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
Sneaky Mutual Fund Tricks
If we didn't think mutual funds were the best investment option for the vast majority of people, we wouldn't have started MAXfunds.com way back in 1999. But that doesn't mean we love everything about them. Author Ric Edelmen exposes three sneaky mutual fund industry tricks fund companies use to confuse and confound fund investors (all of which MAXfunds has written about at one time or another) in this article for the Maryland Gazette.
Confusing share classes
Retail mutual funds are now available with a dizzying array of pricing models. In many cases, a single fund might offer a half dozen share classes, and the only difference among them is the cost. If you select the wrong share class, you could pay more than necessary.
Talk about opening Pandora's box. Today, fund investors must choose among Class A, B, C, D, F, I, J, K, M, N, R, S, T, X, Y and Z shares. Depending on the share class you purchase, you might incur a load when you buy, when you sell or annually. The load might disappear after a time, or it might remain forever. In some cases, you might enjoy a lower load, but incur higher annual expenses, or vice versa. And in some instances, you might buy one share class only to have your shares automatically converted to another share class in the future!"
Incubation strategy
This is one of the retail mutual-fund industry's most devious ploys. Here's how it works: Create a whole bunch of mutual funds. Wait three years. Then evaluate the results of each fund.
The results of each fund will either be good or bad. If a fund's performance was bad, close it before anybody hears about it. But if a fund posts good results, send the data to Morningstar, which will award a five-star rating (Morningstar won't rate funds that are less than 3 years old.)"
Fund seeding
When a company issues stock, it offers a limited number of shares. A given retail mutual fund company buys as many shares as it can, and when it does, it doesn't say which of its individual funds is doing the buying.
Later, if the initial public offering (IPO) proves to be successful, the fund company disproportionately allocates the shares to its newer, smaller funds. Result: the IPO artificially boosts the return of these funds, supporting the Incubation Strategy (see above). The investors who buy seeded funds are in for a rude surprise when the fund proves to be incapable of repeating its earlier 'success.'"
Our Favorite Funds
Which stock funds are best? Which fund categories are most attractive? The MAXfunds Our Favorite Funds Report answers these and other key questions facing fund investors. Fortunately for you, dear fund investor, Our Favorite Funds is now available for FREE. And unlike most things, you get more than you pay for.
With thousands of mutual funds and dozens of fund categories to choose from, selecting the right funds is tough enough, but building a well balanced portfolio is becoming more difficult by the day. Our Favorite Funds is our handpicked list of the best mutual funds in each fund category, along with our analysis of each fund category as a whole.
Discover the complete list of MAX's Favorite Funds by clicking here.
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»
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)
Focus On: Utilities
(Published 09/01/05) One of the hottest fund categories over the last three years (ending 8/31/05) has been utilities. The three-year total return for the Dow Jones Utility index is a whopping 90% –double that of the S&P500 over the same time period. The typical mutual fund in this category scored a whopping 73% return. Our favorite in this category, the American Century Utilities fund (BULIX), which has appeared in several of our MAXadvisor Newsletter model portfolios, scored a 77.5% return over the same three-year period.
With investor excitement for utilities stocks at the highest levels since the days before the Enron debacle, we are finally downgrading utilities to a negative rating. We think utilities funds should underperform the market and 60% of stock fund categories in the next one to three years.
Utilities has been one of our favorite categories since we started the MAXadvisor Newsletter. From April 2002 through the end of January 2004 we gave the sector our highest rating (Most Attractive – should outperform the market and 80% of stock fund categories over the next 1 to 3 years). Then, for the next eight months, we maintained a positive rating (Interesting – should outperform the market and 60% of stock fund categories over the next 1 to 3 years). We then downgraded utilities to a neutral, and finally sold much of our utility stakes in our model portfolios a few months ago. But even after our downgrades, the funds in the category just kept climbing higher.
Despite the sector’s continued outperformance, we’re now more confident than ever that a utilities downturn is imminent. The only reason we’re not downgrading to our worst rating is that new utility funds are not sprouting up like mushrooms (new fund launches are one of the strongest contrarian signals of trouble ahead for a category), but existing utilities funds and ETFs are hugely oversold already. The iShares Dow Jones U.S. Utilities Sector Index Fund (IDU) has $800 million in assets. Our own favorite, Utilities SPDR (XLU), has an unbelievable $1.97 billion in assets.
