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By Gary D. Halbert
November 11, 2003


1.  Byproducts Of The Mutual Fund Trading Scandal.

2.  Just Another Flawed Stock Investment Strategy.

3.  Mutual Funds Are Still Advised For Most Investors.

4.  The Good News About The Mutual Fund Scandals.


With the investigations into improper and/or illegal trading at mutual fund families expanding, you are going to see more and more investment strategies trotted out as alternatives to mutual funds.  This week, I will focus on one particular stock investment strategy put forth recently by Forbes magazine.  While the article and the investment strategy seemed straightforward and well researched enough – and certainly offered a way to invest in stocks without using mutual funds – it also has some huge flaws in it in my opinion, as I will discuss below.

Following that discussion, I will update you on the latest developments in the mutual fund scandal.  While there is new news on the trading scandal almost daily, there is one point that has gone largely unmentioned.  That is, the trading abuses are largely or entirely history.  Around the mutual fund industry, actions have been taken to stop the improper and/or illegal trading practices.  In most cases, they were stopped some time ago.  So, while it is a good thing that the regulators are investigating the abuses, and heads will continue to roll, we should not lose sight of the many benefits of mutual funds.

Forbes Offers A Flawed Stock Strategy

In its November 10 issue, in the “Money & Investing” section, Forbes columnist Christopher Helman offers up a stock selection strategy that he describes as, “You can piggyback on the thinking of the best stock pickers without paying their fees.”  As this catchy subtitle suggests, Helman is apparently one of those investment writers that is overly sensitive to paying management fees for professional advice - in this case, the fees paid to mutual funds. (I’ll come back to the issue of mutual fund fees later on.)

Helman’s basic premise was: If I could find out the top stocks owned by the best performing mutual fund managers, I could just buy those stocks and avoid paying mutual fund management fees and other expenses.  Sounds good, doesn’t it?

Actually, Helman did a pretty respectable job in pursuing his quest to find the most widely held stocks by successful mutual fund managers.  I’ll briefly explain the process he went through, and then I’ll tell you why it’s flawed and why it would not be a good stock investment strategy for most of us in my opinion.

Identifying The Universe

Helman assumed (correctly) that to have a successful stock portfolio for the long-term, he needed diversification.  So, he structured his mutual fund search to include: 1) large-cap funds; 2) small and mid-cap funds; and 3) international funds.  No problem with that.

After determining his fund categories, Helman used the Morningstar database to filter only for very large, well-known funds that have been around a long time.  He also eliminated any funds that tended to trade frequently, instead considering funds that tend to hold their positions for longer periods of time.  So far, so good.

Helman next filtered only for fund managers that had a long tenure and had outperformed their peers.  He compared their performance over periods of one year, three years, five years and ten years.  The usual analysis.

In the end, Helman whittled-down the mutual fund universe to the following successful funds that met his selection criteria: 24 large-cap funds, 38 small and mid-cap funds, and 10 international funds.  Nice work IF you have the expensive software to be able to slice-and-dice funds using your own set of criteria.

PROBLEM #1: Most investors don’t have the expensive software or Internet subscription services to be able to run these complicated mutual fund searches.

Identifying Their Largest Holdings

Helman’s next mission was to identify the most commonly held stocks in all of the funds in each of his three categories.  This is where the search got more complicated and questionable.  Using some subscription-only Internet databases, Helman analyzed each fund’s portfolio to determine which stocks were the most widely held in terms of market value. 

In order to do this, Helman had to look at each of the 72 funds’ top holdings and then aggregate that data (manually, I suspect) to arrive at the most widely held stocks. 

PROBLEM #2: How many of us have the time and software and Internet subscription services to do this?  At my company, we have the software and the Internet subscriptions to do such a search, but we’re an investment firm after all.  I don’t know too many investors who have these tools.

And The Winners Are (Or Aren’t)

Helman didn’t state this in his article, but I’ll bet he got a big surprise when he learned the following: there was no single stock that was among the top holdings of all of the successful funds he selected!  Again, he didn’t say this, but I’ll bet you he expected there would be several well-known stocks that were among the top holdings of all of his carefully selected mutual funds.  Not so.

Let’s take his 24 very successful large-cap funds.  Again, no stock was owned by all of them.  The most widely held large cap stock was Pfizer which was among the largest holdings in only 15 of the 24 funds.  Nine of his top performing funds did not have Pfizer as one of their largest holdings.  Tyco came in second but was among the largest holdings in only 14 of his 24 funds; Microsoft came in third but in only 13 of the 24 funds.

The numbers were even less compelling in the small and mid-cap funds where the most widely held stock was Omnicare, but it was among the largest holdings in only six of the 38 funds.  In international funds, Nestle and Samsung were the winners, but they were among the largest holdings in only five of the 10 international funds he selected.

(By the way, if you want to buy Samsung shares, you have to get an “investor registration card” from regulators in South Korea – and how many of us have that – plus convert to South Korean currency and then place your order on the Seoul stock exchange.)

PROBLEM #3: While I assume Helman’s research is generally correct, I don’t find it overly compelling.  As noted above, I’ll bet that Helman expected to find several stocks that were among the largest holdings of ALL of his selected funds.  Not so.

