ShareBuilder Starts to Offer ING Funds

ShareBuilder continues to make changes after being acquired by ING.

ShareBuilder today announced that it now allows investors to buy mutual funds through it’s automatic investment plans. ShareBuilder is one of the popular discount brokers which offers investors to buy stocks at dollar amount rather than share amount at $4.00 commission. The new service makes 20 funds from ING available to investors:

• ING Strategic Allocation Conservative Fund (IDSIX)
• ING Strategic Allocation Moderate Fund (IDSLX)
• ING Strategic Allocation Growth Fund IDSGX)
• ING Intermediate Bond Fund (IDBOX)
• ING Mid Cap Opportunities (NMCOX)
• ING Small Company (ISCOX)
• ING Value Choice (PAVOX)
• ING Index Plus Large Cap Fund (IDLOX)
• ING Index Plus Mid Cap Fund (IDMOX)
• ING Index Plus Small Cap Fund (IDSOX)
• ING Global Bond (IGBOX)
• ING Global Equity Dividend Fund (IDGEX)
• ING Global Real Estate Fund (IDGTX)
• ING Global Science and Technology Fund (IDTOX)
• ING Index Plus International Equity Fund (IDIOX)
• ING Diversified International (IFFOX)
• ING Greater China (IFCOX)
• ING International Small Cap Multi-manager (NAPOX)
• ING Real Estate Fund (IDROX)
• ING Financial Services Fund (IDFOX)

According to ShareBuilder, there’s no load of any of these funds and investors will not pay transaction fees for investing in these funds. However, there’s a early redemption fee of $19.95 if the fund is held for less than 90 days.

Though the number funds available small and all are limited to ING funds, it’s a positive development. Since now the offering isn’t just stocks, investors use ShareBuilder to build a portfolio for long-term investment.

I am not familiar with ING family of funds, so I can’t comment on whether the funds listed above make good choice. The only one fund from ING I know is ING Corporate Leaders Trust B (LEXCX), one fund that beats the S&P 500 index in the past 10 years. Digging a little deeper, maybe I can find a good fund

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Oakmark, T. Rowe Price Reopen Funds

The Oakmark Funds reopened its Global Fund (OAKGX) on May 9, 2008. The fund, which has been closed to new investors since December 2003, invests in both domestic and foreign markets, holding 42.6% of its assets in U.S. stocks and and the rest in developed and emerging economies outside the country. According to Morningstar.com, OAKGX has an expense ratio (ER) of 1.18% and yield 0.14%. The fund’s 3-year annualized return is 13.70% and 5-year 18.28%. To invest in this fund, a $1,000 initial investment is required. That amount, however, is reduced to $500 if automatic investment plan is used.

T. Rowe Price recently also announced that its Small-Cap Value Fund (PRSVX) reopened to new investors on May 1, 2008. The fund had some great runs in the early part of this decade and was closed in May 2002. PRSVX mainly invests in small companies with market capital within or below those in the Russell 2000 index. Morningstar data shows that PRSVX has a 3-year return 10.83%, 5-year 15.13%, and 10-year 9.58%.

The minimum initial investment of PRSVX is $1,000, which will be waived if an automatic investment plan with at least $50 a month is set up at the time when an account is opened. PRSVX’s ER is 0.81%, which is quite low for a small-cap fund. The fund also has a yield of 0.69%.

I have owned PRSVX since April 2002, shortly before it was closed and currently I invest $100 into the fund every month.

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Wasatch Reopens Two Micro-Cap Funds

Micro-cap fund specialist Washtch Advisors today announced that it will temporarily reopen two micro-cap funds, Wasatch International Opportunities Fund (WAIOX)
Wasatch Micro Cap Value Fund (WAMVX), to all investors. Unlike other funds that were recently reopened, these two funds seem never available to individual investors because they were both closed on the day when they were launched (WAIOX in 2005 and WAMVX in 2003), according to the announcement. That’s quite strange.

According to Morningstar, WAIOX has a 3-year annual return of 18.58% and a yield of 4.66%, both quite impressive. However, the fund’s 2.25% expense ratio (ER) is rather formidable. WAMVX’s ER is also at 2.25% with 13.94% 3-year return.

Both funds require a minimum initial investment of $2,000. However, for automatic investment plan, the initial minimum is reduced to $1,000.

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Vanguard to Launch Global Stock Index Fund

According to a news release, mutual fund giant Vanguard has filed with SEC to offer a new, passive fund that invests in global stock markets. The Vanguard Global Stock Index Fund, which is set to be available for investors in the second quarter this year, tracks the FTSE All-World Index. The index currently covers 48 countries in both the developed and emerging markets and constitutes of more than 2,800 stocks, of which 55% are companies outside the U.S. At the same time, Vanguard also plans to introduce the ETF version of the new fund. The expense ratio of the mutual fund will be 0.45% with a minimum initial investment of $3,000, the same as most Vanguard funds. The cost of the ETF version of the fund will be at 0.25%.

Prior to introduction of this new fund, Vanguard already has funds that cover the U.S. stock market (Vanguard Total Stock Market Index, VTSMX) and stock markets outside the U.S. (Vanguard FTSE All-World ex-US Index Fund, VFWIX). Now investors will have the chance to own the entire global stock markets with a single fund.