For comparison, the Technology SPDR (XLK) – which is also a portfolio holding of ours – has around $1.3 billion. The only sector ETF with more money is the Energy SPDR (XLE), and we just slapped our worst rating on natural resource funds – the category energy falls under.
Can you imagine utilities funds being more popular than tech funds? Certainly not a few years ago. This is why utilities have doubled the market return in the last three years – nobody wanted anything to do with these during the dot-com bubble. Between Enron’s collapse and stories of over-leveraged, new-economy-style energy companies teetering on the edge of bankruptcy, the stocks had nowhere to go but up. The fact that a utilities index paid almost 6% in dividend yield didn’t entice anybody.
The ultimate buy sign was when Vanguard decided to convert their utility fund (one of the only good, low-fee funds around, our former top favorite and portfolio holding) into a plain-vanilla, dividend income fund. Vanguard did this in late 2002 because they couldn’t give away shares of a utility fund at the time.
But the category has now come full circle. This is not a good time to buy utilities funds. It is a good time to sell, which is what we’ve been doing all year in our newsletter and other portfolios. Performance has brought utilities stocks back to their pre-Enron levels, when utilities stocks were priced as if failure in their leveraged business models was impossible.
Worse, yields have fallen near proportionally with the rising prices (dividend increases haven’t come close to matching stock price appreciation). Today’s utility buyer is getting a dividend yield perhaps 1% over the S&P500 (3% instead of 2%) and about the same P/E ratio for owning heavily regulated businesses in one of the slowest growth and oldest economy areas around.
Sure, new home buying will lead to some growth, but come on, is your run-of-the-mill electricity utility going to grow earnings like other components in the S&P500 – like Pfizer, Wal-Mart, and Microsoft? Utilities are supposed to be cheap; they are a nice bond alternative that can perform better with inflation because dividends can go up with price increases, but that’s about it. Today’s utility fund buyer is looking at the near doubling over the last three years while ignoring the fact that utility stocks are going to have a tough enough time keeping pace with the market over the next few years (much less outperforming even more).
We’re sticking with our two lone favorites here largely because there are not too many compelling choices – at least since Vanguard made their utility fund disappear. Does Vanguard regret this move now? Maybe. They launched a couple utility index funds last year (their original utility fund was actively managed). The first was an ETF, Vanguard Utilities VIPERs (VPU), followed a few months later by one admiral class open-end fund with a $100,000 minimum, Vanguard Utilities Index Fund Admiral Shares (VUIAX). Both are fine alternatives to our picks below as well.
Most utilities funds are load funds because brokers need something to sell to widows and orphans and still land commissions since churning a stock account for those needing fixed income and low-risk could get them into trouble. What few utility funds are available without a load are fairly expensive. Since utilities should be bought primarily for yield, this is unacceptable. At the current paltry utilities yields, a 1.2% expense ratio quickly turns a utility fund dividend yield into an S&P500 index fund yield because fund fees are paid with dividends first.
We had our highest rating on down-and-out utilities back in 2002 and 2003. In 2004 the area was about the hottest this side of energy. Money keeps dumping into utilities stocks, and dividend yields are now paltry after even more big gains in stock prices in 2005 (beyond what we expected). Given the likely business growth, this is bordering on absurd. When interest rates move up this hot area is going to fall.
Category Rating: 
(Weak) – should underperform the market and 60% of stock fund categories
Previous Rating (08/31/05):
(Neutral) - Should match the markets return and perform in the middle of other stock fund categories
Expected 12-month return:-2%
| RANK/FUND NAME/TICKER | ADDED | SINCE ADD | vs. S&P | 3 MONTH | 1 YR. |
| 1. American Century Utilities Inv (BULIX) | 8/02 | 77.52% | 38.99% | 9.52% | 33.69% |
| 2. Utilities Select Sector SPDR (XLU) | 1/04 | 43.98% | 34.61% | 9.07% | 34.09% |
Focus On: Convertibles
(Published 06/01/05) You can tell a lot about what’s hot and what’s not in mutual funds by just watching Vanguard.
