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| THE ANSWER DESK . .
. ARCHIVES |
Volume 44: To submit a question to MFI's panel of
experts, please write to us.
Meet Our Q&A Panel:
 Frank ArmstrongFrank Armstrong is author of Investment Strategies for the 21st Century,
published here, and president of Managed
Account Services, Inc., a fee-only advisor specializing in global asset allocation
strategies utilizing no-load mutual funds. Frank is a Certified Financial Planner (CFP)
with 24 years' experience helping investors build wealth. The firm, an SEC Registered
Investment Advisor currently manages in excess of $60 million for over 140 clients
worldwide. Visit Frank's Managed
Account Services, Inc. for more information
about the Alternative to Business as Usual on Wall Street or call 1-800-508-8500. |
 Ron RutherfordRonald K. Rutherford, MS, MBA, CFP,
CIMA, is Chairman & CEO of Rutherford Asset Planning, Inc. and is a
New York City-based fee-only financial advisor. He is registered as an Investment Adviser
with the SEC and a member of NAPFA, ICFP, and IMCA. Ron is the author of The Complete
Guide to Managing a Portfolio of Mutual Funds and has consistently appeared on Worth
magazine's Top U. S. Financial Advisor list. Ron is widely quoted in the financial press
and has appeared on national television to discuss a variety of financial topics. For more
information, visit Ron's website or call
(212) 829-5580 |
Questions and Responses
What are front-end loads and 12(b)-1
charges?
from Tom
Q: When dealing with mutual funds what is front load and what
is 12b-1? And what are the advantages and disadvantages?
A (Frank): Front end sales
charges are the traditional way that brokers get compensated for their recommendations. A
front end load is a charge tacked on to a mutual fund's Net Asset Value (NAV) to
compensate the brokerage and salesperson for selling a fund. Funds that carry this kind of
commission cost are also often refereed to as "A Shares". For instance, if a
fund had a NAV of $10.00 per share, and a 5% commission, the purchaser would buy the
shares at $10.50 each. If he sold them the very next day, and if the market price hadn't
changed he would only net $10.00 per share.
Most mutual fund families have a decreasing charge for larger
purchases, and it may even disappear for purchases over $1,000,000. There is certainly no
advantage to the investor to pay the sales load other than to compensate the broker for
his services. Each investor will have to decide for himself if he receives value from the
broker, and if so, if that is the appropriate amount of payment, and if the structure of
the transaction is fair to all parties. There are alternatives including back end load,
level load, no-load, and fee for service.
A 12(b)-1 charge may be imposed by a fund family to promote sales of
their fund. In theory, growth of the assets under management will allow funds to lower
average management fees. In practice, I am unaware of any fund that has eliminated the
12(b)-1 fee after the size of the fund has grown, or decreased the average costs as assets
rose. Perhaps there is an example out there. If so, it has been well hidden.
The fee is accounted for as part of a fund's "expense
ratio". There are funds with reasonable expense ratios that charge a 12(b)-1 fee, and
funds that do not charge the fee that have expense ratios high enough to gag a maggot. You
should focus in on the expense ratio (rather than on just whether a fund has a 12(b)-1
fee) as the best measure of the total cost being born by shareholders for the service of
the fund family. A 12(b)-1 fee may be charged by either a load or no-load fund, and the
proceeds can be used for a variety of purposes that promote the fund. The 12(b)-1 fee may
be used to compensate brokerages or salespersons as a "trail" commission. Or, it
can be used to pay distribution costs to discount brokerage houses for "shelf
space" in the fund supermarket.
Getting to the bottom of all the various costs imposed by funds is a
little tricky. The industry could benefit from better disclosure. As an investor, you
should be concentrating on funds with the lowest possible expense ratios. Expenses are a
dead drag on performance that come directly out of your pocket. You should also be aware
that compensation for services (commissions) may impose conflicts of interest that can
work to your detriment. Demand full disclosure of all costs and potential conflicts in
writing in advance of making any investments.
Should I stop chasing "last year's
stars"?
from David
Q: I think I need to stop chasing "last year's
stars." I first did this with PBHG and Van Wagoner. Wasted a year. This year I opened
accounts with Sound Shore and N&B Genesis. Both have performed miserably. Should I
dump these puppies and head for Europe or hold on for that "rally" we've been
waiting so long for? I have trouble finding info on why these two "hot" funds
have performed so poorly. Can you offer any info?
A (Ron): You are correct
that "chasing last year’s stars" is a strategy that does not work over the
long haul. Constant rotation among sectors or asset classes does not work either. In
addition, the impact of potential transaction costs and capital gains tax make constant
turnover even worse. Instead, you may wish to consider holding funds with consistent
records each representing an asset class within a broad array of asset classes.
There are any number reasons to explain why the funds you mentioned
ran out of steam at this moment. It is difficult to pinpoint the precise reason. It is
likely that they will come back to produce reasonable returns over time. Here are some
thoughts that you may wish to consider. First, increase your time horizon and your level
of patience with fund management. Second, look for funds that have the most consistent
record in all kinds of market conditions. Funds that do this well are not flashy or
glamorous. They simply produce a respectable return year after year letting the power of
compounding work for you. Third, seek funds with low expense ratios. There are many
actively managed funds that fit these criteria. You can also make a case for index funds
here.
