Where to Turn When a Fund's Board Doesn't Measure Up

Also, Vanguard Health Care's redemption fee, finding a fund to match your stock picks and the outlook for high-yield munis and corporates.
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A compilation of this week's daily Fund Forum columns.

Some people might accuse mutual fund investors of being lackadaisical when it comes to their funds' boards of directors. Who cares, right?

That is obviously not the case with some

TSC

readers, some of whom expressed their concerns following my recent

column on the difficulty of tracking down a fund's directors.

The

Securities and Exchange Commission

"should make it simple and require the information in the annual reports and prospectuses just like a publicly traded company. The information is always useful," writes

Patrick Scaglione

.

"I absolutely am concerned about fund directors and the current approach whereby they do

not

protect the stockholders and apparently are overpaid for services rendered," bemoans

Albert Crawford

. "To whom should I voice my concerns and recommendations?"

Indeed, who do you turn to when you feel a fund's board doesn't measure up?

"Start at the top by all means," recommends Pamela Wilson, an attorney with

Hale and Dorr

in Boston.

Try calling Paul Roye, director of the investment management division at the SEC. The general SEC phone number is 202-942-4144.

The SEC conducted a two-day roundtable last week on the role of fund directors. Roye, the fund industry's chief of police, is preparing a report on the results that will be submitted to SEC Chairman Arthur Levitt within the next 30 days.

You also can try contacting the SEC electronically. On the

SEC's Web site under "Investor Assistance & Complaints," you will find information on how to contact the Commission's Office of Investor Education and Assistance via email. There also is a fax number, another phone number and the mailing address.

Before turning to the federal authorities, you may want to try writing a fund board's chairman or the directors themselves, says Wilson. You can find addresses for the chairman and each director in a fund's statement of additional information. That is precisely why those addresses are there, she adds. (You could also mail any letter care of the fund company, and it should eventually reach that director.)

Remember, a statement of additional information, or SAI, is not typically mailed out to a fund investor. You must specifically request it from a fund company or search for it in the SEC's

Edgar database.

If you are going to fire off an old-fashioned, paper-and-stamp letter, you may want to send a copy of it to the SEC as well, just to make sure you are getting your point across.

Reader

Bill Petersen

thinks, "At least the chairman ought to have a public email for shareholders. Compliments and complaints are never acknowledged by the normal 800 numbers."

Perhaps that is a suggestion someone should make to the SEC.

Vanguard Health Care's Redemption Fee

A friend of mine and a shareholder in

(VGHCX) - Get Report

Vanguard Health Care emailed me yesterday protesting a recent change in the fund's policy that was announced the same day the $10 billion fund

closed its doors to new investors.

Starting April 19, Vanguard will impose a 1% redemption fee for shares sold within five years of purchase, Vanguard said last Thursday.

The new policy applies only to shares purchased on that date or after. The 1% fee already was in effect for shares sold within one year. But FIVE years?

Vanguard implemented the five-year back-end fee to thwart short-term investors who are chasing hot performance, says spokesman John Demming. "We think five years is most appropriate to make it clear to those who are using it as a short-term trading vehicle that they aren't welcome."

I guess it depends on how you define short-term.

Dramatic inflows and outflows can indeed put a burden on existing long-term shareholders in the form of trading costs, realization of unwanted capital gains and disruption of normal investment operations of a fund.

But a back-end fee that lasts for five years also can put a kink in an investor's plans. What happens when an investor experiences a liquidity crisis and needs to sell shares to raise cash? In theory, a shareholder would be penalized when reallocating assets in a portfolio or selling to capture a loss or gain for tax reasons.

"It is ridiculous," says Robert Levitt of

Levitt Novakoff & Co.

in Boca Raton, Fla. The firm "should be able to eliminate market timers with a 90-day holding period."

Other Vanguard funds with such a restriction include its Tax Managed funds, which also carry a 1%, five-year holding fee. (The fee is 2% for shares held less than one year.) Its

(VWEHX) - Get Report

High-Yield Corporate bond fund carries a 1% fee for shares held less than one year. "One percent for one year is reasonably effective. Five years is very effective," says Demming.

Don't get me wrong. These fees are not loads. Any money earned off them does not go to Vanguard. Those fees are paid back to the respective fund rather than to the corporate parent.

On the plus side for investors, the fund company just lowered the up-front purchase fees on some of its index funds. Vanguard has eliminated the 0.25% purchase fee on its

(VIMSX) - Get Report

Mid-Cap Index fund and reduced the fee on the

(VISGX) - Get Report

Small-Cap Growth Index and

(VISVX) - Get Report

Small-Cap Value Index funds to 0.5% from 1% each. Again, these fee aren't loads, and they go back into the funds to cover transactions costs.

