How to Save the Mutual Fund?

Re: How to Save the Mutual Fund?

Robertra — Sat, 06 Jun 2009 12:47:00 GMT

You make a good case for what ails active funds. But passive funds are in worse shape, because of two things: the 4 p.m. strike price, and the ridiculous "round trip" rules that were established as a result of the after-hours scandal of a few years ago. If I can get into an ETF, which is essentially an index fund, for 11 bucks a trade, at the price I want and can trade without restriction, why on earth would I invest in an index mutual fund? I will continue to hold my actively-managed equity money in mutual funds, because I think they are still the best game in town for professional management, but all my index equity money is either in ETFs or on its way.

The active funds may (should) survive, and your suggestions will help. But they can help themselves most by doing one thing - outperform the indexes ! That's what we pay them for.

For all funds, the industry should eliminate round-trip rules, at least for electronic fund exchanges. If they want to charge a quarter of a percent for their trouble on quick turn-arounds, let them, but don't tell me I can't trade. In this market ??

Regarding index funds, unless I am missing something, I believe they are dinosaurs, and won't be around much longer.

Re: How to Save the Mutual Fund?

jagor — Sat, 06 Jun 2009 17:44:00 GMT

Although I haven't yet read the article, I can comment on the first point, that managers should have more leeway in implementing their investment strategy.

Only a day or so ago I posted a comment about the First Pacific Funds and their managers Stephen Romick and Robert Rodriguez, who write extremely candid and detailed reports to their shareholders.

The point I made is that although Mr. Rodriguez clearly forsaw last year's debacle, his fund still lost over 30% of its Net Asset Value in 2008 because the mandates of his fund required him to be invested in certain areas. Had he been able to invest in a more wide basket of investments, his fund just might have performed better.

To make the point a little more, just look at some of the new funds coming on the market [from Pimco, just to name one company] that are categorized by Morningstar as World Allocation, which means that, literally, they can invest in pretty much anything, anywhere.

Maybe in the future, most mutual funds will end up as "World Allocation" funds.

Now if they would only abolish loads, eliminate the unethical 12b-1 fees and start cutting their outrageous expense ratios...but that is another topic...

Jagor

Re: How to Save the Mutual Fund?

bensbucks — Sat, 06 Jun 2009 17:46:00 GMT

I don't think that index funds are "dinosaurs" because the theory behind them is fundamentally sound: that over 50% of the actively managed mutual funds actually underperform their benchmark index. So, when your fund simply tracks that benchmark, you're going to outperform ~50% of the actively managed funds over the long-haul.

"Over 50%, how can that be?"

Not because more than half of the fund managers out there are ignoramuses, but because exorbitant expense ratios and loads kill investor return, not to mention exceedingly high turnover ratios for most funds. The main problem with this section of the fund industry is that it is so dominated by Vanguard. But if you think that index funds are dying out, think again: here's a list of some of the biggest index funds by asset:

Vanguard Total Stock Market ($90.9 billion)

Vanguard 500 Index (77.6)

Vanguard Total Bond Market (56.3)

Vanguard Emerging Markets (18)

Vanguard European Stock (13.7)

Vanguard Growth Index (12.4)

And on and on....

Re: How to Save the Mutual Fund?

ClemG — Sun, 07 Jun 2009 03:44:00 GMT

How come nobody ever brings up the issue of fund traders and performance chasing "timers" who bail out of funds anytime it lags some other hot fund basically forcing managers to sell stocks they bought on the cheap hoping to make a profit in the future? If investors want to buy and sell funds based on whats hot now, why don't they trade stocks instead, and let the long term investors to the mutual funds. It makes me so angry seeing my fund manager forced to sell his best ideas because 3/4 of the investors in the fund can't handle seeing their fund lag for some time while another fund is doing great. I honestly think the funds should charge a serious redemption fee (10 % minimum) for shares held less then 2 years. This would make people think twice before investing in the fund. It would attract an investor more in line with the the manager (ie: long term value investors looking out 5+ yrs). This is what really needs to be discussed, not a stupid little 12b-1 fee that doesn't amount to a hill of beans compared to forcing managers to sell their best ideas because they may be lagging some other guy whos hot at the the moment.