Are taxes owed on a fund withdrawal?
from Barry
Q: My father-in-law has been paying taxes on capital gains
and interest on his Dreyfus fund since he's had it. (It's not a tax-deferred fund,
obviously). If he withdraws money from the fund, does he have to report that money as
taxable income?
A (Frank): When a mutual
fund makes a distribution, that distribution is taxed as either income, or capital gains
to the owner of the fund. However, the owner of the fund increases his basis in the fund
by the amount of the gain that he received.
When shares of the fund are later sold, the owner of the fund has
several options for computing the taxable gain. Almost all brokerage houses or mutual fund
companies will supply you with an "average cost" report. However, you can use a
number of different ways to report the gain. You can use average cost, identify specific
lots of purchases, or use a technique like highest in-first out (HIFO), first in-first out
(FIFO), last in-first out (LIFO).
The IRS generally likes you to be consistent in the method that you
employ. Check with a tax advisor (CPA or Tax Attorney) to see which method will be most
beneficial in your father-in-law's case.
Is there life after Price?
Q: Now that Michael Price is leaving what would you
recommend?
A (Ron): Michael has not
left yet. Further, he is building a team of quality people who take an increasing role in
the management of the Mutual Series funds. I met many of his team members and was
impressed. So there is no need to rush out and sell. Having said that, let us look at the
style that helped get Michael where he is today. Perhaps you can find tips here in
screening for other fund managers that do what he does.
Michael is a value investor in the classic sense. He seeks out funds
that trade at deep discounts to perceived intrinsic value. People often refer to these as
"special situations." They often involve mergers, restructuring, consolidations,
liquidations, or reorganizations. His funds have low risk or volatility since the price
(no pun intended) of his holdings is already at rock bottom. After he identifies a
situation, he often becomes active as a dissonant shareholder to persuade the company
management to act to increase shareholder value. Some cynics refer to this as
"vulture investing." Funds that use a similar strategy may have key words such
as the ones used here in the fund name, the objective, the category, or the analyst’s
description.
Can Asia recover?
from Bob
Q: I am really wondering about the capacity of the
Asian countries to turn things around financially or at least stabilize. What is your take
on that situation?
A (Frank): The recent
financial events in Asia have not been pretty. The various economies are feeling real
pain, and that goes right down to the street level. No one can deny that the situation is
serious.
The Asian conceit that a mixture of Capitalism, cronyism, corruption
and centrally guided economies is somehow better than a market driven economy has been
strongly refuted. Hopefully we will hear no more about the "Asian way".
However, the collapse of the markets may sow the seeds for recovery
and further progress. The IMF, World Bank, G7 and other interested parties are all
clamoring for reform, and reluctant to pony up any funds without it. The people themselves
will demand reform, and I think we are already seeing some very hopeful signs. For
instance, Korea has been one of the most closed economies for foreign investment. So, when
I see the Korean Premier wandering around the floors of Wall Street asking for foreign
investment, I think that they might have gotten part of the message. Recently we have seen
an encouraging amount of direct foreign investment as multi-national companies buy up
whole companies.
The Japanese people recently fired their government due mostly to
dissatisfaction with their economic progress. The new government understands the
imperative of fixing the economy.
The problems are real and deep. But, I am certain that a couple of
billion very bright, industrious, disciplined Asian people will solve their problems. When
they do so, Asia will have an opportunity to renew the greatest increase of wealth and
economic advancement that the world has ever have seen. A well diversified portfolio
should contain some exposure to these markets.
No one can tell us how long that might take. But it would be foolish
indeed for investors to bail out now. Everyone should have known that the markets contain
risk. If they can't stand the risk, they should never have been there in the first place.
The question of risk tolerance should be resolved BEFORE making the investments. Risk
happens!!! Buying high and selling low is the primary investor mistake. Long term
investors should hold tight.
Important Disclaimer
Investing in equities involves a serious principal risk,
and no assurance can be given that the techniques described here will be successful.
Returns vary and you may have a gain or loss when you sell your shares. Past performance
is no guarantee of future results. Index returns shown are historical and include the
change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged
and do not reflect the impact of transaction costs. Transaction costs would have reduced
the total returns.
International investments, especially those in emerging
markets, entail greater risks (as well as greater potential rewards) than U.S. investing.
These risks include political and economic uncertainties of foreign countries, as well as
the risk of currency fluctuations. These risks are magnified in countries with emerging
markets, since these countries may have relatively unstable governments and
less-established markets and economies.
Lastly, the questions and responses set forth here are for
general informational purposes only and are not intended to substitute for performing your
own independent research or contacting your financial or legal professional before making
any investment decisions. We make no guarantees as to the performance of any investment
strategy you choose and are not responsible for any losses you might incur.
 Comments? Criticism?
Suggestions? Talk to us.
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