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Dear Dagen: Enough With the Excuses

Dagen McDowell

Just once it would be nice to see a mutual fund manager explain a bad year in two simple words: I stink.

Unfortunately, this never happens.

Instead, some fund managers churn out excuse after excuse for bad money management. They fill their quarterly shareholder letters with every possible euphemism and buzzword to explain their pathetic results. Maybe they're hoping you'll wind up so confused that you'll forget how awful the returns on their mutual funds have been.

You're paying a manager to beat the market. Sometimes there are legitimate reasons why that might not happen in a particular year. But you should be skeptical of someone who can't tell you what went wrong in simple language.

Here are a few fund managers who need a good editor and a dose of truth serum. If all you're going to get is a lame excuse or endless blather, you're better off putting your money somewhere else.

Blame the Market and the Economy

In a mutual fund's annual or semiannual report, the fund company is supposed to explain poor performance and what caused it -- an exercise called performance attribution. And most investors want specifics: Why did the manager sit on JDS Uniphase (JDSU Quote) all the way down? Why didn't the manager make more defensive moves?

But some managers aren't so forthcoming and don't address such concerns. Rather than owning up to their mistakes, they blame the market or the sector in which they were investing.

That's the tack managers of the Monetta funds use in a recent shareholder letter. "It was a challenging year for most of the Monetta Funds due to our emphasis on growth stock investing, especially in the technology related sectors," write managers Robert Bacarella and Timothy Detloff. "Fund turnover was higher than average during the year as we shifted weightings between technology, healthcare and consumer discretionary sectors in an effort to preserve capital. Despite the positive equity performance during the fourth quarter, it was not enough to offset the negative performance realized in the earlier part of the year."

A challenging year indeed. The (MLCEX Quote)Monetta Blue Chip fund (formerly called the Monetta Large-Cap fund) fell 53.9% last year, making it one of the worst performing large-cap growth funds in the country. The letter does go on to point out that this fund's heavy tech weighting "hampered" performance. "Hammered" would have been a better word to use.

The managers do identify some of their bigger losers last year, including Ciena (CIEN Quote) and JDS Uniphase. "Although these holdings were sold during the year, it was extremely difficult to recoup these losses in an environment of rising unemployment, earnings shortfalls and frequent profit warnings," they write. "Throughout the year we remained fully invested, rotating sector groups and focusing on the leading growth companies with strong balance sheets. Unfortunately this fully invested strategy penalized not only 2001 performance, but also the Fund's long-term performance record."

Well, they still had almost half of the fund invested in tech stocks at the end of November. They can blame that sector all they want, but that explanation won't keep investors around who are looking for a "blue-chip" portfolio.

This approach to explaining pathetic performance isn't unique to small fund companies. The (POEGX Quote)Putnam OTC & Emerging Growth fund used the same technique in its report from July 2001.

The fund's fiscal year that ended in July "was an acutely difficult period for the stocks in which the fund invests," the report states. "Although we sharply reduced holdings in the areas that were hardest hit by the market decline -- namely, technology and telecommunications -- the slowing U.S. economy cast a pall over growth stocks in general, and the fund's performance suffered accordingly."

It sure did. This Putnam fund fell 51.3% in 2000 and was down another 46.1% last year. But money management is not figure skating: You don't get points for degrees of difficulty.

You should know that Putnam is making some changes. It was reported that the company recently fired one of the managers who was responsible for this fund's dismal returns. But shareholders still deserve a much better explanation from Putnam. Maybe they'll get it in the next shareholder report.

False Hope

At least these two money management firms -- to some small degree -- admit their past mistakes right up front. On the other hand, Robert Markman, who oversees four eponymous funds that invest in other mutual funds, wants to turn your attention to the future and how rosy it will be. He starts his shareholder letter from last June by proclaiming: "THE BEAR MARKET HAS ENDED. THE FIRST BULL MARKET OF THE TWENTY-FIRST CENTURY HAS ALREADY BEGUN. IT'S TIME TO MOVE ON."

Yes, it's time to move on, but not in the way that Markman means. His letter focuses on why investors should look to the future rather than the past and why the market had already started to recover. "We believe there is enough evidence to make the case that a real and enduring 'low' was established on April 4," he writes.

The Nasdaq Composite is up 6.9% since that day. And three years from now, Bob Markman might look like a genius because he called the market bottom. But shareholders who received this letter in the mail mostly likely were wondering why the (MMAGX Quote)Markman Aggressive Allocation fund was down 27.7% in 2000. Today, the fund's three-year annualized return of negative 15.8% ranks in the bottom 4% of large-growth funds.

It's one thing to be positive. It's another thing to gloss over poor performance.

Less Is More

In their Nov. 30 annual report, Robert Loest and Gregory D'Amico of IPS Funds do an admirable job of trying to put the events of Sept. 11 into perspective and explain the economic downturn. But a shareholder letter doesn't need to run over 1,600 words and reference everything from the ancient Greeks and the Great Depression to Pearl Harbor and Richard Nixon.

For example, their lengthy diatribe about the supposed misdeeds of the Federal Reserve isn't necessary and doesn't offer much insight or comfort for investors. "It appears to us that the Federal Reserve under Chairman Alan Greenspan has given up on the fundamental faith of America's founders, which is that democratic processes and free markets can achieve on their own fair and moral economic outcomes. Astoundingly, the Federal Reserve led by Alan Greenspan, an Ayn Rand admirer and free market proponent, has become the enemy of free markets," they write.

Such detailed explanations are better than what you'll get from many managers. But a lot of information isn't necessarily a good thing.

These are some examples of less-than-desirable shareholder letters and fund reports. But plenty of excellent ones exist. If you have a favorite or two, let me know. Email me at dagen.mcdowell@thestreet.com.