June 12, 2003 — While long-established mutual funds like Fidelity Magellan (FMAGX) and Vanguard 500 Index Fund/Inv (VFINX) remain the cornerstone of many investors’ portfolios, the mutual fund industry never seems to tire of launching new products, accompanied by lengthy regulatory filings and slick marketing campaigns.
“Most new funds are trying to be opportunistic to respond to an investment cycle,” says mutual fund consultant Burt Greenwald. “They’re launched hoping that everyone will jump on the current bandwagon. It’s just like fashion: when long skirts are in style, Bloomingdale’s isn’t going to sell you a short skirt, no matter how much it suits you.”
Because those new funds are heavily marketed directly to investors, they present investment advisors with a dilemma.
“It’s like being a doctor with all the prescription drug advertising that’s on TV these days,” says one Seattle-based financial advisor. “All of a sudden your patients — your clients — are coming to you asking for the drug they’ve heard about, even if it’s not something that’s right for them.” That puts stress on the relationship between advisor and client, he adds.
A quick look at the history of new funds demonstrates the risks involved in snapping them up as they roll off the assembly line. When gold prices skyrocketed toward $800 an ounce, the industry produced a flurry of gold funds in time for the metal’s slide in price. In the late 1980s, Japan funds were the rage: Since the Japanese market bubble burst in 1989, analysts say investors have made more on currency gains than through the stock investments themselves. A similar pattern was seen in the wake of Wall Street’s infatuation with emerging markets in the mid-1990s, ending abruptly in 1997 with the emerging markets crash.
The most recent example is also the most dramatic: the short-lived infatuation of investors and mutual fund companies for “new economy” funds investing in Internet, technology and telecommunications stocks. For a time, new funds launched by companies like Janus flourished. But like many other fads, these new economy funds proved disastrous investments. A case in point was the Merrill Lynch Internet Strategies Fund, launched just as the market peaked in March 2000, raising $1 billion. Only 18 months later, the fund had only $125 million in assets, and was rolled into another Merrill Lynch fund.
“We are particularly bad at remembering that classic mantra about past performance being no guarantee of future performance” when it comes to new mutual funds, argues Geoff Bobroff of Bobroff Consulting Inc. “The class of 2003 is probably not going to look much better when we reflect back on it in 2006.” Bobroff argues it is essential for investment advisers to ensure the new funds they recommend to clients aren’t part of “yesterday’s investment story.”
The first step is to look at the nature of the fund itself. In the last three months, about 100 new open-end funds have been registered with the Securities & Exchange Commission, according to FundFiling.com. Of those, more than a third are bond funds or money-market funds, and another 10% or so are low-risk, high-income stock funds. (In contrast, about 15% of the funds launched in 2000 were bond or money-market funds, while technology and aggressive growth funds dominated new stock fund launches.) But with Treasury bond yields languishing at 40-year lows, pundits are almost unanimous in agreeing that sheltering in bond funds is risky.
“Interest rates have to rise,” argues Greenwald, adding we may be in the midst of a `bond bubble.’ “What you’re seeing (in the flow of funds into bonds) is a replication of the craze for technology stocks that we saw in early 2000.”