Re: How to Save the Mutual Fund?

M*_EricJ — Sun, 07 Jun 2009 04:33:00 GMT

I'm a very big fan of Mr. Rodriguez, but I don't believe that fund restrictions were a major factor in FPA Capital's losses in 2008. I've pasted below the most relevant sections of the fund's prospectus and statement of additional information. There are a few things slightly more restrictive than they might be for many other equity funds, but I don't see any that would have likely had a suffocating effect on Rodriguez's strategy.

If anything, I think it's more likely that he felt pressure from his client base to avoid changing the flavor of the fund too drastically. He has said before that he felt more comfortable pulling risk off the table dramatically with FPA New Income (his bond fund) than he did with this one.

From the prospectus:

For temporary defensive purposes or in response to adverse market conditions, the Fund may, for varying
periods, take larger than usual positions in cash or high-quality short-term debt securities (U.S.
Government or government agency securities, obligations of domestic banks, prime commercial paper
notes and repurchase agreements). As a result, you may not achieve your investment objectives during
such periods.

From Statement of Additional Information

INVESTMENT OBJECTIVE AND STRATEGIES
• The Fund’s primary objective is long-term growth of capital. Providing you current income is a secondary consideration. The Fund’s
investment adviser, First Pacific Advisors, LLC, believes that the Fund’s goals can best be achieved by investing primarily in common
stocks the Adviser deems to possess above-average ability to increase in market value. The Fund may also invest in United States
Government and government agency obligations, corporate debt securities, preferred stocks and convertible securities. Up to 15% of
the Fund’s net assets may be invested in lower-rated or comparable unrated debt securities.
• Investments in the Fund are not limited by a specific industry, and substantially all common stocks purchased by the Fund will be
listed on a national securities exchange or the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System or National List.

FIXED-INCOME SECURITIES
• Up to 15% of the Fund’s net assets can be invested in fixed-income securities, including convertible securities, that are rated BB or lower by Standard & Poor’s Corporation or Ba or lower by Moody’s Investor Services, Inc.
• The Fund can invest in inflation-indexed bonds, which are fixed-income securities whose principal value is periodically adjusted to reflect the rate of inflation.
• The Fund can invest in mortgage-backed securities, which represent an interest in a pool of mortgage loans. The Fund can also invest
in collateralized mortgage obligations, which are a type of bond secured by an underlying pool of mortgages or mortgage pass-through
certificates that are structured to direct payments on underlying collateral to different series or classes of the obligations. A variety of
CMO certificates may be issued in sequential pay structures. These securities include accrual certificates (also known as “Z-bonds”)
which only accrue interest at a specified rate until all other certificates having an earlier final distribution date have been retired and
are converted thereafter to an interest-paying security. Up to 5% of the Fund’s assets can be invested in interest-only classes of
stripped mortgage-backed securities.
NON-U.S. SECURITIES
• The Fund can invest up to 10% of its net assets in securities of foreign issuers.

