Chapter 20
Fund Ratings and Forecasters
In This Chapter
Steering clear of the lousy newsletters
Getting investment information from the best sources
My father loves data and analyzing it. He likes figuring out how things work. Before he retired, he was a mechanical engineer. (Impressively, he worked his entire career in one field.) He loves making charts and graphs. During the months that I wrote the first edition of this book, he was poring over a veritable truckload of data and information on mutual funds and investing.
So I wrote this chapter for people like my dad. Even if you’re not an engineer by training, there may be a bit of a data lover in you. The challenge as you navigate the landscape of mutual fund data, newsletters, references, and gurus is discerning the good from the merely mediocre — as well as the downright useless and dangerous information and advice. Unfortunately, more of the latter are out there waiting to trip you up.
Avoiding the Bad Stuff
I start with the bad stuff because so much bad investment advice is out there, and odds are good that you may currently be using some of it or thinking of using it, or it may be pitched to you in the future. Finding out the tricks of the trade enables you to better identify the good stuff. But if you’re pressed for time and can’t bear to see the ugly side of the investment newsletter business, skip ahead to the good sources that I recommend later in this chapter. (I cover software and Web sites in Chapter 21.)
Newsletters cost you time and money. Don’t use newsletters for predictive advice. If these prognosticators were that smart about the future of financial markets, they’d be successful money managers making a lot more money. The only types of publications you should consider subscribing to are those that offer research and information rather than predictions. (I discuss those publications in the “Getting In on the Good Stuff” section in this chapter.)
Looking into market timing and crystal balls
Market timing — even in the form of slick, professional-looking packaging and claims — is a losing proposition. Many fund investors believe that they can increase their chances of success if they follow the predictions of certain gurus. Gurus often say (or imply) that they can tell you when you should be in or out of the markets or particular investments. Whenever a prognosticator near you treats you to such “wisdom,” just repeat after me:
“No one can predict the future.”
“No one can predict the future.”
“No one can predict the future.”
If you can remember this one simple fact — a fact supported by mountains of evidence and plenty of good, old-fashioned common sense — you’ll dramatically increase your chances for successful investing in funds, and you will decrease the odds of making major mistakes. And you’ll have a much clearer vision about which resources to use for further reading and research about funds. As I explain in Chapter 10, the strategy of market timing is doomed to failure in the long run.
Take a look at the performance track record of investment newsletters. According to The Hulbert Financial Digest (see the next section), which looks at risk as well as return, only a few newsletters have managed to keep ahead of the market averages over the past 15 years. And these newsletters only managed to do so by a small margin (and that doesn’t take into account the cost of subscribing to a newsletter). The worst investment newsletters, on the other hand, have underperformed the market averages by dozens of percentage points: Some would’ve even caused you to lose money during time periods when the financial markets performed extraordinarily well.
Of course, you’d never know about newsletters’ dismal performances if all you ever listened to were the claims made by newsletter writers themselves. Most claim that they told their loyal followers to sell everything just before the last dozen times that the stock market plunged. They also usually go on to proclaim that they advocated buying at every bottom in the market.
Newsletter writers don’t know anything that isn’t already reflected in the prices of securities. If newsletter writers did have a knack for unearthing information that no one else typically knew, they’d be too busy investing their own money and making millions off their predictions to waste their time publishing a newsletter.
Keeping them honest and providing new fodder: The Hulbert Financial Digest
Mark Hulbert started a useful business in the 1980s. Almost every investment newsletter was making outrageous claims about the success of its previous predictions. But how could you, the potential new subscriber, know whether a newsletter was telling the truth or blowing smoke? Answer: You couldn’t.
Not until Mark Hulbert came along, that is. He tracks the actual performance of the newsletters’ investment picks. He tracks each newsletter’s recommendations. So, over time, Hulbert knows exactly how the newsletters’ picks have done.
Has The Hulbert Financial Digest stopped the outrageous claims of the investment newsletters? No, but the claims seem to be slowly getting more accurate, thanks to Hulbert’s influence. The problem is that people still believe the marketing hype of the newsletters and never bother to check with Hulbert’s service.
Hulbert’s service has created another problem, however. Many newsletters can claim to be number one by selecting short time periods when they actually were number one, even though they’ve underperformed the rest of the time. And some falsely lay claim to the number one status by simply comparing their performance to all those that are worse, while ignoring the ones that perform better!
Using bogus rankings, token awards, and mystery testimonials
Newsletters also cite rankings from other organizations (such as Timer’s Digest) in their efforts to justify their claims of numero uno status. Given enough time periods and categories of newsletters, many newsletter writers can claim the coveted number one spot at some time or another.
