Mutual Funds - General Discussion

http://www.nytimes.com/2004/12/16/busine...

Top 634. Dec 16, 2004 4:36 PM

» SteveT - Company Settles Charges on Funds Sold to Soldiers

December 16, 2004
Company Settles Charges on Funds Sold to Soldiers
By DIANA B. HENRIQUES

First Command Financial Services, one of the best-known companies marketing financial products to military families, agreed yesterday to pay $12 million to settle accusations that it used misleading information to sell mutual funds to thousands of military officers over the last five years.

NASD and the Securities and Exchange Commission said that First Command exaggerated the track record of its high-cost fund products - with fees that ate up 50 percent of an investor's first-year contributions - and misrepresented the costs and availability of cheaper investment alternatives.

The company neither admitted nor denied the accusations, but accepted the punishments, which included a formal censure.

"We at First Command look forward to returning our full focus and attention to helping families pursue their financial goals," the chief executive, Lamar C. Smith, said. "We believe in the integrity of our company, our agents and the products we sell."

The settlement requires First Command to compensate any customer who paid an effective sales charge of more than 5 percent on investments made since January 1999. The remaining money, estimated by regulators at $8 million, will be spent on a financial education program for military families. The company also agreed to hire an independent consultant to review sales practices.

"It is important to note," said Lanny J. Davis, a lawyer for the company, that the regulatory complaints focused on sales practices "and not on the financial investment product that First Command sold."

The company announced this month that it would no longer sell the products, called contractual plans or systematic investment plans. Such plans allow investors to contribute a fixed monthly amount over 15 years or more, but require them to pay the sales fees upfront - and the fees consume half of their first-year investment. Investors who drop out early pay effective sales fees as high as 30 percent, but even those who stay in earn less than they would have if fees had not eaten up so much of their first-year contributions.

Stephen M. Cutler, enforcement director of the S.E.C., said First Command had "targeted members of our armed forces" with sales pitches "that didn't tell the full story."

The conduct raised special concerns, said Mary L. Schapiro, the vice chairwoman of NASD, because of First Command's use of affinity marketing techniques to win the trust of its customers.

"You had former military personnel selling to current military personnel for a brokerage firm controlled by former military personnel," Ms. Schapiro said. "That makes the omissions and misleading statements all the more troubling."

According to regulators, First Command consistently exaggerated the staying power of its military customers and the merits of contractual plans. For example, the company claimed that at least 76 percent of its customers successfully completed their plans. In fact, regulators said, 43 percent of the plans sold from 1980 to 1987 were completed.

Regulators said the company also failed to fully inform investors about the lower long-term returns of contractual plans.

First Command was also accused of misleading customers about cheaper investment alternatives, specifically no-load mutual funds and the government's Thrift Savings Plan, which is similar to a civilian 401(k) plan.

"First Command informed its customers that only speculators invest in no-load mutual funds and that no-load mutual funds have high costs," the NASD complaint noted. In fact, neither statement is true, regulators said.

Mercer Bullard, a securities law professor at the University of Mississippi and president of Fund Democracy, an advocacy group for mutual fund shareholders' interests, said he thought the misrepresentations warranted much stiffer penalties.

"In none of the cases that regulators have brought against mutual funds over the past year was behavior as egregious as this," Professor Bullard said. "And these weren't exaggerations by some rogue agent in the field, these were lies from the very top."

The settlement is an embarrassment for First Command, which has boasted of an unblemished regulatory record. In August 2003, the company demanded and received a public apology from the Air Force's top military lawyer after his staff circulated a request for information about company sales practices.

Contractual plans, which have long been prone to sales abuses, are nevertheless legal under federal mutual fund law. The House adopted legislation in October that would have abolished them, but the Senate did not act before Congress recessed.

-- posted by SteveT

Top 635. Dec 26, 2004 12:39 PM

» Normxxx - The Best Fund Hits

The Best Fund Hits Aren't Always on the Top-10 List

By Don Phillips | January, 2005

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With Louis Rukeyser continuing to convalesce, Don Phillips, managing director of Morningstar, serves this month as guest commentator.

The turning of the calendar to a new year prompts many investors to review their portfolios. This is a wise practice for anyone, but an especially prudent one for mutual-fund investors. Funds aren’t static, after all. Managers come and go; strategies can evolve and change over time. An intelligently diversified portfolio of funds at the point of assembly may in later years evolve into a big and unintended bet on one style or sector of the market. So long as the sector is in favor, the portfolio looks great, but should market sentiment change, the whole portfolio may suffer—a lesson too many investors learned the hard way when tech stocks collapsed in 2000.

The good thing about reviewing your portfolio at this time of year is that newspapers and finance magazines are full of profiles and lists of the past year’s top-performing funds. The danger, however, is that these lists may tempt the more casual investor to pile into funds with similar strategies, thus undermining efforts to diversify. It’s a classic mistake. Investors load up on funds from the list of last year’s leaders, not appreciating that the reason the funds are on the list together is because they hold similar securities and take similar risks. Investors think they are diversified because they buy funds from multiple management companies with different sounding names and objectives, but if the funds are on the leaders’ list in the same year, there’s a good chance that the investor is buying different shades of the same basic style, rather than getting real diversification.