Still, this five-year holding fee for the Health Care fund caught some investors off guard. Is Vanguard trying too hard to make investors behave in the way it sees fit?

I'd like to hear your thoughts. Email me at

fundforum@thestreet.com, and please include your full name.

More Closed-End Sites

For those of you who were not satiated by the list of closed-end fund sites I offered

last week, several readers have suggested a few more.

A few readers wrote in to praise

Site-By-Site for its

closed-end fund data. "I looked long and hard before finding this jim-dandy of a freebie!" gushes reader John Hampton.

You will need

Adobe Acrobat Reader to see the site's Weekly Review, but it's worth the download. Every issue, covering the universe of closed-end funds, includes information on net asset value, market price, a fund's premium or discount and loads of additional information. (

Wiesenberger

provides the data.) You also will find a downloadable Weekly Commentary.

The site also delivers an alphabetical list of closed-end funds with links to snapshots for each portfolio and a roster of links to closed-end fund company home pages.

Some readers recommend sites run by individual fund companies, including

Adams Express.

Reader

Jason Rasp

uses

Morningstar for both closed- and open-end fund information. "On closed ends, you have to subscribe to the site in order to get some of the information, but a good portion is readily available for free."

Readers Sound Off On Vanguard Fee

Like the debate over indexing vs. active management, the

(VGHCX) - Get Report

Vanguard Health Care fund's new redemption policy has sharply divided investors.

When Vanguard announced that it was closing its $10 billion Health Care fund last Thursday, it also revealed a new redemption fee policy. Beginning April 19, the firm will impose a 1% redemption fee for shares sold within five years of purchase. The policy applies only to shares purchased on or after that date. A 1% fee already was in effect for shares sold within one year.

Vanguard says the new redemption policy is intended to screen out "hot money" from short-term investors who are simply chasing the current returns. And it's worth reiterating that the new policy does

not

apply to existing shares or any shares purchased before April 19.

But in Tuesday's

Fund Forum, I suggested the policy might penalize long-term investors facing a liquidity crunch, wanting to reallocate assets or selling shares for tax reasons. Many of you have your own concerns and complaints.

"I stopped the $1,000 automatic monthly amount that I had going into the fund since five years is just

way

too long a time for someone like myself who is about to retire," says reader

Van Nelson

. "What if the fund starts performing poorly? The 1% fee has a tendency to make one reluctant to switch funds. Fortunately, the money presently in the account is grandfathered into the older one-year hold for no fee."

"Although I've been invested in Vanguard Health Care since 1995, the five-year waiting period is troubling," says

Ken Clepper

. "One of my biggest concerns with this investment is the possibility of some big government-run health-care system should the Democrats retain the White House and take control of one or both parts of Congress. If this were to happen, I'd be running for the hills with my redemption."

Reader

Daryl Nichols

hit the pavement a while ago. "I was in Vanguard's

(VWEHX) - Get Report

High Yield fund back in the early '90s when they first implemented their l% redemption fee. I was in

T. Rowe Price's

(PRHYX) - Get Report

High Yield fund when they put in their 1% redemption fee. My response was the same both times: Goodbye, Vanguard fund. Goodbye, T. Rowe Price fund," says Nichols. "Mutual fund companies crow about how easy it is to move money between investments, and then they put the handcuffs on you. Not on this investor they don't."

Then there are those investors who are standing in the opposite corner.

"In my view, redemption fees are justified if they achieve their purpose and, most importantly, if they are well known to prospective investors," writes

Frank Lagemann

.

Shareholder

Michael Randall

says, "You asked, 'Is Vanguard trying too hard to make investors behave in the way it sees fit?' The simple answer is yes. But investors who read the prospectus already know this is a long-term vehicle when getting into the fund, so it doesn't matter." Randall continues, "They could jack it up to 10 years for all I care.

Fund manager Ed Owens will continue to do a magnificent job for those who are willing to indeed stick to a long-term plan. Besides, it's not like there are only a handful of funds out there. If you don't like what you're watching, change the channel."

Jonathan Sherman

seconds that notion. "If you're uncomfortable with the five-year time horizon, invest elsewhere. That's the beauty of an efficient marketplace."

For now, investing elsewhere is the only option for those who don't already own shares of the fund. Vanguard says the fund will remain closed for at least six months, but probably not more than one year. Meanwhile, current shareholders still can invest up to $25,000. And periodic investments by current shareholders in automatic investment or retirement plans can continue "at current levels," says Vanguard.

