you would have sold them all after they fell harder than expected in 2000-2002, missing the better than expected returns from 2003-2007.

There is nothing wrong with a focused fund portfolio. Our MAXadvisor Powerfund Portfolios newsletter publishes seven model mutual fund portfolios, none of which have held more than ten funds and ETFs. That said, there are cases for smaller allocations to certain more targeted funds that could increase the number of portfolio holdings to more than that.

Schwab YieldPlus Investors Run After Fund Goes PriceNegative

March 28, 2008

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?