I’ve seen this situation so often that I’ve become convinced that I can carbon-date portfolios. When I see a portfolio full of growth and technology funds from providers like Janus, AIM and Turner, it’s a safe bet that the investor assembled the portfolio in the late 1990s. Similarly, if I see a portfolio full of real-estate and small-cap-value funds from Cohen & Steers or Royce, it’s likely the investor assembled or reconstructed the portfolio over the past year or two. In both cases, the investor is buying good funds, but good funds alone don’t ensure a good portfolio. To be properly diversified, an investor must have exposure to areas that have been out-of-favor in the recent past, not simply hold a batch of recent winners.

When you buy a mutual fund, in part you’re paying for a manager to try to find the next hot area for you, so to some degree it is the manager’s responsibility to steer the fund toward discounted sectors. Still, it’s important for a fund investor to understand just how much latitude a given manager has. Few managers today consider it their mandate to scour the full market for opportunities. Most managers specialize in certain areas: convertible bonds, small stocks, growth stocks, etc. Moreover, no manager knows which other funds you hold alongside his. It is up to the fund investor to monitor his overall exposure to broad parts of the market.

This issue may be especially timely right now, as there’s been a long and pronounced difference in the performance of large stocks versus small ones and of growth strategies versus value ones in the United States. Over the past five years, stocks in the Morningstar Small Value Index have risen more than 18% a year. At the same time, stocks in the Morningstar Large Growth Index have declined nearly 15% a year—that’s a stunning 33 percentage-point differential per year compounded over five years. Even conceding that large growth stocks were considerably overvalued at the start of the period, that’s a phenomenal performance difference—and one that is clearly not sustainable.

In such an environment, it’s likely that many investors, even those who have made no trades in years, today have radically different bets in their portfolios than those they intended. An unaltered fund portfolio that was well diversified five years ago, today likely has a marked bet on small-cap value stocks, just owing to market forces. So long as the trends favoring small value hold, this is a great positioning, but should sentiment shift, such an investor could be left behind.

And there are signs that such a shift may be near. Fund managers who run small-cap value funds are closing their doors right and left, citing the scarcity of attractively priced stocks in their part of the market. One top small-value manager even went so far as to urge shareholders to consider buying his firm’s growth funds, rather than send more money his way. At the same time, we’re hearing more bullish sentiments from large-cap growth managers than we’ve heard in years. Top investors like Marsico Funds’ Tom Marsico, who played cyclical or defensive stocks in recent years, are now locked and loaded with classic growth fare. Similarly, more-flexible value managers, such as Bill Nygren of Oakmark, are shifting their sights from buying good businesses at cheap prices to buying great businesses at good prices—a concession to the attractiveness of some growth stocks in today’s market.

The early phases of this economic recovery have favored deep-value strategies, but as we move along in the cycle, companies that offer good internal growth are likely to be more prized. The rising tide that has floated the fortunes of lower-quality businesses may have crested. Going forward, it will likely be of greater importance to buy better businesses, a trend that should benefit growth strategies in general and larger-cap ones particularly.

No fund company is going to run an ad today touting the big losses that their large-growth funds have produced over the past five years, so it’s likely that this opportunity will go unnoticed by many. While the exact timing of a change in market direction is impossible to tell, this is not the time to be markedly underweighted in large, quality growth stocks. Now may be a wise time to consider trimming back your small-value winners and redirecting some of those proceeds to bigger growth fare. American Century, Janus, T. Rowe Price and Fidelity all have excellent large-cap growth offerings. And, as an added bonus, many of these funds still hold tax-loss credits from bear-market losses that may make them particularly tax friendly to investors buying in today.

Finally, no conversation about big names and quality would be complete without a tip of the hat to Louis Rukeyser. Lou, our thoughts are with you. I know I speak for millions of viewers and readers when I say that your voice of reason is sorely missed in today’s market. Please get well soon!

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

Top 636. Dec 26, 2004 3:02 PM

» TMStock - a few questions re asset allocation

I have a few questions about the equity portion of a portfolio's asset allocation, based on my understanding. My understanding is that it is recommendable to have a Wilshire 5000 Index fund occupying the bulk of the portfolio, with Value, Small Cap, and International making up the difference. I also understand that the Wilshire 5000 already includes Small Caps, so there should be a smaller percentage devoted to Small Caps than Value. So, here are my questions:

1. Am I missing something in what I wrote above? Perhaps I am missing another sector, or perhaps I should cut out Small Caps altogether since they're already included in the Wilshire 5000?

2. I've read that at least 10 percent of your portfolio should be committed to a particular market segment before it has a meaningful impact on your portfolio. Is it really unadvisable to invest anything less than 10%? I was thinking about investing less than 10% in a European Fund and a Small Cap Fund.

