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Funds Notebook: New Baron Fund Pays for Visibility in Schwab Supermarket

Ian McDonald

Three or four times each year, Charles Schwab (SCH) heavily promotes a new mutual fund to customers and advisers during the fund's subscription period. In return, the fund's adviser pays Schwab an additional fee beyond what it pays to be included in Schwab's OneSource fund supermarket.

In the latest of these agreements, Schwab has agreed to market the Baron iOpportunity fund, which starts raising money today in a six-week subscription period that ends Feb. 29. During this period, investors can reserve shares at $10. After Feb. 29, investors' money will be pooled and used to launch the fund's portfolio. (TSC first reported on these promotional arrangements in a story last fall.)

Schwab will advertise iOpportunity on the home page of its Web site, as well as in emails to customers and financial advisers. These promotional efforts, slated to start in a couple of weeks, will give the fund greater visibility than the other funds on OneSource. (The fund wasn't listed on the Web site at midday Tuesday.)

Schwab says the agreements aren't a conflict of interest, but they seem to add a tilt to what otherwise appears to be a level playing field among the funds in the OneSource program.

"If they have an enhanced interest in any fund and it ends up with additional promotion, that's a conflict of interest," says Frank Armstrong, president of Miami financial planning firm Managed Account Services and chief investment strategist for DirectAdvice.com.

Schwab disagrees.

"We don't think it's a conflict of interest at all," says spokesman Morrisson Shaffroth. "These [agreements] are opportunities for our clients to get in on the ground floor in interesting funds. There's no sales pressure or incentives to our employees. It's just another example of Schwab being an innovator."

Shaffroth says there's a big difference between Schwab giving a fledgling fund higher prominence and traditional brokers' old-school tactic of boosting commissions on a new fund.

Last fall, for example, PaineWebber (PWJ) upped the payout on sales of its new Strategy fund, which raised a whopping $2.1 billion during a six-week subscription. (For more on this practice, known as dealer reallowance, see a previous story.)

Shaffroth also argues that any extra prominence a fund has on the Schwab Web site should be considered advertising, not an endorsement. He also points out that the agreement is disclosed in fund filings and on Schwab's site. But critics say that expecting investors to discern such a fine line and read small-print disclosures is unrealistic.

"If Schwab puts this [fund] on their front page, people will see it as an endorsement or another reason to buy it. How much of the fine print do you really expect someone to read?" asks Joel Davis, a senior financial planner with American Express Financial Advisors in Portland, Maine.

Despite these concerns, it's worth pointing out that investors who piled into funds Schwab promoted during subscription periods probably aren't complaining. In the past few years Schwab has promoted Janus (JAGLX)Global Life Sciences, Janus (JAGTX)Global Technology, Stein Roe (SRLFX)Large Company Focus and Invesco (IVENX)Endeavor. Each has trounced its average peer since being launched.

And fund companies have had reason to smile, too. Most recently Schwab promoted Hambrecht & Quist's (HQ) IPO and Emerging Company fund, which raised $177 million during a six-week subscription period last fall. Baron (BSCFX)Small Cap raised more than $100 million with Schwab's help in 1997.

Baron's new iOpportunity fund will be managed by Matt Ervin and Mitch Rubin, two analysts who joined Ron Baron on the Baron (BGRFX)Growth fund's management about a year ago. The two will select securities from a buy list maintained by Baron and Morty Schaja, the firm's president.

Magellan Puts Billions in Small-, Mid-Caps

Looks like the small- and mid-cap stock resurgence could be for real. At least Robert Stansky, manager of $105.1 billion Fidelity (FMAGX)Magellan fund, thinks so.

Stansky reduced Magellan's cash position to 3.3% from 7.8% in the fourth quarter, raising the number of stocks the fund holds to 422 from 341, according to the fund's quarterly report, released today. That means Stansky put about $2.8 billion in cash to work, and much of it went into small- and mid-cap stocks, according to David Pitelli, senior analyst with independent newsletter Fidelityinvestor.com.

"Clearly he's liking a lot smaller names and is expecting a significant broadening beyond large-caps," Pitelli says. Other Fidelity funds, including (FDGRX)Growth Company and (FMILX)New Millennium, made similar, if less pronounced, moves.

No matter what moves Stansky makes, Magellan will probably lose its title as the nation's largest fund in coming weeks. The folks at Fidelityinvestor.com and their counterparts at another newsletter, The Independent Advisor for Vanguard Investors, say Vanguard (VFINX)500 Index is just $400 million behind Magellan, which is closed to new investors.

Merrill Expands Net Fund Strategy

Merrill Lynch (MER), which dipped its toes into the Internet fund waters last fall, is now going in at least waist-deep, if not further.

The brokerage giant plans to launch Merrill Lynch Internet Strategies, an actively managed mutual fund, in mid-March. This move follows the launch last September of a different kind of Internet investment vehicle, Internet HOLDRs (HHH), which invests in a fixed basket of 20 Net stocks and trade on the American Stock Exchange. (For the latest on Merrill's HOLDRs, see today's Dear Dagen.)

Paul Meeks, who manages Merrill's (MBGTX)Global Technology fund, will lead the Internet Strategies fund's management team. Meeks posted an 86% return last year, but his fund lagged the average tech fund by more than 48 percentage points, according to Morningstar.

Like many recent offerings, the Internet Strategies fund isn't limiting itself to "pure play" Net companies. According to its filing with the Securities and Exchange Commission, the fund will invest in companies whose businesses focus strictly on the Net, but it also can invest in "Internet-related" companies developing a Net strategy that could significantly reduce costs and/or boost profits. Translation: The fund could hold both Yahoo!(YHOO) and Wal-Mart(WMT).

An offshore version of the fund for foreign investors was launched in November. While the fund might have trouble getting noticed among a growing Net fund crowd here at home, the offshore version already has more than $1 billion in assets, according to a company spokeswoman.