Gurus: The Watchdog

FundAlarm.com may not be a household name, but the Web site, founded by Roy Weitz in 1996, has an influence more powerful than the 125,000 user hits the site receives a month, (about a third of them are on the site's discussion boards). It is a favorite of financial journalists and even regulators. Weitz, who is something of a rolling degree-gathering machine (he has an BA in English, a law degree and an MBA), launched the site when he was “between jobs” and touring around the Internet. It didn't take long for him to realize that there was precious little information on when to sell a mutual fund. You can get lots of data that will help you buy a fund, but it's less easy to divine when the time is right to unload a particular fund and redirect the money to some other manager.

FundAlarm.com is noncommercial — he solicits donations on the site — and fiercely independent. Weitz, who works as the investment manager at a Los Angeles foundation, ranks funds in four categories: no-alarm funds, one-alarm funds, two-alarm funds and three-alarm funds. Three-alarm funds are the ones investors should consider selling, Weitz says. But there is a special ring in Weitz's Circle of Hell that he calls, “most alarming” three-alarm funds. That status is achieved by chronic underperformance of the fund's benchmark on a three- and five-year basis. The other big factor that can push funds closer to the center of Hell is a “nonpromising” manager change. Weitz puts his money where his mouth is: He too invests in mutual funds, both passive and managed, and even allocates his foundation's money into mutual funds.

Registered Rep.: Don't want to attack your reason for being, but isn't there plenty of negative information on funds available these days?

Roy Wietz: Yes, but Morningstar and others are more on the buy-side and the information isn't specifically served up in a way that helps people decide whether to sell or not. The other thing was to follow some of the factors that go into the sell decision, such as manager changes. Morningstar does a pretty good job covering manager changes but once they appear, they're gone. They don't have an archive of manager changes. So that was one of the other things that I thought might be useful for investors, to be able to go back and see a permanent archive of manager changes. Maybe that could explain why funds should be sold.

RR: Who are your readers?

Wietz: I only know to the extent that they get in touch with me. I do get a lot of email, and so I have some sense of who they are from the email. But I've never done any surveys; I don't do cookies. But the readership varies from the very, very unsophisticated individual investors to the sophisticated professional advisor. So it's interesting that that diverse of a group actually seems to find something on the site that's useful to them.

There are two ways people enter the site. One is just data; some people simply want to view the data that I collect. And the other is for the commentary I provide. The data are really selected and designed to help people make the sell decision for a mutual fund. And the commentary side is just where I have some fun. It's really designed to poke some fun at the industry and point out some of the areas where the industry could improve.

RR: And do you have the sense that what you say is being heard by the big firms or by regulators?

Wietz: It's read at the SEC for sure. I have a lot of names on my mailing list, and I have gotten communications from the SEC, and there's been a couple of coincidental investigations that sort of have followed Fund Alarm items. I can't say for sure that the items triggered them but the timing has been coincidental in years past.

And I know that it's read very closely by financial journalists. Some of the stories that I cover can trigger other stories in the mainstream press, which is great. I mean that's one of the things I hope will happen. I don't have the resources to really do in-depth reporting or talk to sources or even cultivate sources. But, you know, professional journalists do.

The Scandals

RR: Well, let's not beat around the bush: Do you think mutual funds are still worth it?

Wietz: Yeah I do, I mean, I really do. I think mutual funds, certainly for the self-directed individual investor, are the best deal out there, bar none.

RR: Let me play devil's advocate for a moment. Isn't this market-timing scandal overblown? Can a group of brokers market-timing a few thousand shares here or there really have such a big impact on some of these gigantic funds and their individual managers? Isn't this just political opportunism or a symptom of the bull-market-is-dead-and-someone-has-to-pay mentality?

Wietz: I really strongly disagree. I did an item — I think it was last month or a month before in Fund Alarm — that showed there's basically a formula that you can use based on redemptions and sales. I can look it up if you want, but there's a formula that you can use that pretty much with 100 percent accuracy can identify timed mutual funds. You look at turnover in the portfolio. Imagine that you have a fund with a $1 billion in assets and it has $12 billion in turnover. How can that not cost investors money in just terms of the transaction costs for the long-term investors or in missed opportunities? Managers are forced to keep cash to meet redemptions and abusive trading can be a distraction — forcing the manager to constantly buy and sell to generate huge amounts of cash.

