American Heritage Fund Back on Top Despite Unorthodox Practices

After a long period in doormat territory, the (AHERX Quote)American Heritage fund is back on top.

This unusual fund, best known for keeping nearly three quarters of its assets in one stock, British pharmaceutical maker Senetek (SNTKY Quote), is returning 69.2% this year and ranks No. 1 among all funds through Jan. 20, according to Lipper.

But before you break out your checkbook, consider that American Heritage's outsize bet on Senetek is just one of its uncommon characteristics. Its regulatory filings disclose an inordinately high turnover rate, a result of manager Heiko Thieme's foray into short-term trading (also known as daytrading) with a portion of the fund's assets. Thieme also appears to have made the vast majority of these trades through a broker/dealer he owns. And he also has acted as a consultant for companies in the fund's portfolio.

None of these practices appear to be illegal, and all are fully disclosed in shareholder materials filed with the Securities and Exchange Commission. But they also shatter industry convention.

An SEC spokesman said Friday the commission would not comment on a specific fund.

Still, it's unlikely this fund has escaped scrutiny. "It's a fund that would attract attention from the average regulator or lawyer or (fund) board member," says Pamela Wilson, an attorney specializing in mutual funds with Hale & Dorr in Boston who has never represented Thieme.

American Heritage's ultra-aggressive style and roller-coaster returns -- it was the top-returning fund of 1997, but spent 1998 and 1999 near the bottom of the rankings -- already have scared off most investors. It has only $6 million in assets, down from more than $160 million in 1994, says Thieme. But it does deserve a look as perhaps the industry's greatest curiosity.

Feast and Famine

The affable, 56-year-old Thieme, appears to relish his feast-or-famine style. He says two trophies stand side by side on a mantle in his office: the 1995 Steadman Award for trailing all but three funds with a minus-30.6% return and the 1997 Phoenix Award for leading all funds with a 75% return. Both were won by virtually the same portfolio, he boasts.

American Heritage's swings in fortune are enough to induce vertigo. It was among the top five funds of 1991 with a 97.2% return and had good years in 1992, 1993 and 1997. But it has produced negative returns in six of the past 10 years, and lost a staggering 61.2% in 1998, trailing the S&P 500 index by nearly 90 percentage points.

A Fund That Puts the Checkered in Checkered History Annual returns for the (AHERX Quote)American Heritage fund in the 1990s.
Year	Return	Rank among all stock funds
1990	-30.8%	882 of 891
1991	97.2	4 of 1,007
1992	19.3	104 of 1,161
1993	41.4	99 of 1,476
1994	-35.3	2,008 of 2,011
1995	-30.6	2,781 of 2,784
1996	-5.1	3,465 of 3,508
1997	75	1 of 4,595
1998	-61.2	5,867 of 5,868
1999	-31.6	7,119 of 7,126
Source: Lipper

Thieme says he began buying Senetek, maker of erectile dysfunction and skin treatments, in private placements back in 1992, and has paid from 60 cents to $6 a share. About 70% of the fund's assets are invested in the stock. It closed Friday at 2 23/32, up 93.3% for the year.

No other mutual fund except American Heritage's slightly less-risky sibling, the $1 million (AHEGX Quote)American Heritage Growth fund, currently holds Senetek shares, according to Morningstar.

The fund has a 21.8% stake in No. 2 holding, ADM Tronics (ADMT Quote), an Italian maker of chemical products and medical devices. Shares of this OTC bulletin board stock trade for about 40 cents each and are up 187% this year. Thieme says he began buying shares eight years ago.

Frequent Trading, High Costs

But what goes on behind the scenes is even more unique than the fund's stock picks or returns.

"We may engage in active and frequent trading," says the fund's prospectus or owner's manual. That might be the early leader for understatement of this young century.

The fund's turnover ratio -- the percentage of the portfolio that changed over in the past year -- topped 1,000% in each of the past two fiscal years ending May 31, according to the filing. The average stock fund's turnover ratio is 89%, according to Morningstar.

About 50 funds have turnover rates of 400% or higher, and only three top 1,000%, according to Morningstar. American Heritage's rate is "ridiculous," says Tom Hearden, senior equity trader with Strong Funds in Milwaukee. "It's just extremely unusual for a mutual fund, to say the least."

How did turnover get so high when two stocks have dominated the portfolio for years?

Thieme says he has used 10% to 20% of the portfolio for daytrading. He says he discontinued the practice last year because he lost confidence in his ability to add value through quick-draw trading.

But where Thieme traded is as interesting as how often. In the year ending May 31, 1999, about 94% of all of the fund's commissions went to Thieme Securities, a broker/dealer he owns and runs, according to the fund's statement of additional information (SAI) a document available to shareholders by request.

It's not unheard of for funds to allocate trades to an affiliated brokerage, but that allocation is often in the 50% range, says Hale & Dorr's Wilson.

"It's perfectly OK as long as your commissions aren't higher than anyone else's and the price execution is best. But it's hard to make the case that this broker is best nearly all the time," she says. She adds that a recent SEC report found the average fund's trading commission to be about five or six cents per share.

Thieme says he usually trades with his own brokerage because his orders are often modest and he has better control of execution there. But Thieme also says his fund pays 10 cents per share for its trades.

The fund paid $444,766 in commissions to Thieme's brokerage for the year ending May 31, 1999, and more than $990,000 the year before, according to the SAI. Those commission costs come out of the fund's assets and don't factor into its high expense ratio, currently 5.85%, compared with an industry average of 1.5%, according to Morningstar.

Thieme blames the expense ratio, which was as high as 8.9% last year, on the fund's meager assets, noting that many expenses are the same for funds large and small. In 1994, when assets topped $100 million, the annual expense ratio was lower, 2.4%, but still higher than average.

Expenses are "immaterial," says Thieme, because fund returns are calculated after expenses are paid. Nevertheless, investors in this fund need almost a 6% return just to break even.

Another Thieme-owned business, Thieme Consulting, overlaps with the fund as well. Thieme has advised companies whose stocks are in the portfolio for compensation, according to the SAI. Thieme says he's advised Senetek for free and received stock warrants from ADM Tronics for his advice. The warrants currently have no value, says Thieme.

Most fund companies have policies strictly limiting the degree to which their managers and other employees can be affiliated with outside companies, particularly those that may end up in a fund's portfolio. The limits are intended to reduce the potential for bias in a manager's decision-making.

Clearly these practices are counter to the norm, but industry lawyers say their full disclosure in the fund's filings go a long way toward insulating Thieme from repercussions.

"It's not necessarily problematic, but it raises a potential conflict. You can remedy that by disclosing it, which it sounds like they've done," says a senior attorney with a Boston fund shop.

Fund Discloses All

For his part, Thieme, who left Deutsche Bank to buy the fledgling fund shop about 10 years ago, embraces disclosure. He once ran an ad headlined "Don't buy my fund," pointing out its significant risks so uninformed investors wouldn't chase the fund for its occasional hot returns.

During an interview he breaks the mold again, asking a reporter not to note his fund's surging performance. He fears short-term money will flood in and out of the fund as it inevitably rises and drops.

He says he's not in the money-management business to make money, but to build a legacy as a money manager. But he admits some may look at this methods and record and call him an "idiot or an eccentric."

"Let's say I owned Qualcomm (QCOM Quote) and Microsoft (MSFT Quote) instead of Senetek and ADM Tronics. Then people would say I was a genius," says Thieme.

No matter how you feel about Thieme's methods or his roller coaster fund, at least he's along for the ride. He says he's among the largest shareholders in American Heritage and American Heritage Growth.