Funds I Won't Buy
Some people invest in funds almost entirely by looking at the numbers. I think that's a mistake. Just as good fund managers almost always try to get to know a company's managers before they buy a stock, I want to understand what makes a fund -- and a fund family -- tick before I pull the trigger.
Academic studies show that simply examining past returns, even if adjusted for volatility, only slightly boosts your odds of identifying the one-third of actively managed funds that are likely to beat their benchmarks in future years. Considering expense ratios and manager tenure helps. But I think the numbers, while vital, aren't the whole story.
One key consideration: A fund company's ethical behavior. Breaches of moral and legal standards tell you an awful lot about a manager, in my opinion. What's more, fund companies are surprisingly fragile institutions-once the corporate culture turns sour, it's rare for a fund family to recover.
Once you get to know them, some fund families simply don't pass muster. I won't invest in their funds -- no matter how terrific their returns. Maybe I'm too stubborn, but the following is a list fund families that I avoid and the reasons why.
As far as I'm concerned, one bad apple can spoil an entire shop. The bad apple here is Alpine Dynamic Dividend (symbol ADVDX). It does virtually everything it can to goose its yield -- including buying stocks due to pay special one-time dividends to capture the payout. The fund yields a rich 4.8%. But when a stock pays out a dividend, its price drops by precisely that amount (other things being equal). And the fund turns over its portfolio about twice a year, on average, largely in pursuit of dividends. "By using high-yield rotation, we look to generate more yield by keeping the money moving," co-manager Jill Evans says on Alpine's Web site.
I think that "dividend capture" is a gimmick, not an investment strategy. And a firm that markets gimmicky products isn't one I want to trust with my money.
"Super Mario" Gabelli has a long and superb record as a value investor, but he also has a reputation as a bad boss. Holding Sunday afternoon staff meetings -- and lobbing tirades at his employees -- have been among his trademarks. What's more, he settled two lawsuits for more than $100 million apiece. One, brought by the first investor in his company, alleged that Gabelli had looted the firm; the other lawsuit was over his alleged creation of sham minority firms to bid on discount licenses for cell-phone frequencies awarded by the Federal Communications Commission. Hand Mario my money? Why?
HEARTLAND VALUE FUNDS
CEO Bill Nasgovitz is a likeable manager, and his Heartland Value fund (HRTVX) has a terrific long-term record. But after a protracted legal fight, the SEC forced Heartland Advisors to agree that it had "negligently mispriced" securities. The case involved two high-yield bond funds that blew up in 2000, causing losses to shareholders of $60 million. The SEC alleged that Heartland hid just how bad a shape these funds were in -- until they collapsed. Invest with this fund family? No way.
During the late 1990s, Janus advertised virtually everywhere, touting the superiority of its stock research. Those ads, plus great performance, swelled the firm's assets to $330 billion by early 2000. After its tech-laden stock funds blew up, the firm's research director conceded that Janus had used only 19 stock analysts -- too few to diversify much outside tech and telecom. "When the environment changed, we didn't have enough people covering other areas," he told me in 2003. I believe that more individual investors lost more money in Janus funds during the 2000-02 bear market than in any other no-load company's funds.
The firm has new leadership, more analysts, and claims it will never make the same kind of mistake. But why then does Janus Contrarian -- which sounds to an untrained ear like a domestic fund -- have 38% of assets overseas, including 20% in emerging markets? True, it's just one fund, but that's essentially the same thing many Janus funds did with tech in the 1990s. Am I being too harsh on Janus? I don't think so, but a 2007 article (Janus Rebuilt) in Kiplinger's Personal Finance magazine paints a generally positive picture of the firm.
RYDEX, PROFUNDS AND DIREXION FUNDS
These fund families are the industry's chief purveyors of funds on steroids. (Full disclosure: I recently wrote a positive piece on Rydex Sector Rotation A [RYAMX], which doesn't employ leverage.) Bullish on stocks? These fund families offer you the opportunity to bet on funds that should gain twice as much as an index. Want to bet the other way around? You can also wager on a fund that should gain as much as the same index falls. You can double down, too, by betting on a fund that should gain twice as much as that same index loses. This is a patently stupid way to invest. You'll have far more fun losing your money at the track.
Steven T. Goldberg (bio) is an investment adviser and freelance writer.