A Fund To Match Your Stocks

I have a basket of about 20 stocks I'm interested in investing in. I would like to find a fund that most closely mimics my basket of stocks. Of course, I am assuming the most effective way to invest in all of these companies would be to buy into a mutual fund, rather than buying individual allotments. That may not be the case. -- Kat Reilly

Kat,

Buying a single mutual fund may sound easy, but it may not be your best choice.

I don't know the stocks you want to buy or the details of your personal situation, but you should consider the following issues in making your decision.

Finding a Compatible Fund

Trying to locate a fund that owns all the stocks you want to buy may be your biggest hurdle. If your 20 must-haves all are large-cap growth names, the search may not be as hard. But it will be virtually impossible to find a fund that owns all of these stocks at the same weights in which you want to own them, says Robert Levitt, a financial adviser with

Levitt Novakoff & Co.

in Boca Raton, Fla. Almost any mutual fund will likely own more than just these few names. You might be able to locate a fund that owns them but it may also hold 50 others.

Most investors will buy an actively managed fund to let the manager make the investment decisions. You've already decided what you want. Why pay for the manager's expertise? Even if you do find a fund that owns your stock picks, you have no way of knowing if or when the manager is going to sell them.

Cost

You should consider how much buying these 20 stocks will cost you compared with purchasing an individual fund. By buying the stocks individually, can you get enough diversification at a reasonable price? Do you have enough money to invest that the transaction costs won't dramatically deplete your assets?

Just a few years ago, buying a small basket of stocks might have been prohibitively expensive if you didn't have a big block of money to invest. But that barrier has fallen with the birth and rapid growth of online trading. "Three years ago I would have said, 'Yeah, absolutely buy a mutual fund.' But things are changing so dramatically with online trading," says David Foster, a financial planner with

Foster & Motley

in Cincinnati. Still, if you are trying to buy from a full-service broker, that firm's commissions might consume your assets.

"If your portfolio is large enough, mutual funds are expensive relative to buying individual stocks," says Bruce White, an investment counselor with

Clifford Associates

in Pasadena, Calif. When buying individual stocks, you pay the up-front purchase price but there are no other direct carrying costs. In a mutual fund, you are paying an annual fee to own shares of that portfolio, plus the fund's trading costs come right out of the net asset value, or NAV.

Here is an example: Paying $20 to buy $20,000 worth of one stock is nothing. That is 0.1%. But if you are only investing $200 in one stock and the commission is the same, you are spending 10% up-front in commissions.

Simply, the size of your portfolio drives your choice. It is more efficient to own individual stocks in an larger account, says White. If you have a small portfolio, however, you may be able to own a broader array of stocks and achieve greater diversification via a mutual fund.

A Manager of Your Ilk

You may want to sit back and take a look at the stocks you want to buy to see what they have in common. Try to discern the style of your basket. Do all of these stocks fall into a particular investment approach, such as small-cap growth or large-cap value? Perhaps you are looking for a manager who has your same investment philosophy. That way you wouldn't have to comb through the holdings of dozens of funds, and it would make your search for a fund easier to conduct.

If your 20 favorites all fall within the same industry, say, Internet stocks for example, then a mutual fund may be better for that, says Bruce White. In that situation, "you are really betting on the sector rather than those individual companies. That kind of bet is difficult on your own."

Your Goals and Risk Tolerance

When you are making any investment decision, you should assess your goals, your risk tolerance and how that investment fits into the rest of your plan. Can you afford to put your money into equities?

How many years is the money going to be invested? "If it is less than five years, it does not go in the equity market," says Ron Roge,

R.W. Roge & Co.

in Bohemia, N.Y.

If you have a lower tolerance for risk, you may want to think about a diversified mutual fund. "What is your goal in terms of selecting 20 stocks?" he asks. "You might want to take a look at some of the focused funds out there," which invest in relatively small baskets of stocks.

The Tax Man

Tax concerns inevitably walk a few steps behind any investment decision. With individual stocks, you will likely have more control over your realized capital gains and losses. If you have any specific tax questions, email Tracy Byrnes, our tax columnist, at

taxforum@thestreet.com.

For more on advice on how to choose funds, start by reading Brenda Buttner's

series in our Basics section.

High-Yield Outlook

What is the outlook on high-yield municipal bonds relative to high-yield corporates? -- David Blair

David,

High-yield municipal bonds benefit from the same general conditions that high-yield corporate bonds benefit from: strong economic growth, healthy corporate balance sheets and rising stock prices. So if you believe the 8-year-old expansion can continue, it stands to reason that muni high-yields should also do well, right?

Partially.

Last week's

column explained that many strategists consider taxable high-yield bonds a buy because, even though yields have come down from the super-high levels of last fall, they continue to offer a substantial premium over the alternative -- risk-free Treasury bonds.