INVESTMENT RESTRICTIONS
The Fund has adopted the investment restrictions stated below. They apply at the time securities are purchased or other relevant action is taken.
These restrictions and the Fund’s investment objectives cannot be changed without approval of the holders of a majority of outstanding Fund
shares. The 1940 Act defines this majority as the lesser of (a) 67% or more of the voting securities present in person or represented by proxy at
a meeting, if the holders of more than 50% of the outstanding voting securities are present or represented by proxy; or (b) more than 50% of the
outstanding voting securities. In addition to those described in the Prospectus, these restrictions provide that the Fund will not:
1. Borrow any amount other than as a temporary measure for extraordinary or emergency purposes as determined by the Fund’s Board
of Directors;
9
2. Concentrate more than 25% of the value of its assets in a particular industry;
3. Purchase the securities of any one issuer (except securities issued by the United States of America, or any instrumentality thereof) if
the holdings of the Fund in the securities of such issuer exceed 5% of the market value of the Fund’s total assets;
4. Purchase the securities of any one issuer causing the Fund’s holdings to exceed 10% of the outstanding voting securities of such
issuer or 10% of any class of securities of such issuer.
5. Issue any class of senior security nor sell any senior security of which it is the issuer, except that the Fund is permitted to borrow
from any bank; provided that such borrowing may only be as a temporary measure for extraordinary or emergency purposes, but not
for investment purposes and shall not, in the aggregate, exceed 10% of its total assets taken at cost or 5% of its total assets taken at
current value, whichever is less; and provided that immediately after such borrowing, there is an asset coverage of at least 300% for all
borrowings of the Fund;
6. Underwrite the sale of any securities other than Fund shares;
7. Purchase or sell commodities, commodity contracts or real estate;
8. The Fund may not make loans to other persons, except to the extent permitted under the 1940 Act, the rules and regulations
thereunder, or any exemptions therefrom, as such statute, rules or regulations may be amended or interpreted from time to time;
9. Mortgage, pledge, hypothecate or in any manner transfer, as security for any indebtedness, any security owned or held by the Fund;
10. Participate on a joint or a joint and several basis in any trading account in securities;
11. Purchase from or sell to any officer or director of the Fund, or firms of which any of them are members, any securities other than
Fund shares; but such persons or firms may act as brokers for the Fund for customary commissions;
12. Purchase or retain any securities of any issuer if those officers and directors of the Fund or of its manager or investment adviser
owning individually more than 0.5% of the securities of such issuer together own beneficially more than 5% of the securities of such
issuer;
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13. Invest for the purpose of exercising control over or management of any company;
14. Invest in securities issued by other investment companies;
15. Effect short sales of securities, except that the Fund may make certain short sales of securities or maintain a short position if the Fund
contemporaneously owns or has the right to obtain at no added cost securities identical to those sold short (short sales “against the
box”) or if the securities sold are “when issued” or “when distributed” securities which the Fund expects to receive in a
recapitalization, reorganization, or other exchange for securities the Fund contemporaneously owns or has the right to obtain at no
added cost;
16. Buy securities on margin;
17. Purchase or sell securities other than Fund shares through any brokerage or investment organization in which any officer or director
of the Fund is a partner, officer, director or shareholder;
18. Invest more than 5% of its assets in securities of corporations which have a record of less than three years continuous operation; or
19. Write options, except the Fund may write covered call options and effect closing transactions; provided the Fund shall: (i) write
options only on securities which it owns and which are traded on a national securities exchange; (ii) retain ownership of the
underlying security for the duration of said options and (iii) not write any option which would, at the time, cause outstanding options
written by the Fund to cover securities comprising more than 10% of the value of the Fund’s assets.
ADDITIONAL RESTRICTIONS. The Fund is also subject to the following policies which its Board of Directors can amend and which apply
at the time of purchase of securities. The Fund will not:
1. Invest more than 10% of total assets in repurchase agreements with maturities over seven days and/or other securities which are not
readily marketable;
2. Purchase warrants exceeding 2% of total assets;
3. Invest in oil, gas or other mineral exploration or development programs; or
4. Lend any security or make any other loan if, as a result, more than 33 1/3% of its total assets would be lent to other parties (this
restriction does not apply to purchases of debt securities or repurchase agreements);
5. Invest in any repurchase agreements or senior loans if to do so would cause more than 10% of its total net assets to be invested in
repurchase agreements and senior loans; or
6. Invest more than 15% of its net assets in illiquid securities. Rule 144A securities deemed to be liquid shall be included in this
limitation unless otherwise specified by the Board of Directors.

Re: How to Save the Mutual Fund?

BILKEL — Sun, 07 Jun 2009 13:10:00 GMT

In today's electronic world I believe we should be able to buy and sell mutual funds knowing exactly how much we are going to pay or receive. It seems that it would be easy to give us pricing all day as the market moves. One can only guess by looking at the averages. Why not be able to look at the value of the fund all day long?

I have found buying a basket of balanced stocks made of good performers works very well. You can trade knowing exactly the result. The accumulated costs of trading is much lower than any mutual fund fees. The only cost is time and sometimes that comes at a serious price. This choice works well until you try to venture into small caps. Then being your own mutual fund becomes much more difficult.

Re: How to Save the Mutual Fund?

ClemG — Sun, 07 Jun 2009 13:49:00 GMT

In today's electronic world I believe we should be able to buy and sell mutual funds knowing exactly how much we are going to pay or receive.