3. Considering #1 and #2 above, are there any suggestions for improving the following asset allocation idea?

70% Wilshire 5000 Index Fund
10% Vanguard Int. Growth (or similar)
5% European Index Fund
5% Vanguard Small Cap Index Fund (or similar)
10% Value Fund

4. Would W. Bernstein's book "The Intelligent Asset Allocator" be a good place to look to answer these and similar questions? Or are there any other recommended books that cover asset allocation in depth?

Thanks,

-- posted by TMStock

Top 637. Dec 26, 2004 4:29 PM

» bob90245 - Re: a few questions re asset allocation

In response to a few questions re asset allocation posted by TMStock:

TMStock, you came to the right place. For a long time, authors such as Bogle and Malkiel advocated investors implement an "efficient" portfolio. They reasoned that the most efficient portfolio would be "the market" or the W5000.

Then other authors came along such as Bill Bernstein, Larry Swedroe and Paul Merriman. They argue that the W5000 has limitations. Instead their strategy, sometimes called 'slice and dice', would give a bit more equal weight to other asset classes (large-value, small-value, small-blend, REITs and International).

I decided to go with 'slice and dice' for three reasons:

1) Greater opportunities to 'sell-high' from winners and 'buy-low' into losers when rebalancing.
2) During retirement, you'll have a choice of funds to take profits from.
3) A more diversified strategy that will dampen the effects of a "secular bear market" in any one asset class.

For further reading...

Paul Merriman's interview with John Bogle
http://cbs.marketwatch.com/news/story.as...

Article on my website
http://www.geocities.com/bob90245/overvi...

Slice and Dice message board here at Suite101
http://www.suite101.com/discussion.cfm/i...

You wrote: 4. Would W. Bernstein's book "The Intelligent Asset Allocator" be a good place to look to answer these and similar questions? Or are there any other recommended books that cover asset allocation in depth?

The Intelligent Asset Allocator is very dense read. A more accessible book to start with would be Larry Swedroe's Rational Investing in Irrational Times.

Good luck!

-- posted by bob90245

Top 638. Dec 27, 2004 9:20 AM

» TMStock - Re: Re: a few questions re asset allocation

In response to Re: a few questions re asset allocation posted by bob90245:

Bob,

Thank you very much for such a thorough and imformative response. I sure did come to the right place! Slice and Dice sure makes sense. I'm looking forward to reading all the links and the book.

Thanks again,

TMStock

-- posted by TMStock

Top 639. Dec 27, 2004 7:19 PM

» TMStock - Re: Re: Re: Re: a few questions re asset allocation

In response to Re: Re: Re: a few questions re asset allocation posted by Kirk:

Thanks Kirk,

I will at least check out the "Lazy" and the "Rational" books as a start!

Thanks again,

TMStock

-- posted by TMStock

http://www.fundadvice.com/library.html

Top 640. Dec 28, 2004 9:10 AM

» Normxxx - Re: Re: Re: a few questions re asset allocation

In response to Re: Re: a few questions re asset allocation posted by TMStock:

Paul Merriman's Library is available at:

WARNING: Merriman does not believe in Buy and Hold, nor do I.

But Merriman's method of timing (known as "trend following") is very inefficient and probably does little more than reduce volatility. It is especially to be avoided in a non-trending market or in a Bear market, when it will lead to many "whipsaws."

-- posted by Normxxx

http://www.merrimancapital.com/services/...

Top 641. Dec 28, 2004 10:17 AM

» bob90245 - Re: Paul Merriman and buy n hold

In response to Re: Re: Re: a few questions re asset allocation posted by Normxxx:

Paul Merriman seems to be a big proponent of buy-and-hold. Otherwise, it would be unlikely that DFA would let him sponser their funds.

An exerpt:

"Like the DFA funds, our buy-and-hold programs are based on extensive academic research that shows the benefits of investing in specific non-correlated asset classes without attempting to determine optimum times to enter and exit the markets."

-- posted by bob90245

Active Strategy Management Fees:

Top 642. Dec 28, 2004 12:30 PM

» bob90245 - Re: Re: Paul Merriman and buy-n-hold

In response to Re: Paul Merriman and buy n hold posted by bob90245:

After looking further at Merriman's site, I see that he does both active (market-timing) and passive (buy-and-hold) strategies. A good question is whether the higher fees for active management will produce better returns than the passive management with lower fees.

Minimum investment: $100,000

Less than $250,000 1.8%
$250,001 to $500,000 1.35%
Excess of $500,000 0.9%

Buy and Hold Strategy Management Fees:

Less than $500,000 1.0%
$500,000 to $1,000,000 0.5%
Excess of $1,000,000 0.25%

Another consideration is if the account is taxable or tax-defered. Taxes will surely be a drag on returns in taxable accounts using active strategies.

-- posted by bob90245