Feb. 14, 2003 — Thanks to the now-departed bull market, parents want to make sure little Johnny can not only read, but understand P/E ratios and the value of compounding, too.
Mutual fund companies have attempted to fill that void, rolling out funds designed to let children learn as they earn and allow parents to give them a growing nest egg they can later access to finance everything from education to retirement. But has the performance of these funds justified the extra costs or restrictive structures their shareholders must often deal with? Fund Advisor decided to review the available options and suggest other ways to accomplish the same goals.
Funds for children can be divided into two types: Those set up as irrevocable trusts, for parents and others looking to give a gift, and funds that provide educational newsletters and other bells and whistles to teach children about saving and investing.
There are two trust-structured funds, American Century Giftrust/Inv (TWGTX) and Royce Fund:Trust & Giftshares/Investor (RGFAX), and both require long lock-up periods: American Century’s fund must be held for at least 18 years, while Royce mandates a minimum holding period of at least 10 years, or until the beneficiary reaches the age of majority, whichever is longer. Many donors decide to establish the trust for far longer stretches. “They’re often set up with a 20-40 year time frame,” says Chris Doyle, spokesperson for American Century. “Some are even [designated for the child's] retirement.”
That kind of commitment requires a lot of faith in not just the fund’s current portfolio manager, but the organization behind him — the typical fund manager is lucky to stay on the job for five years. Unfortunately, American Century Giftrust, which opened in 1983, hasn’t justified that faith in recent years. The fund was fast out of the gate, gaining more than 20% per year in its first decade of operation, according to data from Standard & Poor’s. But then money started pouring in (assets swelled to nearly $2 billion by 2000), and performance suffered: Giftrust trailed more than three-quarters of its mid-cap growth peers in five out of the six years between 1996 and 2001. Several investors successfully sued to break their trusts and get out of the fund early. American Century brought in a less-aggressive management team in mid-2001, and performance improved, at least on a relative basis. But Giftrust has a long way to go to prove itself again.
The story is more encouraging for Royce’s fund. Trust & Giftshares (run by small-cap value veteran Charles Royce, who started his firm 30 years ago) has soundly beaten its small-cap value peers in each of the past five calendar years. Unlike American Century’s fund, donors can select one trust option that allows beneficiaries to withdraw funds for educational expenses. And size isn’t a problem — despite its strong performance, the fund has just $29 million in assets. “It’s really a niche product,” says Cheryl Leban, Royce Funds’ Giftshares specialist. Because of that, Leban is able to give personalized service: Besides writing quarterly letters to donors, she answers their questions by phone and e-mail. That was a big help in 2001, when Royce sold the company to Legg Mason, and Leban quickly assured donors that there would be no changes — Royce and the firm’s other portfolio managers signed five-year contracts. Of course, what happens after the 63-year-old Royce retires is another question. Still, this is the more promising of the two trust-fund choices.
Parents more interested in teaching their children about investing than setting up a trust have a broader array of funds to choose from, though they’re not necessarily better. The biggest of the bunch is the $663-million Liberty Young Investor Fund/Z (SRYIX). Shareholders get quarterly newsletters that cover basic investing concepts and highlight the fund’s holdings, which lean towards companies kids can understand. In addition, there’s a website for kids (www.younginvestor.com), and the company sponsors an annual investing essay contest – winners get shares of the fund.
Unfortunately, Young Investor’s performance hasn’t been as distinctive as the perks that come with it. The fund got off to a sizzling start in 1994, and investors rushed in. “That was hot money that was totally unrelated to the basic concept of the fund,” says fund industry consultant Burton Greenwald. Indeed, Stein Roe, which started the fund before the firm was acquired by Liberty, rolled out a cheaper version of the fund without the child-friendly materials. But Young Investor has struggled of late, failing to beat the S&P 500 in four of the last five years. Adding insult to injury, Liberty has raised the fund’s expenses from 1.26% to 1.76% on the no-load Z shares (which are closed to new investors), and the broker-sold A shares cost 1.67% — the fund’s peers charge an average of 1.55%. Liberty spokesperson Marilyn Morrison says the increase was necessary to defray the cost of servicing the fund’s many small accounts, but acknowledges that the portfolio manager “has his work cut out for him.”
Shareholders of USAA First Start Growth Fund (UFSGX), a fund with many of the same features as Young Investor, have had a rough ride, too. The portfolio is down an annualized 7% per year since the start of 1998, worse than 88% of its large-cap growth rivals. Its prospects are brighter, though, now that Tom Marsico — who rang up a stellar ten-year record at Janus Funds and has since done the same at his own firm — has taken the helm. The fund’s expense ratio is 1.45%, but investors might want to check out another Marsico-run fund, USAA Mutual Fund:Aggressive Growth Fund (USAUX), as an alternative. Despite its name, the portfolio is nearly identical to First Start’s, and expenses are just 0.99%. Children won’t get any newsletters or other perks with this fund. However, if Aggressive Growth and First Start each gain 10% per year (before expenses) for 10 years on a $10,000 investment, shareholders of the former will reap an additional $1,000.
Investors who start a Coverdell Savings or custodial account for their child with Monetta Funds get a kid-friendly investing kit, as well as a bean-filled train car for every $500 put in. Unfortunately, it’s tough to recommend any of Monetta’s funds — all five stock portfolios trail more than three quarters of their rivals over five years, and the firm’s bond fund has been subpar as well. However, even non-shareholders can take advantage of Monetta’s Miles Program, in which kids earn prizes by playing educational games on its website (www.monetta.com).
Clearly, every one of these funds has its snags in one way or another. But maybe a specialized fund isn’t the best way for parents to invest for and educate their children, suggests Neale Godfrey, chairperson and founder of The Children’s Financial Network, an advocacy group. Although she served as a consultant to Stein Roe, and wrote some of the Young Investor fund’s ancillary materials when it was launched, she says she’s “a proponent for getting kids involved in investing, not necessarily for the funds.”
Industry consultant Greenwald goes further, calling the Liberty and USAA funds “marketing gimmicks of limited value” and the trust-structured funds “inflexible.” He suggests parents make “a modest investment in a good, diversified growth fund, then go over the shareholder reports with the child.” They could supplement this with one of Godfrey’s best-selling books for parents and children, such as “Money Doesn’t Grow On Trees.” Then little Johnny can begin to learn to read and pick stocks and funds at the same time.