Like Vanguard founder John Bogle said before, the best way to invest for small investors is own the entire stock market, then forget about it. That will soon become true. Now I just hope that someone comes up with a global bond fund to make investing really, really simple: a global equity fund and a global fixed income fund and that’s it

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Dodge & Cox Reopens Stock and Balanced Funds

According to a statement released yesterday, Dodge & Cox will reopen its flagship Stock fund and Balanced fund next Monday, February 4th. The two funds were closed to new investors since 2004, though existing shareholders can still invest in both of them.

In the statement, the company cited the lackluster return of both funds in 2007, which caused investors redemption, as the main reason for the reopening. Indeed, in 2007, the Stock fund (DODGX) returned a meager 0.1%, trailing the S&P index by 5.4%, while the Balanced fund (DODBX) had a negative gain of 3.1%. However, both funds have beaten their peers easily in the past 10 years. DODGX has a 10-year annualized return of 10.87% and DODBX gained 9.5% on average during the same period.

We own both the funds plus the International fund (DODFX) and they have been our core investments for many years. Despite the dismal performance last year, I have no plan to shift to any other funds. And if you are interested in buying these two funds that have been great for investors for many years, the opportunity to get them is now.

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Recently Reopened Mutual Funds: Any Interesting Ones?

Around the new year, many previously closed mutual funds reopened their doors to new investors, including such well-known names as Fidelity Magellan (FMAGX) and Oakmark International (OAKIX), after a rough second half of 2007. For investors who had an eye on these funds, but were denied access due to the closure, the reopening present an opportunity to get into the doors of some good funds.

Why do funds close and reopen?

The main reason for a fund to close to new investors has a lot to do with the fund’s past performance. It is one way to prevent the fund’s assets from growing too big, which could force the fund manager to invest the extra cash in companies that don’t fit in the fund’s investment style. This is particularly true for mid- and small-cap funds, which have seen some good time in the past few years (for example, the small-cap dominated Russell 2000 Index has a 5-year return of 16.25%). As investors chase hot funds with big returns, billions of dollars from new investors were pured into small-cap funds, specialty funds, and foreign funds. While the pace of a fund’s growth can serve as an indicator of whether the fund manager is *successful* or not, the problem with too much cash on hand is that the fund manage may end up buying something that he/she doesn’t really want to buy. And that could push the fund out of its original investment style and hinder its performance. To prevent such a dilemma, funds seeing rapid growth in assets can choose to close them to new investors to limit the cash inflow.

If a fund’s close indicates too much cash than the fund’s manager can handle, a fund’s reopen usually means the opposite: the lack of fresh money to invest. Fidelity’s Magellan is an example of how redemption and short of cash flow have become an obstacle for the fund manager to invest in the areas where he sees opportunity.

Closed fund -> Better return?

Not necessarily.

Though the impression investors get when a fund manager closes a fund is the manager is taking measures to maintain the fund’s performance. However, many times a closure is not really a *prevention*, but a *cure* because by the time a fund closes, its assets may have already become a burden. Plus, closing a fund won’t stop the growth of its assets as in most cases existing investors can still invest in a closed fund, keeping it growing.
Among the 10 actively managed funds I own, two are closed to new investors: Dodge & Cox Stock (DODGX) and Buffalo Small-Cap (BUFSX). For DODGX, the fund had $29B in assets when it was closed in January 2004. Currently the fund’s assets is $63 billion, more than doubled in three years, and show no sign of slowing down as existing shareholders continue to add money to the fund. How did DODGX perform since its closure? The fund’s returns against the S&P 500 index in the past four years are: 2004: +8.3%, 2005: +4.5%, 2006: +2.7%, and 2007: -5.4%. Not a very good example to show the effectiveness of the closure. In contrary, I see this as a perfect case of what bloated assets could do to a great fund.

Past performance doesn’t guarantee future return, whether the fund is open or closed.

Recently reopened funds

According to Morningstar, the following funds recently reopened to new investors. Do you see any interesting ones that you want to invest in?

Third Avenue International Value (TAVIX)

• Fund category: Foreign small/mid-cap value
• ER: 1.45%
• Yield: 3.57%
• Front load: 0.0%
• Minimum initial investment: $10,000
• 3-year return: 10.88%, 5-year return: 20.86%

Longleaf Partners (LLPFX)

• Fund category: Large-cap blend
• ER: 0.90%
• Yield: 0.20%
• Front load: 0.0%
• Minimum initial investment: $10,000
• 3-year return: 4.94%, 5-year return: 10.08%

Tweedy, Browne Global Value (TBGVX)

• Fund category: Foreign small/mid-cap value
• ER: 1.37%
• Yield: 1.45%
• Front load: 0.0%
• Minimum initial investment: $2,500
• 3-year return: 10.33%, 5-year return: 15.83%

First Eagle Overseas (SGOVX)

• Fund category: Foreign small/mid-cap value
• ER: 1.37%
• Yield: 1.45%
• Front load: 5.0%
• Minimum initial investment: $2,500
• 3-year return: 14.24%, 5-year return: 19.70%

