John LaForge posted an enviable track record over the past five years as a contrarian small-cap stock-picker. He racked up a 15% annual gain in
Phoenix Small-Cap Value Fund, better than most of his peers and way better than the broad market.
Investors who paid a hefty fee for access to his stewardship looked forward to his guidance in this difficult year. And yet many may not know that LaForge, who served as manager of the fund since 1997 from an office in Florida, was quietly fired by
The Phoenix Cos.
on Oct. 31 and replaced by an in-house manager with a subpar record in what the company describes as a cost-cutting move.
His exit provides one more example of ways in which mutual fund companies take advantage of ambiguous disclosure rules, act in ways that benefit professionals over private investors and may actually harm fund shareholders in an attempt to benefit their own company shareholders.
In this case, several financial institutions with funds under LaForge's control learned of his termination in late October, quickly withdrew their money from Phoenix and followed him to his new operation under the aegis of FA Asset Management, a division of investment bank
But private investors and small financial advisers were not informed of the manager change until two months later. And new investors would need to ask the right questions, or read between the lines of a long prospectus, to learn that management of the fund -- with the strong record in Morningstar and Lipper databases -- had changed.
Paul Moroukian, a financial adviser in New York who had personal and client money in the fund, said Phoenix "hardly" told him about the change. Instead, it simply sent him a single form letter on Dec. 8, headlining the fund's new name without articulating any reason for the management switch.
"Phoenix left us in the lurch," he said. "We understand they've got to do what's in the best interests of their company, but at least tell us why it benefits us to substitute a manager with a good track record for one that doesn't
LaForge, moreover, said he has heard from several financial advisers who had recommended the fund to clients that they did not learn of the management switch until they called him to discuss his outlook this year. "They had no idea," he said, noting that advisers are inundated with mail from fund companies, particularly at year's end.
It's About Cutting Costs
Why would a fund company jettison a top performer? A Phoenix marketing representative said the company's relationship with LaForge was terminated in an effort to consolidate operations, not to improve performance. "It's kind of ironic to get rid of a manager who's doing well," but from a cost-management standpoint, it made sense, he said.
If that's the kind of answer you'd expect from bureaucrats at an insurance company rather than entrepreneurs at a dedicated fund-management company, you're onto something.
In the mid-1990s, the board of dowdy Phoenix Home Life Mutual Insurance in Connecticut embarked on a build-and-buy program to create an investment management arm and put a sexy "wealth management" spin on its dull but profitable business. LaForge and his partner Chris Bertelsen were hired to build a core-value product. The company slapped the made-up name Hollister on its small-cap and large-cap funds to give them some class.
At the same time, Phoenix went out and bought whole or majority interests in a series of prominent specialized fund-management firms around the country, including Kayne Anderson Rudnick Investment Management in Los Angeles; Roger Engemann & Associates in Pasadena, Calif.; Seneca Capital Management in San Francisco; and Zweig Advisers in New York.
During the subsequent bear market, the performance of most of the mutual fund products created by those purchased firms was demonstrably subpar.
Phoenix-Engemann Capital Growth, for instance, declined 18% in 2000, 35% in 2001 and 25% in 2002, for a five-year return of -8.9% -- thudding to the 88th percentile of its class.
Phoenix, which too late determined that it had bought into the asset management business at the top of the cycle, began bleeding money and assets. Bears, critical of the company's losses at a time when other insurers were doing fine, pushed the stock down as low as $6 per share in early 2003 from prior highs in the mid-$20s. Shareholders demanded improved expense control, and Phoenix obliged last year by closing down several subsidiaries and consolidating staff.
Although LaForge and Bertelsen had compiled a better record than most of their peers at Phoenix, they were let go last fall as part of the shake-up. The small-cap value fund, minus the Hollister brand name, was then turned over to a manager in the company's Phoenix/Zweig unit, named Carlton Neel, who had previously put in an unremarkable stint prior to 2002 as manager of the small-cap blend fund
Phoenix Appreciation. That fund's return, at 7.1% annualized over the past five years, was worse than 95% of its peers, according to Morningstar data.
It's easy to see now why Moroukian is upset. But it gets worse from his perspective: In addition to handing Neel the small-cap fund, Phoenix also heaped four more portfolios on his plate: Phoenix Appreciation,
Phoenix Market Neutral and two closed-end funds. (The return of the market-neutral fund, which Neel has run since inception, is worse than 81% of peers, according to Morningstar data.)
In other words, Phoenix saved money by piling more work on a fund manager with an already unimpressive record.
And how much of this are new investors told? Very little. In the Phoenix Small-Cap Value Fund's current prospectus, there is no mention of the fact that the 15% annualized five-year record was put up by managers no longer associated with the fund. It would be up to new investors to deduce it by reading the following on page 12: "Since Oct. 31, 2003, Mr. Neel serves as the equity investment team leader for the Small-Cap Value Fund and for the Appreciation Fund of Phoenix Trust."
Likewise, in a 34-page Statement of Additional Information about the Phoenix Small-Cap Value Fund, there is no mention that a change in management has occurred. For all anyone knows, Neel could have been a member of the fund's prior management team, which he was not.
Of course, it's hard to pull this sort of stunt on professionals. So while retail fund owners were forced to accept his replacement or forfeit their 5.75% initial sales charge, LaForge was allowed, with Phoenix's blessing, to take the accounts he managed for state, municipal and labor-union pension funds to his new firm. "Our record was so good that they knew no institutional clients would stay at Phoenix anyway, if they were going to switch their accounts," he said.
Moroukian and other financial advisers are now stuck in the uncomfortable position of having to tell clients they should now exit Phoenix Small-Cap and pay a new 5.75% sales charge to another fund company. He said he has studied the Phoenix/Zweig style that Neel represents and does not think its demonstrably mediocre market-timing and asset-allocation model works.
In fact, he's so frustrated with Phoenix over this change and lack of communication that he's also considering firing the company as his own firm's retirement plan administrator.
Four Big Lessons
The lesson of this saga is at least fourfold: First, get your life insurance from a dedicated insurance company, and get your investment management from a dedicated investment company. Insurers' actuarial approach to business tends not to mesh well with the freedom of thought emblematic of the most creative portfolio managers.
Second, realize that management is critical to an actively managed fund's success. If a company changes the management of your fund, assume the worst and investigate the track record of your new leader.
Third, don't assume a fund company will make changes obvious to you: Study the management section of prospectuses regularly. If anything looks fishy, speak up and ask questions.
Finally, on the regulatory side, investment firms should be required to explicitly state on sales materials and in prospectuses the names of managers most responsible for a fund's track record. Doing otherwise is duplicitous, as prospective clients may be lured into a product under false pretenses.
Jon D. Markman is publisher of
StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at
email@example.com. At the time of publication, Markman had positions in the following securities mentioned in this column: The Phoenix Cos.