Newsletters also refer to awards they’ve won from the Newsletter Publisher’s Association (NPA). My advice: Ignore NPA awards. They’re meaningless. They have nothing to do with the performance of a newsletter’s advice. And because the NPA is an association made up of the newsletters themselves, they’re just giving themselves a pat on the back! Not a very objective way to dole out awards, eh? (The association isn’t very large and is always doling out awards, which doesn’t hurt newsletter writers’ chances of winning, either.)
And, of course, you have the inevitable customer testimonials. Curiously, though, testimonials almost always parrot the promotional material for the newsletter, and they never include the person’s name. All they provide are the person’s initials, such as B.S., and good old B.S.’s home, such as Brooklyn, N.Y. Some of these testimonials are made up — so they really are B.S.!
Pitching a product: Filler and ads in newsletter form
Many newsletter writers publish newsletters as a means of drawing people into their money management business. For some, that’s the only reason they produce the newsletter. So they don’t really want to teach you too much about investing; they want to convince you that your money is best off in their hands — which means that their articles are usually trying to tell you that investing is complicated and market timing is everything.
Some newsletters that are already short on content plug their money management service right in the newsletter. One monthly newsletter that sells for more than $100 per year publishes issues that are 80 percent filler; performance numbers for funds are an example of this filler. In the four pages of articles in the typical newsletter, readers often confront a plug for the editor’s money management business because (according to him) a newsletter’s advice can’t substitute for the daily oversight of your portfolio.
Don’t believe it. Of course, this claim isn’t what they told you in their marketing materials to get you to subscribe to the newsletter. What the newsletter should’ve said (and what would’ve been accurate) is that the editor nets a lot less profit by selling a newsletter than he does by landing another client for his money management business.
Investing newsletter Hall of Shame
The following sections reveal some of the many examples of the really heavy stuff that gets shoveled by some of these folks to sell you on their investment newsletters. All the examples are drawn from real-world newsletters. However, I’ve modified the names to keep you focused on the types of misleading practices that marketing newsletters engage in instead of having you focus on the particular scoundrels behind each of these disreputable newsletters.
Dwayne Dweeb’s Personal Finance
Dwayne Dweeb’s newsletter marketing materials issue the following proclamation about Dweeb, a veteran newsletter writer: “A Millionaire Maker Outsmarts the Market. Again.” In a glossy, multipage brochure, Dweeb is said to have “the highest IQ of them all . . . somewhere between Einstein, Mother Theresa, and an IBM mainframe.” (I’m not making this up!)
His literature goes on to say: “The reason he can expand your money by 30 percent to 50 percent a year is sheer mental horsepower.” You’re also told that his newsletter is rated number one by “both of the major rating services.” Dweeb’s materials assert that he’s developed a brilliant and totally awesome proprietary model, which he calls the “Numero Uno Indicator.” His claim is that this model has predicted the last 28 (count ’em, 28) upturns in the market in a row without a single miss. The odds of doing this, according to Dweeb, are more than 268 million to 1!
But wait, it gets better. The ad goes on to claim that Dweeb’s “Numero Uno Indicator” market timing system could’ve turned a $10,000 investment into $39.1 million in 12 years. That would be a return of 390,000 percent!
Does this claim sound too good to be true? You got it. This outrageous claim, if not purely fabricated, was based on backtesting, looking back over historical returns and creating “what if” scenarios. In other words, Dweeb didn’t turn anyone’s $10,000 into $39.1 million. Much too late after that ad appeared, the Securities and Exchange Commission (SEC) finally charged Dweeb with false advertising. Dweeb settled out of court, and a $60,000 fine was imposed.
Here’s the real scoop on Dweeb’s investing ability. In 1991, Dweeb established a mutual fund. Over the next decade, this fund was one of the worst growth stock funds around. His fund underperformed about 90 percent of its peers.
Harry Hacker’s Mutual Fund Investing
Steer clear of anyone who claims to be “America’s #1 Mutual Fund Adviser.” I remember Hacker’s name as if it were my own, because for a while, it seemed, once a month I’d receive a glossy color brochure more than 20 pages long from him in the mail. Like Dweeb (see the preceding section), Hacker claimed to have been rated number one by Hulbert. Hulbert responds, “It is a fabrication. Mutual Fund Investing is not now, nor has it ever been, rated number one by my digest.” Hulbert was so incensed by Hacker’s claim that he devoted an entire column, appropriately entitled “Lies and near lies” to setting the record straight in Forbes magazine.
