BOSTON – Some investments just dabble in stupidity, while others seem to have stupidity as a mission.
The difference is that the part-timers can sometimes come off the "danger" list and get back into good graces, while the truly dreadful funds will remain that way until they are shut down.
To see that in action, Stupid Investment of the Week today reviews several past mutual fund picks that have resurfaced into the news of late, sometimes for the better and sometimes proving the point that awful is forever.
Stupid Investment of the Week showcases the conditions and characteristics that make an investment less-than-ideal for the average investor, and is done in the hope that spotlighting trouble in one situation will make it easier to root out elsewhere. While obviously not a purchase recommendation, neither is the column meant to be an automatic sell signal, as there may be times when unloading a worrisome investment simply compounds the problem.
One case where SIOTW was clearly not intended as a sell signal came at the end of 2005, when Pimco Commodity Real Return Strategy Fund (PCRDX) was on the wrong end of an Internal Revenue Service ruling that jeopardized the fund's strategy, and investors were advised to sit out while the details got sorted out. Now the details appear to be sorted out, and while it's not all good news, it should remove the fund from limbo.
Pimco Commodity Real Return is a unique fund providing exposure to the Dow Jones AIG Commodity Index; commodities offer a reasonable way to diversify an investment portfolio, while reducing volatility. Commodities typically don't move in tight formation with stocks or bonds, and can be a sound hedge against inflation.
There aren't many commodity-based funds out there, and the Pimco offering is the biggest, with more than $12 billion in assets. But the fund built its terrific track record using a unique strategy, investing in "total return swaps," a type of derivative investment. In buying derivatives, the managers must only put down a small portion of the value of the underlying investment in the commodity index.
Think of it like investing $10 to have $100 worth of exposure to the index; that leaves management with a big wad of cash that it can invest elsewhere, and the Pimco fund favors Treasury inflation-protected securities.
It was working great until Uncle Sam got involved. The IRS, in a December ruling, decided that total return swaps are not "qualifying income." That definition is critical because 90% of a fund's income must "qualify" in order for a fund to be a registered investment company. Having that status as a registered investment company, in turn, gives a mutual fund favorable tax treatment; if a fund loses that status, it is subject to having its income taxed at both the fund level and again when the income flows to individual investors.
Pimco had through the end of June to make a move, but it has already taken most of the steps needed to go in a new direction.
Specifically, the fund has invested billions into structured notes, a commodity-linked product that every other commodities-related fund already was using to get the job done. Ironically, one of the fund's chief competitors, Oppenheimer Real Asset Fund (QRAAX) has been investing in similar notes for years but recently closed to new investors, suggesting that the structured -note market lacks liquidity.
Assuming the fund can find (or create) sufficient notes - and manager John Brynjolfsson suggests that it won't be a problem - the fund will move forward with a new and different strategy, one that is not the manager's first choice but that should be effective.
"You're still getting the exposure you wanted, both to commodities and Treasury inflation-protected securities," Brynjolfsson says, "so the fund can continue to serve the same role in your portfolio."
You will pay a bit more for the fund with the new investments. It's not clear just how much costs will rise yet, but it looks like it will be in the neighborhood of 0.1 percentage points.
That's unfortunate, but it's not enough to keep the fund in the realm of the stupid now that the IRS storm has passed.
By comparison, the storm at Vice Fund (VICEX) disappeared only for a short time and has just recently resurfaced.
The Vice Fund - which buys "sin stocks" that are in the alcohol, gaming, tobacco and other sinful businesses — was a SIOTW pick in late 2003 at a time when the leaders of its management firm, Mutuals.com, were charged with making thousands of illegal trades. The resulting fallout forced some changes in the management team.
I've never been a fan of gimmick funds - let alone issues that get into trouble with regulators - but Vice Fund bounced back and had a good year in 2004. That said, the fund made news this week when it filed a proxy statement, asking shareholders to approve a structure that would allow the current management firm to ship off responsibility for running them money to anyone, at any time, based entirely on the whims of the fund's directors.
Approval for that proposal is important, as the fund's lead manager through the hard times, Dan Ahrens, left Mutuals.com last fall. While new managers took over, the new filing makes it clear that there's ongoing potential for changes that can and should make shareholders nervous.
Plenty of funds are going the route of Vice Fund and asking for approval to change sub-adviser, but that doesn't mean shareholders should be happy about it. Instead, they should be nervous.
Put that uncertainty into a fund that is more gimmick than core holding, and you wind up with a fund that is proving its stupidity all over again, making it best if avoided.
Finally, Columbia Management announced that it was merging several funds out of existence, including its Young Investor Fund, as well as its Florida and Texas muni bond funds.
Bad management pursuing poor strategies is a recipe that doesn't work. It makes a fund perennially stupid, which should make consumers wonder "What took them so long?"
Then again, the closing funds had combined assets of almost $1 billion, so it's obvious that some investors simply hadn't figured out that the funds were the type that would never live up to expectations.
Copyright (c) 2006 MarketWatch, Inc.