The Fund Outflows Keep Coming

The mutual fund outflows for the first 2 weeks of October exceeded those of the entire month of September. And the money came out of stock AND bond funds indicating utter panic as the money basically is moving into cash equivalents, one step away from going under the mattress. My gut feeling at this point is that a significant market recovery around dow 10,000, s+P 500 around 1000)and/or a testing of the lows (around 8,000 on the dow,s+p500 around 850) will spark more outflows, flushing out most of the remaining "weak hands".

At that point there would be what is probably close to record amounts of cash on the sidelines, which when put back into the market by market chasing individual investors would lead to a significant market rally.

But please take this, like any other short term market forecast, with a massive amount of skepticism.

What Do They Do Now ?

It was only on Septemeber 1 that I wrote about the latest "hot product" from the mutual fund industry, the 130/30 fund which combines long positions (100) with short positions up to 30% of the value of the longs thus allowing the fund to produce "alpha" and profit in up and down markets.

Well under current conditions with a list of around 900 (and it seems growing) stocks that cannot be sold short the strategy is difficult if not impossible to implement.

Have the fund companies announced anything about how they are responding to this major impediment to their strategy ?...not that I could find.

There are no geniuses/past performance doesn’t guarantee future results department

It seems like the surest kiss of death for an active fund manager is to be proclaimed by the financial press as a genius hot fund manager. The latest seems to be Kenneth Heebner, whose high flying CGM Focus fund has turned in eye popping results including an 80% return in 2007. Not surprisingly the returns were generated with highly concentrated positions and leverage (the fund can go short stocks).
For those familiar with how these stories usually pan out, the results of the past two months should not come as a shock. CGM Focus fund managed by Ken Heebner has fallen 21.33% since the Fortune Magazine May 23,2008 cover article proclaiming him America’s hottest investor. That is almost 3x the 7.27% decline for the s+p 500 over the same period .


s

ome excerpts from the article
America's hottest investor

Never mind the rocky market. After a string of supersmart calls, mutual fund manager Ken Heebner is putting up the best numbers of his sterling career