First Eagle Global (SGENX)

• Fund category: World allocation
• ER: 1.13%
• Yield: 2.16%
• Front load: 5.0%
• Minimum initial investment: $2,500
• 3-year return: 13.81%, 5-year return: 18.29%

Oakmark International Small Cap (OAKEX)

• Fund category: Foreign small/mid-cap value
• ER: 1.37%
• Yield: 0.87%
• Front load: 0.0%
• Minimum initial investment: $1,000
• 3-year return: 9.48%, 5-year return: 21.01%

Oakmark International (OAKIX)

• Fund category: World allocation
• ER: 1.05%
• Yield: 0.69%
• Front load: 0.0%
• Minimum initial investment: $1,000
• 3-year return: 11.25%, 5-year return: 17.45%

Westport Select Cap (WPSRX)

• Fund category: Mid-cap blend
• ER: 1.32%
• Yield: 0.53%
• Front load: 0.0%
• Minimum initial investment: $1,000
• 3-year return: 6.97%, 5-year return: 11.55%

Royce Low-Priced Stock (RYLPX)

• Fund category: Small-cap blend
• ER: 1.46%
• Yield: 2.48%
• Front load: 0.0%
• Minimum initial investment: $2,000
• 3-year return: 9.19%, 5-year return: 15.00%

Royce Micro-Cap (RYOTX)

• Fund category: Small-cap blend
• ER: 1.43%
• Yield: 2.48%
• Front load: 0.0%
• Minimum initial investment: $2,000
• 3-year return: 12.05%, 5-year return: 19.18%

Royce Opportunity (RYOFX)

• Fund category: Small-cap value
• ER: 1.29%
• Yield: 0.38%
• Front load: 0.0%
• Minimum initial investment: $2,000
• 3-year return: 5.31%, 5-year return: 16.90%

Fidelity Magellan (FMAGX)

• Fund category: Large-cap growth
• ER: 0.53%
• Yield: 0.42%
• Front load: 0.0%
• Minimum initial investment: $2,500
• 3-year return: 7.23%, 5-year return: 10.41%

FPA Crescent (FPACX)

• Fund category: Large-cap growth
• ER: 1.25%
• Yield: 2.73%
• Front load: 0.0%
• Minimum initial investment: $1,500
• 3-year return: 8.58%, 5-year return: 12.24%

T. Rowe Price High-Yield (PRHYX)

• Fund category: High yield bond
• ER: 0.77%
• Yield: 7.74%
• Front load: 0.0%
• Minimum initial investment: $2,500
• 3-year return: 4.65%, 5-year return: 8.60%

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Update: Active & Passive Funds Comparison

Early this month, I read an article on USA Today with title, Index funds are never out of style. The article pointed out that for the past 10 years, the return of diversified US stock funds, which include small-, mid-, and large-cap funds, averaged at 6.7% while the S&P index returned 5.9% a year. The author of the article attributed the slightly superior performance of actively managed funds to what has been a remarkable run for small-cap funds during that period, during which small-cap funds outperformed large-cap funds by a sizable margin. However, things were a little different in 2007 as small-cap funds began to fade. The Russell 2000 index, which consists of small-cap companies, lost 2.67% last year, comparing to a gain of 3.53% of the large-cap S&P 500 index. From the article, one of the conclusions seems to be that with actively managed funds, the performance, sometimes even the fund itself, came and gone, just like small-cap funds may have run their course in 2007.

I used actively manged funds in our taxable investment when I started to buy mutual funds, although all the advices I have heard suggested using low-cost index funds instead because, on average, index funds outperform actively managed funds in the long term. At the end of 2006, I compared my mutual fund investments against some index funds from Vanguard in the same Morningstar category. The purpose of that comparison was to see how my funds were doing in both returns and costs of ownership. Now that 2007 was over, I feel it’s time to give that post an update and see if what I concluded a year ago still holds true after a tough year (at least the second half of the year) in the stock markets.

The comparison includes all the actively managed funds in our taxable accounts and the corresponding Vanguard funds that I think are most appropriate:

• Alpine Dynamic Dividend (ADVDX) vs. Vanguard Mid Capitalization Index (VIMSX)
• Buffalo Small Cap (BUFSX) vs. Vanguard Small Cap Growth Index (VISGX)
• CGM Focus (CGMFX) vs. Vanguard PRIMECAP (VPMCX)
• Dodge & Cox Stock (DODGX) vs. Vanguard Value Index (VIVAX)
• Dodge & Cox International Stock (DODFX) vs. Vanguard International Value (VTRIX)
• Oakmark Equity & Income (OAKBX) vs. Vanguard STAR (VGSTX)
• T. Rowe Price Small-Cap Value (PRSVX) vs. Vanguard Small Cap Value Index (VISVX)
• T. Rowe Price New Era (PRNEX) vs. Vanguard Energy (VGENX)
• Third Avenue Real Estate Value (TAREX) vs. Vanguard REIT Index (VGSIX)
• Tocqueville Gold (TGLDX) vs. Vanguard Precious Metals and Mining (VGPMX)

The costs and performances of these funds are listed in the following table.

