Unusual, Novelty Funds Confuse Investors

(Correction: An earlier version of this article incorrectly identified the Roosevelt Multi-Cap Fund (BULLX) as the Roosevelt Anti-Terror Multi-Cap. The fund's advisor has discontinued the use of a screening process for companies that do business in Iran, Syria, Sudan or North Korea. More information on the fund is available at www.rooseveltmcf.com.)

BOSTON ( TheStreet) -- There was the StockCar Stocks Index Fund ( SCARX), the Blue Fund and the Golf Mutual Fund.

They are no longer with us, victims of niche marketing gone awry in the worlds of exchange traded funds and mutual funds. The StockCar Stocks Index Fund, formed in 1998 with NASCAR fans in mind, held shares of companies that sponsor the colorful cars. The Blue Fund offered investments consistent with liberal ideology, and the Golf Mutual Fund had positions in companies surrounding that sport.

The multiplying array of exchange traded funds and mutual funds are increasingly presenting investors with the challenge of separating novelty, or "flavor of the month" funds, from broad-based vehicles that consistently make money year after year.

According to the Investment Company Institute, 149 ETFs were launched in 2008 and 50 closed shop. There were 797 ETFs by the end of 2009, when 120 entered the marketplace and 49 left. In 2008, 704 mutual funds were created, compared with 321 that closed. In 2009, launches were outnumbered by closures, 457 to 488, and 336 funds merged with others.

The StockCar Stocks Index Fund presents a good example of the limits of niche funds. Numerous companies dropped out of NASCAR and, in turn, were dropped from the fund, hurt by the economic recession. Ever-changing holdings, however, weren't the only cause of the fund's demise. Over the years, its assets rarely topped $6 million.

Nevertheless, uniquely narrow funds are still doing their best to lure assets.

There are ETFs dedicated to specific states, with the Oklahoma Exchange-Traded Fund ( OOK) investing in its homegrown companies, and the TXF Large Companies ( TXF) ETF is doing the same for the Lone Star state.

The Vice Fund ( VICEX), with its focus on alcohol, gaming and tobacco stocks, is often compared with faith-focused options like the Timothy Plan family of funds that hold companies deemed to best reflect conservative Christian values.

And the Congressional Effect Fund ( CEFFX) invests in the S&P 500 on days when Congress is out of session and switches to domestic securities when it resumes.

Financial professionals often dismiss such funds as risky and lacking sound fundamentals. But are they really that much different from well-respected ETFs that, for example, index to water-related companies ( PowerShares Water Resources ( PHO)) or focus on coal ( Market Vectors Coal ETF ( KOL))?

There can be a big difference, says Howard Present, chief executive officer of Massachusetts-based F-Squared Investments. He recalls heading new-product development for a major financial firm when he was pitched the StockCar Stocks Index Fund.

"We rejected it because there was no investment benefit or mandate," he says.

As for the plethora of funds to choose from, he sees the challenge in separating quality from quantity.

"What was the intent behind the design?" he says. "If it was done predominantly for marketing purposes, then it should be taken behind the tool shed and put out of its misery. If it was designed because there was a targeted investment benefit, that there was a large enough group of investors they thought could utilize it, then it is fine. Some very successful, very valuable products never get very big because they are narrowly defined. Others have gotten very large and they are lousy products because they were really designed with a marketing premise first, instead of an investment concept or validation."

Dan Weiskopf, who focuses on ETF research and strategy for New York based Forefront Advisory, suggests that investors can evaluate new funds by following the early progress of its launch, specifically how it trades in the aftermarket.

"There are too many funds which have market caps of less than $20 million and just linger in hopes of a catalyst occurring," he says.

He says most ETFs take a minimum of six months to launch and, with seed capital more difficult to access, many have been stuck in registration for years.

"Launching an ETF and a new fund family is not as simple as people think," he says. "Most new launches this year have been broad in scope offering access to small cap country funds, fixed income funds and commodities. Since fees remain under pressure most new launches are being driven by clear differentiation or a rounding out of a product line. I don't think any of the larger firms are anxious to launch narrow ETFs, since simple unit growth does not leverage the channel of distribution. Distribution is becoming very critical because demand is coming from different sources - institutional, hedge funds, RIA and wire houses."

-- Reported by Joe Mont in Boston.

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