Investors got gold fever? Vanguard closed their precious metals fund. Bond investors have no more Enron and WorldCom type fears? Vanguard closes their high yield bond fund. ETFs all the rage? Vanguard launches VIPERs. Nobody wants anything to do with utilities stocks? Vanguard re-badges their utilities fund as a plain-vanilla dividend growth fund.
We watch Vanguard closely, not just because several of their funds are in our model portfolios and on our favorites lists, but because Vanguard offers a strong signal of what smart investors should avoid or invest in.
Lack of investor interest is a good thing. Two of the hottest areas in the market over the last few years have been utilities and natural resources. Vanguard couldn’t give away their utility fund, so they gave it a strategy-altering makeover. American Century couldn’t find buyers for their global natural resource fund (an old holding in our newsletter) so they liquidated it. Both would have been up around 60% or more had they stuck by those funds as out-of-favor categories came back.
In 2003 plain old convertible bonds were on fire. Vanguard Convertible Securities (VCVSX) was up 31%. By 2004, investors were piling into Vanguard’s Convertible bond fund. In May when the fund neared a billion in assets, Vanguard simply had to shut the door. We dropped the fund as a favorite soon after, in August 2004.
From April 2002 until the end of September 2004 we had the convertible category rated 2 – Interesting. We had a convertible bond fund in our two safest model portfolios for much of this period. At the end of September 2004 we skipped 3 – Neutral and downgraded the convertible fund category to a 4 – Weak. (Too much of a good thing.)
Then a funny thing happened – convertible funds started to stink. Vanguard Convertible Securities was down 5.12% for the year to date as of May 31st, although it has recovered a bit recently.
Another funny thing happened: a half billion (about 50% of total assets) vanished from Vanguard Convertible Securities in a matter of months. In March of this year, Vanguard even opened the fund to existing investors while assets under management continued to drop (previously the fund was hard-closed, meaning essentially nobody could buy). Still, the assets fell.
On June 23rd Vanguard announced the fund was now open to new investors once again, but with a couple caveats: 1) the minimum is raised from $3,000 to $10,000, and 2) the fund will slap a 1% redemption fee anybody (who buys after September 15th 2005) selling within a year.
So now that the performance chasing investors have left the convertible bond market, we can safely upgrade the category to 3 – Neutral. We can also add Vanguard Convertible Securities back to our favorites list, it will join our other favorite pick and former portfolio-holding Northern Income Equity (NOIEX). Unlike Vanguard’s previously bloated fund, this fund has done fine over the last year, up about 11% landing it in the 10% of similar funds, although the fund underperformed when convertibles were red hot in 2003.
Category Rating: (Neutral) - Should match the markets return and perform in the middle of other stock fund categories
Previous Rating (12/31/05): (Weak) – should underperform the market and 60% of stock fund categories
Expected 12-month return: 5%
| RANK/FUND NAME/TICKER | ADDED | SINCE ADD | vs. S&P | 3 MONTH | 1 YR. |
| 1. Northern Income Equity Fund (NOIEX) | 9/01 | 32.82% | 12.75% | -1.43% | 8.89% |
| 2. Vanguard Convertible Sec (VCVSX) | 5/05 | 0.00% | 0.00% | 0.00% | 1.19% |
Focus On: Natural resource funds
(Published 03/01/05) When we started the MAXadvisor Newsletter in early 2002, natural resources was one of only three stock fund categories that had our top rating of “Most Attractive”. We give this rating to fund categories we think will beat the U.S. stock market and 80% of fund categories over the next 1 to 3 years.
It turns out that our optimism for this category was well-founded. Natural resources funds have been near the top of stock categories over the last three years.
As we often do when an area comes into favor, we downgrade the ratings – but not until we think things are really getting overblown. We kept natural resource funds at a “Most Attractive” until May of 2004, when we downgraded the category to “Attractive” (these funds should beat the market and 60% of fund categories).
The category kept performing well, so we downgraded the category again to “Neutral” in October of 2004. The million dollar question: what should we do now?