Soon after Hulbert’s scathing column about Hacker appeared in Forbes, in Hacker’s next mailing he changed his tune a bit. His newer marketing materials displayed a colorful chart showing that his stock and bond fund picks returned 1,517 percent over a 15-year period — for a nearly 20 percent annualized rate of return, which would’ve put him in an exclusive league with the like of investing legend Warren Buffett. This return would imply that his advice had beaten the average stock fund, which over the same time period returned just 14.7 percent per year, and the average bond fund, at 9.1 percent per year, by some distance significantly greater than a country mile.
Hulbert’s tracking of Hacker’s recommendations clearly shows that Hacker’s portfolio returns fell well below the market averages.
Getting In on the Good Stuff
If you want to read more about investments, by all means read more. But read useful information. Most of the better financial magazines and newspapers, for example, cost a fraction of the newsletters’ prices, and provide more useful information.
Many of the major financial publications — Barron’s, Business Week, Forbes, Fortune, Kiplinger’s Personal Finance, SmartMoney, and The Wall Street Journal — do annual mutual fund roundups. Most newspapers and many large news magazines provide fund coverage as well. Some good newsletters are available, too.
Morningstar Mutual Funds
If you want a snapshot summary of a lot of data, as well as some thoughtful analysis about a fund you’re considering investing in or currently own, Morningstar can’t be beat. Most of the information summarized on its pages comes from a fund’s prospectus and semiannual reports. Some of the data it provides for funds may take you hours to calculate and may require a sophisticated computer software program.
Morningstar Mutual Funds covers load funds (funds that carry commissions) as well as no-load funds. As I explain in Chapter 7, loads are an additional cost to buy funds that brokers sell. If you have load funds that you want to evaluate, Morningstar Mutual Funds can help.
A one-year, Web-based subscription costs $179. (See Chapter 21 for details on the Morningstar Web site and software offerings.) In the sections that follow, I highlight the more pertinent information in an individual Morningstar bond fund and stock fund report.
Reading a Morningstar bond fund report
In this section, I highlight some of the more useful features to examine for bond funds that you may be considering.
Quote: This section presents a data dump of all sorts of information for the fund over more than the past decade. Here you can see how the total return, performance versus benchmarks, dividend (income), capital gains, the fund’s annual operating expenses, and trading (turnover rate) have varied over the years.
Management: This section highlights the fund’s managers and notes the date the manager(s) started managing the particular fund as well as their investment management experience.
Strategy: This section provides a summary of the general investment objectives and limitations that a fund subjects itself to.
Performance: The first section displays the total amount that investors made or lost (from dividends, capital gains, and share price changes) for each quarter over the past seven years. This section can give you a sense of the likely volatility of an investment in the fund. (Remember, though, that this is history, and the future will differ.) If you get queasy looking at these numbers, don’t invest.
The second section — the trailing returns — shows annualized total return information over longer time periods. (Total return numbers don’t account for loads, but you’re not going to pay any anyway, are you?) The fund’s returns are also compared to benchmark indexes, which in some cases aren’t so comparable. (See Chapter 17 for more background on benchmarks.)
Portfolio: This data is summarized from a fund’s most recent reporting. Detailed are the total number of securities this fund holds and the listing of the top 25 holdings.
• The Investment Style box shows you which types of bonds the fund mainly holds at the moment (in this case, high-quality, intermediate-term bonds). Measures of interest rate sensitivity — average maturity and duration (both of which I explain in Chapter 12) — are provided here, as well as the average credit quality of the fund’s bonds.
• Sector Weightings quantifies the fund’s current holdings of the major types of bonds. Asset Allocation details the fund’s recent holdings of cash, bonds, and other securities. This section is worth looking at to determine whether a fund really is what it says it is.
• The Bond Quality section highlights the fund’s holdings by the credit rating of the bonds it is invested in (see Chapter 12).
Fund Analysis: Each fund at Morningstar is assigned an analyst. Analysts use available information, as well as interviews with fund company managers (and others), to summarize the fund strategies. This section is usually well worth reading, especially if you’re not a numbers kind of person.
Rating and Risk: Without a doubt, this section is the most overused and abused part of a Morningstar report. Funds are given ratings, based on past performance and volatility, from one (worst) to five (best) stars. The folks at Morningstar say that “funds with 3, 4, and 5 stars often make the most sense for many investors.” I think that says it well — you can’t really say much more about the star rating system than that. More stars are not necessarily better than fewer and vice versa.
Here you see more details for the determination of the ranking and the way the fund rates over different periods.
All sorts of other quantitative measurements of risk are presented here. One of the more useful is beta, which helps you calibrate the volatility of a fund compared to relevant benchmarks. The overall bond market benchmark is assigned a beta of 1.00. Thus, a fund with a beta of 1.2 implies that it’s 20 percent more volatile on average (perhaps because it invests in longer term bonds or lower credit-quality bonds).