My fund	ER(%)	Yield(%)	5-yr return(%)	Vanguard fund	ER(%)	Yield(%)	5-yr return(%)
ADVDX	1.18	13.57	6.70*	VIMSX	0.22	1.29	14.11
BUFSX	1.01	0.0	15.47	VISGX	0.23	0.47	14.00
CGMFX	1.02	0.08	32.57	VPMCX	0.43	0.62	14.61
DODGX	0.52	1.54	12.57	VIVAX	0.21	2.63	11.87
DODFX	0.66	2.65	23.80	VTRIX	0.45	2.12	20.86
OAKBX	0.86	2.13	11.93	VGSTX	0.35	2.90	10.43
PRSVX	0.83	0.69	13.96	VISVX	0.23	2.28	11.89
PRNEX	0.66	0.84	26.68	VGENX	0.25	1.36	30.86
TAREX	1.11	1.91	17.12	VGSIX	0.21	4.94	15.72
TGLDX	1.50	0.80	24.71	VGPMX	0.35	1.81	33.29

* 3-year return

So what do I see from this table?

1. Compared to one year ago, the fund expense ratios declined, though only by a very small amount.
2. On one hand, I am quite happy with the ERs of my funds, though half of them still charge more than 1% fees. On the other hand, my cheapest fund, DODGX, still costs more than the most expensive Vanguard fund in my comparison list. When it comes the cost of owning a fund, Vanguard is hard to beat.
3. None of my funds went out of business. In fact, three funds (BUFSX, DODGX, and PRSVX) are closed to new investors, which means that the fund managers have taken measures to prevent the growth of the assets from hurting the fund’s performance, a good sign of actively manged fund. Ironically, those three funds are among my worst performers in 2007.
4. One year ago when I looked at the 5-year returns of my funds, I didn’t see the reason of not using actively managed funds. Today, while most of my funds still beat their Vanguard counterparts on average in the past five years, the performance difference when both expense ratio (ER) and yield are considered, became smaller (Note: The return data from Morningstar.com already subtracted fund expenses and included reinvested dividends) .

I will revisit this topic next year to see if my actively managed funds can hold up well over time.

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Fidelity to Reopen Magellan Fund to New Investors

The Fidelity Magellan Fund (FMAGX), which was once the nation’s largest mutual fund with an asset at $100 billion, will reopen to new investors tomorrow, January 15, 2008 after shutting its door more than 10 years ago, according to a Fidelity announcement. The main reason to make the flagship fund available to new investors is to give the fund manager, Harry Lange, new cash to invest as the fund now has less than 45 billion in assets, of which nearly 85% are in retirement accounts.

In 2007, the fund returned 18.8%, easily beating the S&P 500 index by 5.5%. However, the performance in the past decade since it closed in September 1997 was less impressive, outperforming the benchmark by only 0.40%, according to Morningstar.

The fund currently has an expense ratio (ER) of 0.54% and yield 0.42%. To invest in FMAGX, an initial investment of $2,500 is required.

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Investing with Small Amounts: Stocks or Mutual Funds?

There was a short Q&A in The Wall Street Journal yesterday where the question being asked is the following:

I would like to buy only a few stocks in certain companies. Are there any online brokers that handle people with only a couple hundred dollars in their account and don’t charge heavy fees for infrequent traders?

In the answer part, several popular online discount brokers, such as ShareBuilder, Firstrade, TradeKing, and Zecco, were mentioned as possible choices for investing with small amounts.

While I agree that the brokers mentioned are pretty cheap and don’t charge the so-call inactivity fee for small investors doing sporadic trades, the question I asked myself actually is: if one only has “a couple hundred dollars,” is buying “a few stocks” the best way to invest the money even if he/she goes with Zecco which charges no commission at all?

And my answer is No. If I have only a few hundreds to start investing, I will choose mutual funds over individual stocks because, no matter how good one’s stock picking skill is, the nature of individual stocks is volatile, at least in the short term. With mutual funds, the risk is lowered as one fund can invest in hundreds of stocks at the same time.

Then the problem with investing in mutual funds with a small amount of money is that most funds require a minimum initial investment which could be anywhere between $500 to $3,000 (most of Vanguard’s index funds require $3,000 initial investment). However, there are funds which waive the initial investments if an automatic investment plan is used. For instance, funds from T. Rowe Price don’t require any initial requirement when using their Automatic Asset Builder program with $50 monthly contribution and TRP has quite some good funds to choose from.

If I’d rather deal with a broker than a mutual fund company, I will use a commission-free broker like Zecco (Zecco does require a minimum of $2,500 to open an account though) to buy a low c0st, diversified exchange-traded fund (ETF) such as Vanguard Total Stock Market ETF (VTI) to give me the broad coverage of the stock market.

Though I may not get spectacular return from a mutual fund or ETF, I know my money won’t disappear in hours as could happen with individual stocks.

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Oakmark to Re-open International Funds

Investors will soon be able to invest in Oakmark’s two international funds again.

I received an email from Oakmark Fund yesterday which announces that two previously closed international funds, International Fund I (OAKIX) and International Small Cap Fund (OAKEX) will re-open to new investors on January 2, 2008.