The best mutual fund manager around - a.k.a. Ken Heebner of Capital Growth Management - looks restless. He is sitting in a conference room at Goldman Sachs's Boston office, listening to a young analyst pontificate about all the trends he thinks will sweep the markets in coming years. Oil demand outpacing supply. The rapid growth of agriculture. The increased sway of sovereign wealth funds. And on and on.
Heebner couldn't care less. His flagship fund, CGM Focus (CGMFX), has already made a killing on energy and agriculture, and Heebner has no patience for the pet theories of this or any other analyst (or economist or strategist). "I want information, not opinions," Heebner will later tell me. Then, just as the meeting is looking like a washout, Goldman analyst Marc Fox lets something slip that starts Heebner's brain whirling.
Fox mentions that sovereign wealth funds are diversifying out of bonds and bank bailouts and into broad portfolios of common stocks. Coming from Goldman, the world's top trading house, this is valuable information. Heebner is one of the few fund managers who routinely engages in short-selling, and the prospect of a couple of trillion dollars flooding the equity markets should be enough to give any short-seller pause.
Immediately Heebner is peppering Fox with questions about where all this sovereign dough is going, wondering, for instance, whether Goldman is now recommending "short-busting" strategies to its worldwide clientele. (Short-busting involves trying to drive up the prices of stocks that a lot of investors have sold short.) "All I can say," Fox replies, looking a tad overwhelmed, "is you're multiple steps ahead of me."
Fox shouldn't feel too bad: Heebner is multiple steps ahead of everyone these days. At an age when most of his contemporaries have either retired or given up the daily grind of running publicly traded funds, the 67-year-old Heebner is putting up the best numbers of an already exemplary 30-year career. He's Barry Bonds without the steroids. "He's a rock star - he's Bono," quips his Irish-born (and U2-loving) analyst Catherine Columb. Given that U2 hasn't put out a good album since Joshua Tree - sorry, Catherine - Bono should feel flattered. (Of course, it's doubtful that Heebner, who by his own admission spends most of his waking hours thinking about the markets, could pick either Bonds or Bono out of a lineup.)
Just how good has Heebner been? We may well be witnessing the most dazzling run of stock picking in mutual fund history. Since May 1998, Focus has an average annualized return of 24%, the best ten-year record of any U.S. mutual fund, compared with only 4% for Standard & Poor's 500. Focus, which has $7.4 billion in assets, is already up 15% in 2008 (as of May 19), but it is 2007 that will be remembered as Heebner's pièce de résistance. Fueled by big bets on energy, fertilizer, and metals, Focus soared 80% last year, vs. 5% for the S&P 500. "I told Ken it was like he was walking between the raindrops," says CGM president Bob Kemp, who oversees sales and marketing at the firm, of the year Heebner had in 2007. "It amazes even us." Last year marked the fourth time since 2000 that the fund returned 45% or better. And it's not as if Heebner has needed the big years to make up for a lot of losses: Launched in late 1997, Focus has had only one money-losing calendar year (2002).
Peter Lynch's 14-year tenure at Fidelity Magellan has long been the gold standard for mutual fund excellence. During Lynch's best ten years - August 1977 to August 1987 - Magellan recorded an average annual return of 36%, according to fund tracker Morningstar. It's a remarkable achievement, but even Lynch acknowledges that he was backed by a strong tailwind. The S&P 500 returned 19% a year over the same period. In other words, Lynch beat the market by 17 percentage points a year during his heyday. Ken Heebner has beaten the market by 20 points a year during his heyday…
And Focus isn't the only Heebner-managed fund that's excelling. CGM Realty (a sector fund), CGM Mutual (a balanced fund that owns stocks and bonds), and CGM Capital Development (closed to new investors since 1969 and soon to be merged into Focus) have been standouts too. Realty boasts a 22% annualized return for the past ten years, sixth-best in the mutual fund universe, according to Morningstar. It's also the only fund in its category that's been bucking the real estate slump. Realty's one-year total return: 34%, vs. 6% for its nearest rival.
A true contrarian
Even more remarkable than the raw numbers is how Heebner has earned them. Heebner is a true contrarian, who says he's most confident as an investor "when everyone else thinks I'm nuts." He works long hours trying to identify emerging trends in the economy. When he finds a promising one, he'll go all in, making huge bets on the stocks poised to benefit. Asked how long it takes him to identify those stocks, Heebner answers, "About ten minutes. I've been at this a long time." It's an investing style that will never be taught in business schools and is definitely not something any amateur should try at home. But Heebner, blessed with uncanny instincts, has managed to see around just about every corner in a market that has befuddled just about everyone else.

the above seems a strange definition because if anything Heebner seems to be the ultimate momentum player according to morningstar his CGM focus fund which can go both long and short has 58% of its long positions in energy, 38% in materials, Its short positions are heavilty concentrated in the financial sector)

If you ever needed some good reasons not to buy an actively managed mutual fund read on

my comments are in italics


Foreign, Energy Bets Start to Haunt Janus
Some Funds Drop
To Bottom Decile
From Being on Top
By DIYA GULLAPALLI

Wall Street Journal August 6, 2008; Page C15

'Has Janus jumped off the deep end -- again? In the 1990s, the Denver money manager went heavily into tech stocks. When those blew up, it suffered mightily. In recent years, the firm has clawed its way back.
But now Janus Capital Group Inc.'s impressive recent results are threatened by big energy and foreign stock bets that these days are rapidly heading south.
Janus rocketed in the 1990s under founder Tom Bailey but then tanked as its concentrated technology and telecommunications bets imploded. A 47% return at the flagship Janus Fund in 1999 was followed by three years in the red, including a 28% decline in 2002. The firm was later caught up in the market-timing scandal, in which quick trading hurt investors, and paid $226 million in 2004 to settle charges.
Since then, Janus has made a big push under its new chief executive, imported from Goldman Sachs, Gary Black. He moved to improve stock research, expand analyst staff and ditch portfolio managers who don't fit with its new approach.
Investors have rewarded such fixes with a rich stock valuation and big fund inflows. …
On July 28, J.P. Morgan's Mr. Worthington released a note applauding the great quarterly results. Perception is now changing quickly. He has since noticed performance reversals are coming "hard and fast."
Some Janus funds have declined badly this year. That includes offerings that have now fallen to the bottom decile year-to-date after being top performers in the past three and five years. "(more evidence that past performance says nothing about future performance)