It’s not enough for us to recommend an out-of-favor category that goes on to do well. We need to tell you when to sell, or at least cut back on your stake of categories that have done well but are heading for a downturn. This is where things get a little tricky. To be perfectly frank, we tend to get out of hot categories a little too early, as long-time subscribers to MAXadvisor (and MAXfunds readers) know. Real estate and precious metal funds come to mind.
Natural resource funds have been hot because commodities have been hot. These funds largely own mining and energy related companies. Until more resources can be explored for and produced, stocks in the category tend to do well when natural resource prices rise.
Natural resource stocks have also done well because they were cheap before but aren’t so cheap now – valuation expansion. Nobody wanted anything to do with such dull, old-fashioned businesses back in the new economy days. Today, the benefits of buying a business on the cheap are obvious, as are the negatives from paying too high a price. The five-year average annual return on the typical natural resource funds is about 18% - good enough to turn a $10,000 investment into $23,000. (The five-year average annual return on tech-nology funds? Try a negative 21% per year, enough to turn a $10,000 nest egg into a $2,700 cracked egg.)
Among the signs we look for that a category might be heading south are 1) huge inflows of fund investor money in the category, 2) new category focused mutual funds being launched, 3) increased ‘buzz’ about the category, 4) over-stretched valuations.
1) Inflows And this is where we are a bit on the fence concerning the natural resources sector. We’ve seen big flows of cash to energy funds. One of our favorite funds in this category, Vanguard Energy, just closed with $6.5 billion in assets. It had $2.5 billion in 2003 and $1.3 billion in 2001. Shareholder inflows to funds here make us negative on natural resources.
2) New Funds As for new funds, there have been a few, notably Guinness-Atkinson Global Energy (GAGEX) – a decent but expensive choice (full disclosure: Jim Atkinson of Guinness Atkinson is a former MAXfunds executive). We’d like to see more fund launches to really mark a top here. The “new fund” signal produces no clear verdict one way or the other on the future of natural resources.
3) Increased Buzz Recent trends suggest that you just can’t get away from Johnny-come-lately energy bulls. I’m not going to name names, but guys I recall touting tech stocks five years ago are now ga-ga over Exxon- Mobil. Amazing how the new economy gurus crossed over to the old economy. Too bad they didn’t change their minds earlier. They could have saved investors some money…
And of course, the experts talk a good game, and energy seems to make sense. Things look good for energy stocks, which is why they’re up a gazzilion percent, for Pete’s sake! Many natural resource funds were up 15% or more last month alone! But then, didn’t tech stocks look pretty good back in the day?
This week on CNBC one energy bull showed a chart of energy stock’s percentage of the S&P500. Unlike tech stocks, which peaked out as a bigger chunk of total market cap in the S&P500, energy stocks are a mere 10% or so. This analysis was compelling because we look at the bigger parts of the S&P for contrarian signals as well. Then he went on to show how energy stocks used to be 20% or more of the index a few decades ago. So therefore, we have got a long way to go in this new bull market in energy.
Or do we? A few decades ago we didn’t have mega cap software and computer companies with billions in earnings. By the same historical logic, buggy whip stocks should stage a comeback. What about textiles? Agriculture? Railroads? Autos? Tech bubble or no, companies like Microsoft earn billions and deserve to hog up some of the index – the economy has evolved to the point where old industries like transportation and energy will never be the percentage they once were in the stock market, or in the economy for that matter.
4) Valuations While energy earnings are very strong right now, they are tied to sky high oil prices. While there is no law that says oil prices have to fall again, they could, and drastically. With commodities, you’re always one global recession away from a 50% haircut in prices. Profits could get cut sharply at energy companies in short order. Does Microsoft have to worry about such a situation? Maybe commodity based businesses should have lower P/Es than stocks that are more in control of their own near term destiny.
Even worse, Vanguard Energy now has a LOWER dividend yield than the Vanguard 500 Index – 1.1% compared to 1.6% (only some of this is because of slightly higher fees on the former). This is troubling because energy stocks are largely owned for dividends as long term growth prospects are expected to be average at best. Stock valuations point to a below average future for energy stocks.