Both funds are managed by David Herro, who was named Morningstar’s 2006 Manager of The Year International. According to Morningstar, the reason for the re-opening of the two funds, which has been closed since 2003 and 2002, respectively, is “Herro’s strict value style caused both funds to struggle mightily relative to peers in 2007.” Year-to-date, OAKIX has a mere return of 1.7% while another popular international fund, Dodge & Cox International Fund (DODFX) gained 12.4% so far. And with an expense ratio of 1.10%, OAKIX is much more expensive to own than DODFX OAKEX’s 2007 return is a -5.7%, though the fund has very impressive performance from 2003 to 2006.

I own DODFX and am very happy with its performance. Better yet, the fund is still open.

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Finding the Funds That Beat the S&P 500

In the third part of the 2007 Consumer Reports Ultimate Money Guide, a method was provided by the magazine on how to beat the broad market index, which is repeated in the following:

• No-load: Look at no-load funds only.
• Low-fee: Identify those with lowest expense ratios.
• High-asset: Keep those with the most assets under management.
• Long-tenure: Get rid of funds whose manager’ tenure is less then two years.

Though it’s commonly believed that in the long term, a majority of the actively managed mutual funds, with the promise of providing investors with better return, failed to deliver, there are still some funds that outperform the S&P 500 index in extended period of time. The above method is actually a general guideline in selecting a mutual fund, not just those that beat the S&P, and I usually use 3 out of the 4 steps when researching mutual funds. However, I never applied them all in selecting a fund.

With beating the S&P 500 index in my mind, last night I used Morningstar’s mutual fund screening tool to see if I can find any winner with the method suggested by Consumer Reports. Here are my criteria:

• Fund group: Domestic Stock
• Morningstar category: Large Value
• Manager tenure greater than or equal to: 5 Years
• Minimum initial purchase less than or equal to: $3,000
• Load funds: No-Load funds only
• Expense ratio less than or equal to: 1.00%
• Morningstar Star Rating: None
• Morningstar risk better than or equal to: Average
• 5 year return greater than or equal to: S&P 500
• 10-year return greater than or equal to: S&P 500
• Turnover less than or equal to: Category Average
• Total assets less than or equal to: $5bil.

So basically, I was looking for low-cost funds, low risk funds that beat the S&P index in 5- and 10-year period that also require a reasonable minimum initial investment. Given these criteria, the Moningstar fund selector returned only four funds:

Details of these funds are shown in the following table. Among these funds, ING Corporate Leaders Trust B (LEXCX) has the lowest expense ratio (ER) and the highest long-term return, beating the S&P 500 index by almost 4 percentage points in the past decade. The fund’s total assets is $467 mil., which is quite small compared to other larger-cap funds.

Then I kept all other criteria the same, but changed the Morningstar category from Large Value to Large Growth. Another six funds returned, which are listed in the table below.

Of course, all these funds are selected based on their returns in the past. Though we all know that past performance doesn’t guarantee future returns, history is all we have right now and it’s an important gauge to make our selections. Can these funds maintain their performances and beat the index in the next 5, 10 years? Nobody knows, but if I would choose a fund for my long-term investment, I definitely won’t pick a fund with terrible historical returns and hope for the best for the future. I will still check out the fund’s history and pick a winner, though maybe not the winner as listed in the above tables

How do you select your funds?

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Determining the Mix of Stocks and Bonds in Your Portfolio

Early this month, there’s an article on Morningstar.com discussing the allocation of stocks and bonds in an investment portfolio. Determining the right mix of stocks and bonds depends on many factors, such as age, risk tolerance, and return expectation. For aggressive investors with longer time horizon, they can afford to put a large port of their investments in equities, if not 100%, to seek higher return and growth at the early stage of investing. As time goes by, the focus of investments changes from growing money to preserving capital and, accordingly, investment strategy becomes more conservative.

But what is the right mix of stocks and bonds? If you don’t know how to determine your own stocks/bonds allocation, you may get some clue from the target date funds (or lifecycle funds), which adjust the allocations for investors as the target date approaches. The following is a table of equity allocations in some target date funds from 2005 to 2045 in the Morningstar article.

However, as it shows in the table, even for funds with the same target date, the difference between the highest and lowest allocations is quite substantial (a 39% gap for 2035 and 2045 funds), reflecting each fund manager’s view on the balance between risk and reward. In fact, when I looked at some target date funds from Vanguard, Fidelity, and T. R. Price early this year, I got the conclusion that not every lifecycle fund is created equally, though in that case, the difference is not as large in the Morningstar article.

Though Treasury bonds are regarded as safe heaven when the market is volatile (like the one we are experiencing now), holding too much cash/bonds on hands can do more harm than good for the long term as it will hamper investors’ efforts to reach to reach their financial goals. The long term return of bonds is much lower than that of equities. To me, it really doesn’t make too much sense to have some 30-40% in bonds when I have some 30 years before I use the money. Generally, as pointed out in the article:

investors in their 20s and 30s can glean that they should have upward of 80% of their assets in stocks and stock funds, and even those already in retirement should consider devoting a healthy portion of their portfolio to equities.