One example is the $6.8 billion Janus Contrarian Fund, managed by David Decker. It's up 11% in the past three years, or eight percentage points above the Standard & Poor's 500-stock index total return. This year, however, it has declined 18%, four points behind the benchmark. That's taken it from the first to 94th percentile among large-blend peers. As is almost always the case outsized returns vs. the index are achived by taking big risks, usually with highly concentrated portfolios, this certainly was the case here:

now this is really scary:

The fund was recently almost 40% invested in foreign stocks, and had 18% invested in Indian stocks through the end of last year, the latest data available. (morningstrar lists the fund as US large blend)That has soured, as such emerging markets have seen some of the biggest declines world-wide in 2008. Indian bank ICICI Bank Ltd. is down 52% this year.
Then there is the new weakness in once-booming commodities. The fund's Forest Oil Corp. is down almost 12% in the past three months, while utilities player NRG Energy Inc. is down 24% this year.
Big funds like the Janus Research and Janus Twenty have seen stunning recent declines for similar reasons. "With energy and commodity investments beginning to roll over, Janus' best performing funds are at risk," notes Mr. Worthington.
Meanwhile, Janus's domestic growth funds were invested 31% outside the U.S., compared with just 12% by the typical U.S. fund through June.

I must say I had never seen the last statistic and was truly shocked: even when you buy an actively managed mutual fund you are likely buying into a portfolio with 12% of more in foreign stocks…so much for keeping a handle on your domestic/international asset allocation with the active funds you trying to hit a moving target and driving by looking into a rearview mirror (excuse the mixed metaphoR).

Janus's Mr. Coleman notes that more than half of its funds were recently in the top two quartiles of their Lipper peer groups on the basis of one-, three- and five-year total returns. The $12.8 billion Janus Twenty's 14% gain in the past three years is 12 points ahead of the S&P 500. It is in the top-fifth percentile or better for the past year-to-date as well as one, three and five years.
In the past three months, though, Twenty has fallen 12%. That's about in line with the benchmark but in the bottom 85th percentile of large growth funds.
More than a quarter of the fund is in oil, mineral and agricultural chemicals and operations firms. Top holding Potash Corp. of Saskatchewan is down 11% in the past three months. Brazilian miner Cia. Vale do Rio Doce is down about 20% this year. Also potentially affecting Janus Twenty and Janus Adviser Forty is star manager Scott Schoelzel's departure in the past year.
So a large blend US fund is 31% internationally invested and more than 25% in the energy sector...and what would never know the holdings of the fund in real term only quarterly in arrears.
Many of the firm's biggest funds share the same now-falling energy and international stocks. The Janus Fund, Janus Orion fund, Janus Research and Janus Twenty, for instance, all recently held energy firm Hess Corp., which is down 11% in the past three months.

And in a classic illustration of all the bad habits of investors documented in the work of behavioral economists. Investors chased performance big time buying high and selling low, using past performance as their critieria for buying and selling funds.:I

Investors are starting to notice the shift. Janus Contrarian was the firm's biggest asset gatherer in 2007,

(after it beat the s+p by 11% for 3 years)

pulling in $2.5 billion, but has seen $240 million in sales this year

,(after declining 18% ytd)

according to estimates cited by J.P. Morgan. More redemptions could eventually nick earnings, as fund consultants and brokers who only recently got comfortable with Janus again pull back.

Target Date Funds: Do You Know What You Own ?