Three out of our four sell-warning bells are ringing; the other (new fund launches) isn’t giving us a clear indication one way or the other. Our signals are clear – natural resources stocks have peaked. We’re now downgrading the category - for the first time in MAXfunds history - to a negative rating.
We are dropping the category; going to a “Least Attractive” should under-perform the market and 80% of stock fund categories over the next 1 to 3 years.
We recommended an energy fund in our 2004 hot sheet and we own energy funds in many of our managed accounts. We are now in the process of selling at least part of the stakes and locking in these gains – something you should consider if you followed our advice with this area in recent years.
When you do sell, be wary of short term redemption fees and short term tax rates if you own these big-gain funds in taxable accounts. Vanguard Energy is up 50% over the last year- you don’t want to pay a short term tax rate on that gain if you can push it off a few weeks and trigger a long term gain.
Remember the golden rule of fund investing with MAXadvisor: The (fund) customer is (almost) always wrong!
Sell when they buy and buy what they sell and you’ll do just fine over time.
Category Rating: (Weak) – should underperform the market and 60% of stock fund categories
Previous Rating (12/31/05): (Neutral) - Should match the markets return and perform in the middle of other
stock fund categories
Expected 12-month return: 5%
| RANK/FUND NAME/TICKER | ADDED | SINCE ADD | vs. S&P | 3 MONTH | 1 YR. |
| 1. T. Rowe Price New Era Fund (PRNEX) | 9/01 | 101.71% | 80.95% | 10.96% | 38.67% |
| 1. Vanguard Energy Fund (VGENX) | 9/01 | 138.38% | 117.61% | 14.78% | 49.65% |
| 2. Excelsior Energy & Natural Resources Fund (UMESX) | 9/01 | 101.37% | 80.60% | 14.16% | 48.20% |
| 3. iShares Goldman Sachs Natural Resources Index (IGE) | 4/04 | 40.64% | 31.91% | 11.89% | 37.93% |
Focus On: Emerging Markets
(Published 12/01/06) There are two ways to invest in emerging market funds. One is to choose a small allocation and stick with it through booms and busts. As these fluctuations will sometimes occur opposite the other investments, investors may experience a lower overall risk. With a buy and hold strategy, investors should rebalance after big market moves to maintain their small – say, 5% to 10% – emerging market allocation.
The other way is to invest a bit more than this permanent allocation, but only after significant weakness in emerging markets and widespread fear of crisis by investors occurs (i.e., when prices are dirt cheap). Such an active strategy would require lightening up after a big run-up in emerging markets (such as we did in our portfolios in recent years). This means a 20% allocation after an emerging market slide, lowered to perhaps 5% after significant gains.
We’re following the second plan – invest when down, and lighten (even to 0%) when up. However, there is nothing wrong with the first method for investors who don't have the time or the expertise to be active investors.
Sadly, too many investors follow plan 9 (from outer space) – they load up on emerging markets funds after a big 3-5 year run, only to get slammed by the eventual hit these markets will take. Then they sell low. We know this happens because funds in this category often have tax loss carry forwards on the books – ghosts of bad investments by investors.
We can tell we're probably near a market peak when all the past losses on the books of old emerging market funds are gone. Today, the Vanguard Emerging Market Index fund (VEIEX) – one of the largest (started in 1994) and a favorite here – has almost no capital gains on the books, even after a 5-year average ANNUALIZED return of 23%. That's one of the best performing funds in recent years, and as a group, shareholders haven’t made a dime. That should give you an idea of how badly fund investors time their buying and selling of emerging market funds. (Not to brag, but our other fund favorites in this category have beaten even this top–performing, low-fee emerging market index fund, and the bulk of all emerging market funds since we added them as favorites).
Investor activity is a good way to gauge optimism – tracking what they’re buying and what they’re selling. This is our primary gauge of investment opportunity. Another is fund company launch dates. Check the inception date of most emerging market funds and you’ll see they were launched in the early 1990s – around the time of big run-ups in emerging markets, and right before a big slide.
Another useful indicator is relative valuations across investment categories.