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• A Look at Lifecycle Funds from Vanguard, Fidelity, and T. R. Price
• The Best Investments in IRA Accounts

September 2007 Score Card — Part II: YTD Performance of My Actively Managed Funds

I have a previous post that compared my actively managed funds against Vanguard funds for a 5-year period that covered most of the time I invested in those funds. The purpose of the post was to have an idea whether actively managed funds, while costing a little more to own, indeed lagged low-cost index funds in returns. Of course, five-year isn’t long enough to draw a convincing conclusion on which one, active or passive, is superior, but the result of my comparison reaffirmed my belief that having actively manged funds in my portfolio isn’t that bad an idea.

Recently, I have posted a couple entries regarding passive and active investments. To me, there’s no clear cut on which is good and which is bad. They both have their own merits. So I use both in my investments (actively managed funds in taxable accounts and index funds in IRAs).

After a volatile summer, the stock markets are rebounding strongly, with the Dow reaching historical high early this week and the S&P several points away from its peak. So how are my actively managed funds doing in this environment? I checked the YTD performances of my funds last night and compared them with the respective benchmarks (mostly S&P 500).

It’s a mixed bag.

I am not surprised by the big loss in the real estate fund (TAREX) given what we have seen in the housing market this year. I added some shares of TAREX when 2007 began and will probably do the same thing next year in hoping for a rebound in real estate.

What did surprise me was the trailing performance of two of my favorites, DODFX and DODGX, against their respective indexes, especially DODGX. However, I am not too worried about D&C. Looking at the fund’s performance in the past 7 years, the third quarter was always the weakest while the forth being the strongest. So hopefully, the fund can catch up in the last three months of the year.

One of the biggest stories recently is that gold price has climbed to nearly 28-year high and that boosted performance of precious metal mutual funds/ETFs. My investment in precious metal is TGLDX which has returned nicely so far this year despite the fund’s 1.50% expense ratio (ER).

The biggest gainer so far is CGMFX, which benefits from the fund manager’s heavy investments in oil and oil services related stocks. For a 1.0+% ER, I will take the 50% return. This is an example of what an actively managed fund looks like. Last year, the fund had a 300% turnover ratio and generated big capital gains. The fund is very volatile, but the return is exceptional.

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• September 2007 Score Card — Part I: Net Worth
• September 2006 Score Card — Part I: Expenses
• April 2007 Score Card — Part II: Year-To-Date Returns

Is the Small-Cap Party Over?

I am a big fan of small-cap funds. At one time, I had several small-cap funds, both value and growth, in my taxable investment accounts. Though I have trimmed the number to two, they are still a significant portion of my portfolio as small-cap is nearly a quarter of my taxable mutual fund investments.

The reason for having a large small-cap investments is quite simple: Historically, the return from small-cap investments is 2% higher than the return from large-cap stocks. Since the burst of tech bubble in 2001, small-cap stocks as a group have outperformed large-caps each and every year. The following is a chart comparing Russell 2000 (small-cap) and S&P 500 (large-cap) for the past five years. The superiority of the small-cap is evident.

The argument for the better performance of the small-cap during the recovery from a recession is that small companies can response quickly for the change of market conditions. However, when the economy enters the normal growth mode, large companies have an edge over their small rivals because of the advantage of their ability to obtain capitals to sustain the growth.

It has been quite a well since some experts predicted that in the current economic cycle, the small-cap has run its course and it’s time for the large-cap to shine. After some delays, that prediction may finally come true. The following is the YTD performance comparison of Russell 2000 and S&P 500. What I saw from the chart is that every time the stocks dropped, especially since the credit crisis began in July, the small-cap went down even further while the rebound wasn’t as strong as the large-cap has experienced. That’s understandable because during the credit crunch, small companies could feel more pain from the rising cost of credit.

Year-to-date, S&P 500 has returned 9.03% while Russell 2007 has gained 5.60%. 2007 could be the first year in a while that the large-cap outperforms the small-cap. Does it signal that the small-cap party is finally over?

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CGM Focus Fund: My New Performance Leader

For quite some time, Dodge & Cox International Fund (DODFX) was the top performer in our mutual fund investments. Less than two months ago, our investments in the fund have returned more than 100%. However, the market downturn since then has eroded some of the gains. Now the overall return of this fund is down to 88%.

Then a new leader has quietly emerged recently and it’s CGM Focus Fund (CGMFX), a fund that once I was considering cut loss due to its high turnover ratio (300% in 2006). I am glad I didn’t

The following is a chart comparing YTD return of CGMFX against S&P 500, which speaks for itself. As of September 27th, S&P gained 9.46% while CGMFX returned 61.57%!

So what’s behind the fund’s astonishing run this year? According to a news report on Bloomberg.com, CGMFX

has more than two-thirds of the fund in energy, commodities and mining companies, three of the 10 best industry groups in the S&P 500. The fund has risen 59 percent this year, driven by Potash Corp. of Saskatchewan Inc. in Saskatoon, Saskatchewan, the world’s biggest maker of fertilizer, and Houston-based oil-services company Schlumberger Ltd. Shares of Potash have more than doubled this year and Schlumberger has surged 67 percent.