If good investing advice means knowing what you own then it seems the breathlessly enthusiastic report on target date funds in the current Business Week mystifies me. BW exclaims that:

“

Target-date mutual funds were supposed to lead a revolution in retirement savings. These funds, which automatically adjust their asset mix as an investor's retirement date approaches, were seen as a way for individual investors to achieve the discipline, diversity, and typically higher returns of pension funds. Now, 15 years after the first target-date fund launched, they are finally positioned to live up to their initial promise.
What took so long? One reason is that many funds didn't previously include the range of investments that have helped the traditional pension plan—that rapidly disappearing benefit—outperform the average 401(k) retirement savings plan. Commodities, emerging-markets stocks, and even private real estate are now being thrown into the mix”

In other words the mutual fund industry has been experimenting on your dime and you could have been investing for over a decade while the fund company figured out the “right” mix of assets. How one could have confidence that the funds are” ready to live up to their initial promise” is a mystery to me because the asset mix for funds with the same target date from different fund companies varies widely.
BW goes on:

“One key variable among the funds is the size of their equity stakes. Conventional wisdom once held that retirees should pare equities as they move into their 60s. But AllianceBernstein and T. Rowe Price argue that people need to invest more aggressively to make their nest eggs last longer. How much stock is enough? The typical pension fund is 65% invested in equities. A study by Watson Wyatt Worldwide shows that in target-date funds, equity allocations in the year of an investor's retirement range from 20% to 65%.”

Not only that, the fund companies have been changing their allocations within their target date funds:
International and emerging markets may be growing in your retirement portfolio, in a proportion sharply higher than when the funds opened:

“Target-date fund providers are also hiking their stakes in international equities. From 2005 to 2007 the international-equity weighting in these funds rose by as much as 7%, to a typical 17%. Managers say they want to capture a more accurate representation of global capital markets. T. Rowe Price broadened its international-equities position in target-date funds from 15% to 20% last November, beefing up investments in emerging markets such as Brazil, Russia, and China. “…

AND

“Real estate holdings, another pension-fund staple, are popping up in more portfolios..

“

AND

“Hedging strategies, long used in the institutional world, are also adding zest to target-date portfolios. Treasury inflation-protected securities (TIPS) and commodities have cropped up in a few target-date funds, including those offered by Fidelity and Principal Financial Group (PFG). Providers are mulling ways to invest in hedge funds and private equity, too.”

All the above leads one to wonder whether these are target date funds with a defined strategy for retirement savings or a license for the fund company to enter into whatever asset mix it sees as appropriate to maximize short term returns. What will these funds(and their investors) do if the investments in exotic emerging markets or commodities take a big tumble just as the target date approaches ? Are such volatile assets eliminated from the portfolio as the target date approaches ? I have yet to thoroughly research this issue but it seems that there are few explicit restrictions on the manager.
I wonder how much transparency is in these funds in terms of what they can hold, what their target allocations are and how often they can be changed. And it seems that there must be little in the way of tax management. What was peddled as a simple worry free form of retirement investing may be more of a potential problem than many investors think.
The Business Week article lists the % of Equity Holdings in the Target Date 2020 funds from several major fund companies. As you can see there is quite a range:
Alliance Bernstein: 80%
T Rowe Price 75.1%
Fidelity 69%
Vanguard 63%

Past Performance is No Guarantee of Future Results...One More Example

Fortune Magazine November 15, 2006:


“The greatest money manager of our time

What do ant colonies, novels and river systems have to do with making money? Ask Bill Miller, the man who's topped the market 15 years running. Fortune managing editor Andy Serwer reports. …