The chart below illustrates the phenomenon. The difference in yield between the average taxable high-yield fund and the average Treasury bond fund tracked by

Lipper

is at levels not seen since 1991.

With municipals, the comparison is different. High-yield munis are compared not with Treasuries (since it's assumed that if you're buying munis, it doesn't make sense tax-wise for you to buy taxable bonds) but with top-quality munis. Of course, even top-quality munis aren't considered as safe and liquid as Treasuries. Still, on the tax-free side of things, they are the alternative to high-yield.

Top-quality munis are a much more attractive alternative than Treasuries are to taxable high-yield, as it turns out. In stark contrast to the situation on the taxable side, the yield premium that the average high-yield muni fund offers over the average insured muni fund (a proxy for the top-quality sector, since insured munis carry the highest rating) is slimmer than it's been at any time in the past nine years. Compare this chart with the first one:

The difference exists for several reasons, muni market participants say.

First, taxable quality spreads widened out in the fall not just because high-yield bond prices crumbled, but because long-term Treasury yields dived to 30-year lows as investors reached for safety and liquidity. Top-quality munis may offer safety and liquidity relative to other munis, but they're not Treasuries. Also, the tax exemption that makes munis so valuable to wealthy Americans isn't worth a dime to anybody else, so munis lagged while foreign buyers helped propel Treasury prices higher.

At the same time, the supply of high-yield munis has been shrinking as strong economic growth has improved the credit quality of many municipal issuers. A measure of this, the ratio of upgrades to downgrades by credit rating agencies has been positive for four years running and hugely positive for each of the past two years. At

Standard & Poor's

in 1998, the dollar volume of upgrades exceeded that of downgrades by a ratio of nearly 9 to 1. "There's not a lot of traditional munis in a distressed state these days," says Richard Ciccarone, co-head of municipals at

Van Kampen

.

Also, whenever interest rates in general are falling, as they have been for the past several years, demand tends to grow for the highest-yielding issues, which causes further spread compression. "Investors look for return anywhere they can find it," says Chris Dillon, municipal strategist at

J.P. Morgan

. "People are adding exposure to high-yield in pursuit of more income."

Bottom line: Even if you think a strong economy will continue to benefit high-yield munis, they simply don't offer much value right now. That's certainly the view

Vanguard Group

is expressing by running

(VWAHX) - Get Report

Vanguard High-Yield Tax-Exempt with an average credit rating of A-plus. When high-yield munis offer good value, portfolio manager Reid Smith says he'll drop the fund's average quality as low as A-minus.

And if you are at all concerned, as Smith is, that the economic expansion may falter, causing high-yield muni spreads to widen further, you really might think twice about buying them now. High-yield taxable bonds, by contrast, are at least compensating you for that risk.

Bond Funds Down Under

I was surprised that in discussing the risks of First Australia Prime Income (FAX) - Get Report, you did not mention that it employs substantial leverage. You also did not mention Kleinwort Benson Australia Income (KBA) - Get Report, which is trading at a 20% discount as opposed to FAX's 14%. Finally, you didn't mention that Prudential Securities, whose analyst you quoted as recommending the fund, is the fund's underwriter. These all seem to be important facts for your readers to know in understanding FAX. --Alexis Aniatis

Alexis,

All true, but I believe I can redeem myself.

First let me say that it will not always be possible for me to explain every aspect of every investment I write about, and that no one should buy anything solely on the basis of what he or she reads here.

Yes, FAX employs leverage, and yes, that increases its volatility, but the fund's leverage ratio actually dropped after its rights offering, from about 31% to about 26%, since the new assets are not being leveraged. That makes it less leveraged than most leveraged closed-end funds, which typically leverage themselves up to their limit of 33% or 40%, says Mariana Bush, closed-end fund analyst at

Everen Securities

.

As for KBA, yes, it trades at a steeper discount (15.6% as of last Friday, vs. 9.54% for FAX), but it's a different kind of fund and it has a much lower yield. Because it sticks to Australia and New Zealand government bonds and doesn't employ leverage, it yields 7.18% vs. 12.26% for FAX. Discounts are typically wider for lower-yielding funds.

Finally, yes, Prudential is the fund's underwriter, and I ought to have mentioned that and will in the future, but analyst Kristoph Rollenhagen's view on the fund doesn't stand out. The other two firms that follow the fund -- Everen and

Gruntal

-- also strongly recommend it, and Rollenhagen (who downgraded the fund to hold in December 1997) was the last of the three to act.

Elizabeth Roy answers your bond fund questions every Friday. Dagen McDowell answers general mutual fund questions Monday through Thursday. Send questions on either topic to

fundforum@thestreet.com, and please include your full name.

TSC Fund Forum aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.