If junk bonds (high yield bonds) are in favor with investors, prices generally run high relative to other bonds. This means a low quality corporate bond might pay just 2% more than an ultra safe U.S. government bond. In times of investor fear of default, junk bonds can pay 4% or more than U.S. government bonds. We had larger allocations to junk bond funds in our model portfolios in the “Enron” days a few years back when these fear premiums were more pronounced.
Emerging market stocks currently trade at a discount of roughly10-15% to the valuations of “emerged” stocks like you find in the U.S. In other words, a beverage company in Brazil may trade at 15 times earnings, while Coca-Cola (KO) trades at 17 times earnings.
Clearly, Coke is a safer investment. The company is based in the U.S. and has global operations. As far as any single stock goes, Coke is relatively low-risk. The chances of currency fluctuations, accounting shenanigans, or political risks destroying your investment in Coke are small.
The Governor of Georgia isn’t going to nationalize Coke. Their core product is safer than most products from the risk of competitors guzzling their market share, and most people that drink Coke can afford to – regardless of where the economy goes. Investors can relax…and enjoy Coke. They’ll even collect dividends along the way. Unlike bank CDs, the dividends will even likely go up over time.
By comparison, a company located in an emerging market is chock full of extra risks. How much cheaper investors expect to get emerging market stocks as a whole is a good indication of how enthusiastic they are about investing in emerging markets in general. Scared investors would expect a big discount. You want to invest where investors are scared to go without major incentives in the form of cheaper stocks.
Just a few years ago, before most emerging market stocks went up 2x, 3x, even 4x or more, emerging market stocks were trading at big discounts to U.S. stocks – 50% or more typically, or 10x earnings compared to 20x earnings in the U.S. Not anymore. Returns have been exceptional because there has been valuation expansion (now stocks trade at higher multiples of earnings) AND earnings have grown faster than safer stocks. This is the double whammy that leads to huge investor returns – it’s exactly what drove tech stocks in the late 1990s.
Rather than considering the risks in emerging markets, investors today are more focused on great opportunities. Unlike in the U.S., economic growth in many emerging markets seems boundless. The worldwide commodity boom has been particularly lucrative for many emerging markets that rely heavily on commodity exports.
But there is always a good reason why an investment can continue to go up. The investment went up largely due to these reasons in the first place. In fact, those reasons seem more sound the better the past performance – the ultimate legitimizer of investor theories (…these numbers don’t lie…).
This current optimism is why future returns will be sub-par going forward. Current optimism is not quite as wild as it was in the last emerging market craze – the early 1990s. Back then, emerging market stocks were actually trading at HIGHER valuations than U.S. stocks. From those levels investors in U.S. stocks did very well, and investors in emerging markets fared poorly. Some emerging market funds are only now getting back to those boom 1993 levels. The difference was about as extreme as it has been in the last five years, as the Dow struggled to get back to year 2000 levels and emerging markets posted double digit gains year after year.
It’s possible that the action in emerging markets will continue a little longer. We’ve already shortchanged the emerging market move and bailed out a little too early. Maybe we’ll return to early 1990s valuations and U.S. stocks will be cheaper than emerging markets. However, we don’t play the hope-for-valuation-expansion-to-save-us game.
Category Rating: 
(Least Attractive) - should underperform the market and 80% of stock fund categories over the next 1 to 3 years
Previous Rating (12/31/05): (Weak) – should underperform the market and 60% of stock fund categories
Expected 12-month return: -8% (lowered from -7% in our last favorite fund report)
| RANK/FUND NAME/TICKER | ADDED | SINCE ADD | vs. S&P | 3 MONTH | 1 YR. |
| 1. SSgA Emerging Markets (SSEMX) | 9/02 | 209.90% | 145.86% | -2.93% | 45.08% |
| 2. Excelsior Emerg Mkts (UMEMX) | 9/02 | 217.43% | 153.39% | -5.09% | 37.90% |
| 3. Vanguard Emerging Markt Indx (VEIEX) | 9/01 | 224.45% | 194.02% | -3.20% | 37.89% |
| 4. Bernstein Emerging Markets (SNEMX) | 9/02 | 270.69% | 206.65% | -3.26% | 36.36% |
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.
LINK