Isn't that what ETF's are for? Mutual Funds were designed so smaller investors could pull their money with other small investors and invest with a perfessional money manager who will invest our money based on his or her style and knowledge. If a person wants to be their own manager then they can buy ETF's or individual stocks. Correct?

Why would anyone want to try and manage a mutual fund manager? By buying and selling mutual fund shares all day long your essentially making a manager buy and sell the funds holdings to deal with your redemtions and purchases. This makes absolutely no sense to me, but maybe I'm missing something?

I guess I don't understand why someone would buy a mutual fund if they want to make their own deceisions about what stocks they want to own and when they want to buy and sell them. Maybe it has something to do with people needing to blame someone else (ie: the manager) when their investments don't pan out the way they had hoped?

Re: How to Save the Mutual Fund?

CaleInTheKeys — Sun, 07 Jun 2009 15:32:00 GMT

The mutual fund model is broken.

How else would you describe an industry in which 80% of products fail to perform better than the industry benchmark...less than half of all managers own any of the products they sell...built on a framework unchanged since the 1940's?

It's time for a new model. Long live spoke funds.

www.caleinthekeys.com/.../spokefunds

Re: How to Save the Mutual Fund?

closer — Sun, 07 Jun 2009 19:34:00 GMT

From August 2007 through March 2009, one primary principle guided my investment decisions: It is just as important to keep the money you make as it is to make it in the first place. Alas, the majority of mutual fund managers did an awful job of preserving their shareholders' capital during the bear market. And many of them are still in denial, blaming their funds' misfortunes on external factors rather than internal or personal failures. Examples: Tom Marsico says institutional investors put pressure on him to stay fully invested; Dodge & Cox managers have blamed the U.S. government for destroying the equity of the financial stocks they held; Third Avenue's Martin Whitman has blamed bear raiders. Excuses are easier than taking responsibility.

As for destroying or preserving their shareholders' capital, consider the performance of two large-cap value funds over the past 17 months. Dodge & Cox Stock Fund (DODGX) lost -43.3% in 2008 and has returned +6.32% to date. Forester Value (FVALX) returned +0.4% in 2008 and has returned a modest +3.57% to date. Do the math.

Full disclosure: I sold my remaining shares of DODGX in August 2007. I have held FVALX since 2008.

Re: How to Save the Mutual Fund?

CaleInTheKeys — Sun, 07 Jun 2009 20:52:00 GMT

The mutual fund model is broken.

It's time for a new model. Long live spoke funds.

Re: How to Save the Mutual Fund?

CharlotteHomes — Thu, 11 Jun 2009 21:57:00 GMT

... don't save them. Let them end up on the scrap heap of bad investment vehichles. www.southeastcharlottehomes.com">Charlotte Homes thinks the ETF will win out!

Re: How to Save the Mutual Fund?

Kirkydu — Wed, 17 Jun 2009 15:33:00 GMT

As an investment advisor, I agree in theory with much of the article. However, there are so many mutual funds and so much money in motion that there is no way to "save the mutual fund" in general. There will always be better funds than others as there will always be competition between managers.

Because the bigger players in the industry have accepted that matching market returns with slightly less risk, or slightly beating market returns with about same risk is their goal, there is little difference between big players. It is both what keeps them all in business but limits investor returns. There are a small number of managers at boutique firms that seek to, and generally do, beat by 4 or more pct points year in and year out, those are the only guys I'll use for my client's money, though only in the core of the portfolio (about 40% of assets), the rest I buy individual securities and ETFs (you or your advisor should too).

I have long since fired the big fund companies, i.e. American Funds, Putnam and am almost rid of Fidelity.

The reason that the author's prescriptions will only work in a limited way is that the broad industry has too much money under management (Morningstar calls it asset bloat) to really broadly apply an alpha-like strategy. So while the theory and practices as described in the article can work at smaller fund companies with smaller asset bases, it will never work for the big fund companies with huge asset bases. Big fund companies are doomed to mediocrity or worse, as are their clients.

It is best as an investor to take advantage of this size issue. Heck, Peter Lynch pointed this out the small guy advantage twenty years ago. It applies to funds too.