From the fund’s semi-annual report, CGMFX investments include

• Oil service: 19.4%
• Metals and mining: 12.8%
• Oil - Independent production: 9.2%
• Offshore drilling: 4.5%

Among the fund’s top 25 holdings, 7 of them have gained more than 100% so far this year and 10 have returned more than 50%.

No wonder it can perform so well.

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Weather the Stormy Market with a (Re)Balanced Portfolio

There are sellers, there are buyers, and there are investors doing nothing. In this stormy market, who are you?

I think I belong to the third group with a little bit buy activities. Rather than seeing the current market as the prelude of a recession as some have predicted, I treat the month-long decline as a buying opportunity, though I won’t be on any kind of shopping spree. My strategy is keep buying funds that I have been investing for years and, at the same time, adding a little bit more here and there when I feel the time is right. This approach was used in the last recession (early this decade) and it has really paid off as those shares purchased 5 or 6 years ago are making big contributions to the growth of our nest eggs.

Then, is there anything else investors should do to weather the market? The answer is yes and what investors can do is maintaining a balanced portfolio that is rebalanced periodically. That’s main message from an article on yesterday’s Wall Street Journal. The article, Staying Balanced in a Wild Market (free) by Jonathan Clements, argues that for investors looking for long-term benefit from the current market, it’s better to act now than stay idle and wonder what to do next. And the right course of action is buying the sector that has been beaten down, if that sector is a component of a balanced, well diversified portfolio.

For a diversified portfolio (here are some examples of model portfolios) that invest in, say, both domestic and international stock markets, as well as bonds, real estate, precious metal, the allocation to each category (i.e., the portion of assets invested in each category) could change over time and the asset allocation may drift away from the target as some sectors outperform (international) while others lag (real estate) the general market. However, it’s important to maintain the target percentages because the portfolio was constructed based on investor’s investment objective, time horizon, risk tolerance level, and return expectations, etc.

The article used an example to show how rebalancing could be done. If you have a portfolio that has

30% large-company shares, 10% small stocks, 3% real-estate investment trusts, 2% gold shares, 12% developed-foreign stock markets, 3% emerging-market shares, 20% high-quality short-term bonds, 15% inflation-indexed Treasury bonds and 5% high-yield junk bonds.

After reviewing your investments, you find that the initial allocation is lost because one particular sector in this portfolio has been hit hard and that’s REIT. To rebalance and get REIT back to the 3% target, you need to add more money to the REIT fund, which now you can buy at cheap. The money can come from selling some emerging-market funds which have gone over the 3% target due to the strong performance of oversea markets. Or it can be fresh cash to avoid selling shares and incurring taxes.

But what if real estate keeps going down? I will lose more money if I keep buying, right? Right, that could happen. However, if you plan to hold your investments for 20, 30 years, why that matters? As Clements says in the article:

Nobody, of course, knows how the sector will perform in the months and years ahead. Still, if you own a well-diversified collection of these stocks through a real-estate fund, you can be pretty sure you will make decent money over the long run.

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Merger Arbitrage Funds: The Weak Link

Several years ago, I invested in a mutual fund called Arbitrage Fund (ARBFX) for a short period of time (less than two years). The reason for me to get into this fund was that the fund’s investment strategy is different from any other funds I invested in and I was looking for an investment with weak correlation with the broad market. ARBFX, along with a few other funds, belongs to a category whose investment strategy takes advantage of the price discrepancy in the merger or acquisition activities.

What’s merger arbitrage fund

Unlike the majority of mutual funds, index or actively managed, which seek either growth or value of underlying companies, merger arbitrage funds invest in companies that are subject to merger or acquisition and make profits from the expected price change following the announcement of the deal.

According to Investopedia, merger arbitrage is

a hedge fund strategy with which the stocks of two merging companies are simultaneously bought and sold to create a riskless profit. A merger arbitrageur looks at the risk of the merger deal not closing on time or at all. Because of this slight uncertainty the target company’s stock will typically sell at a discount to the price that the combined company will have when the merger is closed.

How merger arbitrage fund works

To illustrate how merger arbitrage funds work, suppose that Company X, currently traded at $15 a share, is the takeover target with the purchase price of $20 a share. After the deal is announced, the share price of Company X is expected to rise, but may not reach the target price as there’s possibilities that the deal could fall apart. If Company X’s stock is traded at $19 instead of $20, a fund engaging in merger arbitrage will then purchase Company X’s stocks and, at the same time, short the company that buys Company X, anticipating that the deal will eventually go through and Company X’s stock will reach the target price of $20/share.

In this case, the arbitrage fund captures the $1 difference (the spread) between the price when it purchased shares of Company X and the target price when the deal completes. The return of the fund by investing in Company X is 1/19 = 5.26%. The annual return of the fund depends on how long it takes the deal to complete. If, for example, the completion of the acquisition of Company X uses four months, then the annual return = (12 months)/(4 months) * 5.26% = 15.78%.

Pros and cons of arbitrage funds

From the above example, we can see that whether the arbitrage fund can profit by investing in Company X is determined by whether the announced acquisition can go through. Thus, the profit of the fund employing the merger arbitrage strategy has relatively weak correlation with the performance of the broad market, offering a certain degree of diversification.