And Now For The Biggest Problem Of All

Currently, the SEC requires mutual funds to disclose their holdings twice a year, with most funds doing so as of the year-end and as of June 30.  I say “as of” because some funds announce their holdings weeks after the year-end or June 30.  You might not know until sometime in February what the largest holdings were on December 31.  More importantly, you won’t know if those holdings changed significantly until six months later.

PROBLEM #4: What if the most widely held stocks change, and you don’t know about it until months afterward?  Maybe one or more of your carefully selected stocks falls out of favor.

To his credit, Helman said he selected only those funds and managers that tend to invest for the long-term (ie – they don’t trade very often).   So maybe the positions don’t change that often.  However, when a stock falls out of favor, there’s usually a good reason.  I, for one, would not want to hold a small basket of stocks selected in this manner if I could only check it twice a year.

The SEC is said to be considering requiring mutual funds to disclose their holdings more frequently, probably quarterly.  I’m all for that.  However, I still would not invest using this strategy, even if I could check it four times a year.  A stock that is a “darling” today could fall a long way in three months if it goes out of favor with fund managers.

Also, from a “contrarian” standpoint, one could argue that you do NOT want to own the most widely held stocks.  Simply put, if all the big boys have already bought them, maybe they’ve already gone about as high as they will go.  And if they decide they don’t want to hold some of these stocks anymore, look out below.

Another problem is that Helman only recommended 10 stocks in total: four large-cap, three small and mid-cap, and three international.  Here again, if only one of your stocks in each category goes bad, it can do a lot of damage by the time you learn that it has fallen out of favor.  I’ve always believed that you need at least 20 stocks to have a well- diversified portfolio.

Mutual Funds For Most Of Us

As noted at the beginning, we are going to see more and more new (and not so new) stock investment strategies trotted out as a result of the mutual fund scandals.  There are those who will use the mutual fund problems to their advantage in trying to lure investors into buying individual stocks as opposed to mutual funds.  But the truth is, most of us (including me) aren’t very good at picking individual stocks.

This is why I still believe mutual funds are the best choice for most investors.  Despite the recent negative developments, all of which will be corrected in my opinion, mutual funds still have many advantages.

Helman suggests that the reason he developed the system described above was his concern about paying mutual fund management fees.  Yet the issue of mutual fund fees is not black and white – low fees are good and high fees are bad.  There are some mutual funds that charge higher fees but still outperform their lower fee competitors.  When it comes to fees, I always defer to “net performance”– performance after fees and expenses are deducted.

In summary, Helman states that his goal was to avoid paying the management fees charged by mutual funds.  But does his strategy really save money?   There are commission costs when you buy and sell individual stocks.  Of course, if you buy them once and hold them a long time, the brokerage costs are probably less than mutual fund management fees.  But then you have to add in the costs to subscribe to the various databases to allow you to slice-and-dice the many mutual funds based on your particular selection criteria.  In the end, I don’t know that Helman’s strategy really saves much money, not to mention all the other flaws noted above.

And last but definitely not least, consider the amount of time on the investor’s part that is required to follow this strategy.  Most of us who are successful enough to have an investment portfolio are busy people.  If you value your time, I don’t think this stock investment system saves any money at all, again not to mention its other flaws.

The Mutual Fund Scandal - Good News & Bad News

If you’ve followed the mutual fund scandal much at all, you know that the investigations are widening.  More mutual fund families are being investigated for allowing “late trading” and what is incorrectly being called “market timing” (frequent buying and selling of shares even though the fund prospectuses prohibit such trading).

Yet amidst all the negative headlines, there is some very good news resulting from this scandal.  First, the illegal and improper trading of mutual funds has stopped, either largely or entirely.  Most of it was stopped sometime ago based on what we know now.  Second, across the industry, mutual fund families are examining trading practices and reviewing the investment activities of their fund managers and staffs.  Fund managers who have used non-public information to trade their own funds are being fired.  This is good.  The mutual fund industry will be better in the future.

The bad news is that long-term shareholders of those mutual funds involved in the abuses have lost some returns due to higher fund expenses.  But these losses have not been huge on a per-investor basis, and it now appears that many of the fund families are going to reimburse their funds for some of the losses.

The worst news, in my opinion, is that it now appears certain the SEC will impose new mandatory fees for cashing out of mutual funds prior to a certain holding period.  The amount of the early redemption fee is not yet known, nor is the length of time of the required holding period.  However, it does appear that such a “go load” will be required.

While early redemption fees will serve to curb the frequent trading in and out of mutual funds, they will also penalize investors who have legitimate reasons to take their money out of funds early.  Emergencies happen.  Yet as it looks now, there will be no exceptions to the early redemption fees.   Fortunately, most of us do not trade in and out of mutual funds frequently.

In closing, you will be seeing more and more new stock investment strategies in the wake of the mutual fund trading scandal.  Some will be well researched (but flawed), as was the latest strategy offered by Christopher Helman in Forbes. Others will simply be schemes to separate investors from their money.  Caveat emptor!

As always, I believe that most of us would be better off to use successful professionals to manage most of our investment dollars.  You can CLICK HERE to see the latest performance of some of my favorite professional money managers.

Finally, let me express my sincere gratitude to all you Veterans reading this, and especially to our brave men and women currently serving our nation in the military.  Happy Veterans Day!!

Wishing you the best,

Gary D. Halbert


What is a Veteran?

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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