And some of these market-timers weren't small investors. Some were moving hundreds of millions of dollars, sometimes in days. I've never worked at a mutual fund. But I have a good enough feel for the back room in mutual funds to know that when you move a few hundred million dollars — in and out — several times a month, there are costs involved.

RR: Still, no investor has received a cent. They still haven't figured out who to pay and how much.

Wietz: Right. Yeah, I was very disappointed. I've been very disappointed in how it's all worked out. I mean if you had told me on, I think, Sept. 3, 2003, when it started that nobody was going to go to jail and that as of March 2005 essentially no money would be distributed to investors in restitution, I just wouldn't have believed you. So I mean I think Spitzer — I'm reluctant to say — I think he did good on balance. I think what he did was positive, but I think he clearly was motivated by politics here, and I think he let investors down ultimately by not pursuing some of these cases. I think if you don't send some of these people to jail you don't send a message.

RR: Still, how much does the average fund investor get paid? To make it easy, just spread it out equally: What would the remuneration be per investor?

Wietz: Yeah, that's one of the problems with this scandal. If I had to come up with an average number I'd say $150 per fund investor. Which doesn't sound like a lot of money. That's just a ballpark number. But this is a business where you take $150 times several million investors and you've got some serious money. It's one of the problems with mutual funds expenses, you know. The difference between a 50-basis-point management fee and a 55-basis-point management fee doesn't sound like much.

RR: But over time …

Wietz: It's a huge amount over time, and it's a huge amount to the manager, because you're dealing with small amounts spread over a very big base, and I think that's what you had in the market-timing scandal. So one of the reasons the fund companies just weren't totally obliterated from the scandals was that people had a sense, aw, it's just a few pennies here and there. And even if it was a few dollars, people didn't get that upset.

But if you thought about a bank manger dipping into your checking account every month to take a dollar out, guaranteed you'd be upset. And that's not a far-fetched analogy here. It's the exact analogy. They were dipping into your account and taking money out of it.

RR: But still, it's a trifling amount of money.

Wietz: Well, yeah, and large-cap equity fund investors at Putnam probably lost less, I mean certainly lost less. Yet, I still don't think it is a reason to dismiss the scandal.

RR: What about the whole revenue-sharing thing? Broker/dealers are now getting fined by regulators along with fund companies.

Wietz: I think that's a case where there's two sides to that story and both are at fault. I think the fund companies are at fault for their ridiculous and sham disclosures. Fund companies have disclosed revenue sharing, but in a way that even a professor of mutual funds, if there were such a thing, wouldn't understand what the disclosure is about. And the SEC's at fault because they knew this was going on, or, if they didn't, they should have known, certainly. But there is some element to this of the rules changing after the game has started. I think a good solution to this would be to forgive and forget the past revenue-sharing abuse and come down really hard on future disclosure.

Still Crazy for ‘Em

RR: And, yet, more retail money than ever flows into mutual funds.

Wietz: Exactly. And basically when you hit a mutual fund with a financial penalty, it doesn't hurt that much. I mean these companies mint money. Management could figure out how many days it'll take them to make back even a $500 million penalty. If you just turn violation of fiduciary duty into a financial penalty only, in the financial industry, you're basically guaranteeing that the malfeasance is going to happen again. It'll be regarded as a cost of doing business. But, you know, what happened at Putnam and elsewhere is very serious.

The mutual fund industry is such a lucrative industry and the profit margins are so high. And this is just another example of how lucrative the industry is and how astonishing it is that even with the amount of money the companies are making, they can still be pigs. Think of another business where you get your overhead covered by your customers.

RR: Talk about Putnam.

Wietz: Putnam's fines and management dismissals will certainly teach other firms a lesson. Or it might not. One lesson is, don't do bad things, but the other, cynical lesson is don't get caught and don't get caught first. Oh, and get a better PR person — and don't have Larry Lasser run your firm. Depending on how you look at Putnam, it is either a very broad and very positive lesson, or it's a very narrow and very cynical lesson. And I suspect the fund industry has interpreted the lesson as the narrow cynical one, which is, like I said, if you're going to get caught don't get caught first and handle it better in the press.

And, if that's the lesson, then guaranteed there's going to be some other scandal and probably fairly soon.

RR: Yup. And what parting advice do you have for our reader, the financial advisor?

Wietz: I think the parting advice would be: to treat your clients' money like it's your own. And invest in firms that you have no problem with, invest in fund companies that you have no problem investing in yourselves.

Sell These Funds Now!