The risk facing arbitrage fund, obviously, is that the merger or acquisition could fail. To reduce such risk, the arbitrage fund could invest in friendly deals, which have a higher possibility of success. In addition, the fund usually invests in multiple deals at the same time to mitigate the risk of failing deals. Then, if the deal is a sure thing, the spread will be small, leading to lower returns. Also, if the deal takes longer than anticipated time to complete, the annual return of the fund investing in the deal will be reduced even more.

Merger arbitrage funds

In addition to ARBFX, another bigger player in merger arbitrage is Merger Fund (MERFX), which has about $1.9B in assets.

As M&A booms in recent years, one may think that funds such MERFX and ARBFX should enjoy some good times. Well, not so. According to Morningstar, the 5-year return of MERFX is 6.82%, lagging S&P 500 by 5.85% (shown in the above plot) and ARBFX recorded a far inferior 5-year return of 5.32%. While these funds posted lackluster returns in extended periods, they are not cheap to own. MERFX’s expense ratio (ER) is 1.37% and ARBFX has a ridiculously high ER of 1.95%.

While merger arbitrage funds may offer weak correlation between the fund’s performance and the movement of the overall market, their returns are pretty weak as well, making the high fees of these funds unjustified.

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Do I Need VISVX When I Own VTMSX?

Unlike our taxable investments which consist of quite a large number of mutual funds, ETFs, and stocks, I try to maintain a small number of funds in our IRA accounts and use mostly Vanguard index funds to keep the expenses low. Among the total of 10 funds in our IRA investments, we own Vanguard Total Stock Market Index (VTSMX) and Vanguard Small-Cap Value Index (VISVX).

As John Bogel, founder of Vanguard, said in his book The Little Book of Common Sense Investing* that the best way to invest in the US stock market is to own the entire market and hold it forever. If VTSMX already covers the entire domestic equity market, why bother adding VISVX to the mix? The reason for having both VTSMX and VISVX in the portfolio is not for diversification, but for asset allocation, which can be explained by the asset allocations of these two funds:

Since VTSMX has 72% of its assets invested in large-cap companies, having a single fund doesn’t give me the enough exposure to small- and mid-cap stocks, which have been outperforming large-cap stocks for quite some time. Historically, small-cap stocks returned more than 2 percentage points higher than large-cap did. Thus, I want to have a larger portion of our investments in small-cap companies in an attempt to boost the overall return. Adding VISVX can give me just what I want, though it means overlaps between these two funds.

Using Morningstar’s Instant X-Ray, if I mix VTSMX and VISVX at a 4:1 ratio, the combined asset allocation becomes

Now the large-cap is only about 58% of the total investment, with mid- and small-cap going up to 42%. To me, this allocation is better than what I would have if investing entirely with VTSMX.

I applied the same approach to my 401(k) plan, where I have Fidelity Freedom 2035 as core holding and a small portion (15%) of Fidelity Small-Cap Value Fund to add small-cap exposure.

*Affiliate link

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Alpine Dynamic Dividend — My Dividend Generator

Tax law mandates that stocks be held for a minimum of 61 days after purchase (including the ex-date) for the dividends they generate to qualify or preferential tax rates (“qualified dividends”). In High-yield Rotation, we look to purchase high dividend paying stocks and hold them for the minimum 61 day period necessary to achieve qualified dividends. We then rotate that money into other high dividend payers, aiming to capture more than our quarterly dividends per year.

• Atlas Copco
• Bank of America
• JM AB
• General Electric
• Macquarie Infrastructure
• Regal Entertainment
• Altana AG
• PepsiCo
• United Technologies
• Diamond Offshore Drilling

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Our Investments in DODFX

have doubled

When I checked with Quicken last night, I found that our investments in Dodge & Cox International Fund (DODFX) have gained 100%, the first fund in my collection that has posted triple digits return.

I purchased my first share of DODFX on June 9, 2003 at $17.41. Since then, I have been making regular investment of $100 every month into the fund, though I don’t use their automatic investment plan. In just a little over four years, the share price has increased more than 200% to $50.41 as of yesterday and the $2,500 initial investment I made four years ago is now worth $7,254, even without considering capital gain and dividend distributions.

About two weeks ago, Five Cent Nickel asked his readers to name their favorite mutual fund companies. With Vanguard and Fidelity being the obvious choices of many people, my favorite is Dodge & Cox as I own three quarters of their fund offerings . Unlike Vanguard, Fidelity, or many other fund companies whose products cover almost every sector and category in both fixed income and equities, Dodge & Cox, a company that has been in the business since 1930, only has four funds: stock fund (DODGX), international fund, income fund (DODIX), and balanced fund (DODBX), and two of them, DODGX and DODBX, are closed to new investors. If you are considering adding foreign funds to your portfolio, DODFX would make an excellent candidate (Oakmark International Fund (OAKIX) is also worth considering), and if you want to invest in DODFX, then

Get in before it’s too late!

BTW, what’s your favorite fund company?

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Mutual Fund Holdings: Less One

I moved one step further in achieving