In case you haven't heard of him, Bill Miller is one of the greatest investors of our time. Refreshingly, he isn't some sort of billionaire hedge fund recluse. Miller runs an ordinary mutual fund, the $20 billion Legg Mason Value Trust, where he has produced extraordinary returns.
As it stands now, Miller has compiled one of the most remarkable records in the history of investing: His fund has outperformed the stock market for 15 straight years. That's right, 15 years, starting in 1991 - during George Bush the elder's presidency - through the tech bull market, then the crash and now the recovery.
That puts him in the same league as Peter Lynch, George Soros, even Warren Buffett. In recent years Miller has inadvertently added to the drama of his DiMaggio-like streak by falling behind in the first half, only to come roaring back in the fall and pass the market at the last minute. This year Miller's fund again got trounced by the market in the spring, and since then it has come back, only this time there's a difference. As of early November, Miller was still about 10 percentage points behind the S&P 500. So it is almost certain that he has too much ground to make up and that the streak will be broken. If you don't believe me, ask Miller: "It's unlikely I'll beat the market this year," he says, though he certainly thinks the condition will be temporary.”

Any reader of Naseem Taleeb’s brilliant book Fooled by Randomness would not be surprised by what came next:
Legg Mason Value Trust is = - 28.4% ytd through June 30,2008 underperforming the s+p 500 by 17.46%
3 year return is -8.52% (12.17% worse than the s+p 500)
5 year return is -.53% (8.03% worse than the s+p 500)

Target Date Funds..A Good Idea to Look Under the Hood

I am not a big fan of target date funds since they give the investor little control over the content of their portfolio, how rebalancing is implemented and tax management. Also there is often little transparency. In my view most investors are better off constructing their own investment portfoilo by themselves or with an advisor that gives them individualized advice.

So I was not surprised to find the following in Investment News a financial industry publication. Apparently the interpretation of what the appropriate target date allocation consists of differs massively between fund companies….and it seems to be a moving target my bolds, my comments in italics

Target date funds increase equity exposure
Equities average 68% of portfolios, up from 55% in 2003, new study from FRC finds
By Lisa Shidler
June 16, 2008
“Managers of target date funds have increased their allocations to equities, on average, but some of the funds' specific investment strategies are difficult to discern, a new study from Financial Research Corp. has found. …..
…"We reviewed their prospectuses and we found that as a general rule we could find the basic features of target date asset allocation strategies in the fund prospectuses," said Lynette DeWitt, a research director with Boston-based FRC.
"However, there were cases where data [were] missing," she said. "It was difficult for us to compare one strategy against another."
“One strategy was clear: increasing equity exposure. The report found that at the end of December, the average target date fund had 68% of its assets invested in stocks, up dramatically from 55% five years earlier. “ Does that mean these folk have changed their view of the proper allocation, how much disclosure to current and future investors have they given about this ?This is certainly disturbing….funds with the same target date can have quite different allocations:But the disparities among funds are marked. For example, Wells Fargo Advantage Dow Jones 2020 fund had 51% equity exposure, while Fidelity Freedom Fund 2020 had 69% equity exposure and Oppenheimer Transition 2020 had 90% of its assets in equities.
And this is faint praise imo:

“While target date funds may not make much sense for high-net-worth clients, 401(k) participants who lack investment expertise may find them useful, said Lisa Falcone, a financial adviser with Newton, Mass.-based Sapers & Wallack Inc., which manages $200 million in assets.
"If you have no investment knowledge whatsoever and you're not comfortable picking funds and don't want to be bothered, then target funds are the way to go," she said. “
In other words if you are clueless and have no desire to increase your knowledge or hire an advisor to help you with one of the most important decisions in your life then unlike wealthier folk you should go ahead with one of these funds
I actually agree with these comments by the same advisor although I don’t think it means that these funds are a good choice for anyone:
“Ms. Falcone also worries that many of these funds don't make their investment choices easily discernable.
"It's just not as transparent as other mutual funds where I can see everything," she said.
And this retirement plan administrator seems to agree that they are not a particularly attractive choice even withing 401ks:
"In a typical target date fund, you really don't know what the makeup is," said Joseph Masterson, a senior vice president at Purchase, N.Y.-based Diversified Investment Advisors Inc., which administers retirement plans having $43.2 billion in assets as of yearend 2007