Tax Analysis: This section provides some insightful measures of a fund’s tax efficiency or tax friendliness. If you’re investing in a fund inside a retirement account, ignore this section. If you’re investing outside a retirement account, the tax-adjusted return column shows what your effective return would’ve been in this fund over various periods if all the dividend and capital gains distributions that a fund makes were taxed at the highest applicable federal tax rate and then reinvested in the fund.
Potential Capital Gains Exposure measures how much, if any, unrealized profit exists. The larger the number here, the greater the potential risk of larger distributions in the future, particularly for funds that trade a lot (that is, that have a high turnover), as this one does.
Purchase Information: Here’s where you see how to get in touch with the fund, how much is required as a minimum investment, and so on.
Reviewing a Morningstar stock fund report
Morningstar’s stock fund reports carry much of the same types of information that its bond fund reports contain. I won’t repeat my explanations of the same sections I cover for a bond fund report. (To see what I’d be repeating if I did talk about it here, skip back to the preceding section.) The sections of a stock fund report that significantly differ from a bond fund page include
Quote: Stock funds, of course, have different benchmark indexes suitable for comparison purposes.
Portfolio: The summary of a fund’s holdings is the most important area of difference between a stock fund report and a bond fund report. That’s no surprise, though, because stocks are quite different from bonds.
Similar to the bond fund report, the stock fund page notes the total number of securities that it holds. A list of the top 25 securities, along with what portion each stock comprises of the fund’s assets and its recent return and price-earnings ratio, also shows up here.
• Investment Style classifies a fund’s current stock holdings based on the size of the company, as well as on whether those stocks tend to be growth, value, or both. (I cover the difference among these various types of stocks in Chapter 13.) The page also presents a variety of statistical measures for the stocks that the fund holds. For example, you can see the average rate of growth in the earnings of the companies that this fund invests in and how that rate compares to that of other funds in its category.
• Asset Allocation is also useful because it indicates whether a fund is holding major cash positions and whether it invests in securities other than stocks. Market Cap shows how the fund is allocating its holdings among stocks of companies of varying sizes. Sector Weightings breaks down a fund’s stock holdings by industry and compares the fund’s holdings to those of a relevant index.
No-Load Fund Analyst
Those people who enjoy doing more reading about funds and the financial markets should consider the No-Load Fund Analyst newsletter, which tracks a much smaller universe of the better no-load funds than Morningstar does. This monthly publication provides commentary and analysis of trends in the economy, happenings in the fund industry, and fund manager interviews and profiles. In an industry in which many publications claim that they can double your money in a snap if you become a subscriber, the No-Load Fund Analyst is a breath of fresh air — it includes no hype or inflated marketing claims.
Personal interviews and the tracking of individual fund managers are unique and valuable aspects of this publication, which tries to identify talented fund managers at some of the smaller, lesser known funds. These funds, of course, are riskier to invest in. Also, because the No-Load Fund Analyst recommends funds in numerous fund families, as an investor you must be willing to deal with many fund companies or establish an account at a discount brokerage firm (see Chapter 9). The editors’ primary business has been their investment management company. They manage money for institutions and wealthy individuals in mutual funds — their minimum account size for new clients is $3 million.
The No-Load Fund Analyst also follows and discusses closed-end mutual funds, which I cover in Chapter 2. An annual subscription to the No-Load Fund Analyst costs $600. For $50, you can obtain a sample issue by calling (800) 776-9555 or visiting its Web site at www.nlfa.com.
The Independent Adviser for Vanguard Investors
As you may have guessed from its name, the Independent Adviser for Vanguard Investors is a useful publication that focuses exclusively on Vanguard’s extensive family of mutual funds (and now exchange-traded funds). Editor Dan Wiener, who’s a former financial journalist, also operates a money management business.
What I really like is that Wiener does his research and homework. He’s adept at sifting through the large number of Vanguard funds and highlighting those that do the best and are likely to continue performing well. That said, he isn’t like many other newsletter writers who make predictions about the stock market and economy. He also shies away from making major shifts in his suggested holdings — he’s much more of a buy-and-hold investor. This newsletter costs $99.95 for the first year, and you can order by calling (800) 211-7641 or going to the Web site at www.adviseronline.com.
EricTyson.com
Drop on by and visit my Web site — www.erictyson.com — where I digest and summarize what the best newsletters and other resources highlighted in this chapter are saying now. I also discuss current economic news, books worth reading, and prominent gurus, among other topics.