Archive for the ‘Mutual Funds’ Category

Over the coming months, mutual fund fees will come under greater scrutiny. Of course, there has already been a tremendous amount of attention devoted to fee structures, how the fund companies are compensated, how the adviser is compensated and so on. But what does this mean for the average investor whose financial planner suggests, say a dividend fund for them to invest in?

Well, there are several key areas that both regular and more serious investors need to be aware of when it comes to buying mutual funds. But first, let’s examine what the fee structure is all about.

For starters, the fees associated with mutual funds are called 12b-1 fees. This fee, at the moment, lumps all expenses into one, including what you pay to the fund company and ends up getting paid back to the adviser in the form of trailers. How much goes to whom is really anybody’s guess except for the fund company who manages collecting the fees and, in some cases, the adviser who might know what is being paid back to her.

Now, things get a little muddy when you consider that from the amount that the fund company gets to keep, how much of is compensation for the management team, how much is administrative and how much is sales and marketing. And, of those sales and marketing fees, how much gets paid back to the adviser responsible for successfully marketing that product?

The changes proposed by the SEC will eliminate a lof this confusion. To a large extent, this change is about as much of a shocker as disclosure of real estate fees might have been years ago. It makes sense to know what your adviser is earning, no? It also makes sense to know if Fund A that charges 0.90% and Fund B that charges the same thing are paying more toward management or more toward sales and marketing… which fund would you want, the one that underpays its management team or the one that pays them competitively? The implications are clear and, overall, these changes make for a more-level playing field for the industry.

Where the proposed mutual fund fee changes have a potentially greater impact is in how the fund companies can charge these fees. One of the changes recommend a maximum fee that the investor could pay. So while a 5.25% Front-End fee (the fee you pay to get into the fund) might charged on one class of fund for Mutual Fund Company C’s ABC Fund, the total Fund Company C can collect on all other classes class will also be 5.25% (or whatever the maximum is set at). So if your adviser suggests a no-load version of ABC Fund that charges just 0.9%, the most Fund Company C will earn is 5.25% (about 6 years worth of annual fees). Thereafter, the most they can charge for administrative-type fees will be 0.25%, good for the investor, not so good for the adviser.

Two Problems

The first problem with limiting fees is how will your adviser be compensated in those years after the maximum fee has been collected? Will this type of limitation encourage churning (where advisers recommend changes simply because of favorable fees — in this case, no fee vs. fee is heavily tilted on the fee side)? We argue that it will. And if fees are not paid by the fund company, then it is likely that advisers will start charging management fees… but at what cost? Will the average Joe be able to afford the advice and services of a decent adviser (today, trailer fees allow a relatively average investor to obtain fairly decent advice).

The second problem is how will fund companies change in terms of quality and sustainability? If fees are only to be collected to a maximum of x%, is it in the in anyone’s best interests to encourage buy and sell investing? And what will happen to funds that people traditionally bought and held for decades?

More Work Needed

Without question, added transparency is always a good thing. It often keeps key individuals and companies honest and allows for a more-level playing field. But will the changes to 12b-1 fees that the SEC is proposing actually limit competition and close the door on a segment of the investing public that needs access to good advice as well as the best-managed funds?

At the Mutual Fund Site, we believe more work is needed before such huge changes are put into force. As they stand, they could serious impact the quality of service individual investors receive at the fund company as well as adviser level and, in some cases, will probably result in a lack of access to a segment that needs it the most.

As far as dividend funds go, the Invesco Diversified Dividend Fund (LCEIX) has managed to secure itself some high returns, making it a natural short-list favorite among investors who are looking for dividend mutual funds as part of their investment strategy. What makes this Invesco mutual fund such an easy choice also has a lot to do with its consistent returns, consistently beating its peers (overall) when it comes to risk-adjusted returns.

Interestingly enough, this mutual fund has managed to earn above average returns over the past 5 years. Currently, it holds 90% domestic equities, itself a difficult achievement given the volatility the markets have shown on a year-to-date basis, particularly with how this fund invest: primarily, it adopts a large cap, value/blend approach. Kudos for that.

Unlike other funds in its category, the Invesco Diversified Dividend fund has stepped back from IT and media plays, clearly taking an underweight position in those areas and instead beefing up in the Industrial Materials, Consumer Goods and Financial Services segments. This makes a bit of sense when you look at the underlying assets. Its biggest earners have been Fifth Third Bancorp (26% YTD return), SunTrust Banks (24% YTD return), Eaton Corporation (23%), Marriott Corporation (22%) and Emerson Electric (20%). These are all top 25 holdings and clearly strong performers.

At the Mutual Fund Site, our biggest concern with the investment style is the fund’s heavy investment in manufacturing type companies. While these have clearly provided some good returns, the uncertainty surrounding the manufacturing sector and its reliance on consumer spending could have terrible implications for these securities, particularly these days when you hear about consumers spending less thanks to the “slow recovery.” What people should be worried about is the company’s ability to continue paying dividends even in the face of slowing demand.

What we like to see here is its marginally below weight holdings of financial services firms. This has been an extremely popular segment and has quite possibly become overbought, resulting in longer term cost problems for some funds. But even if we are right about high price of entry here combined with a lack of profits thanks to slower than expected consumer spending, this fund’s financial services choices are brilliant, having opted for strong financial services firms that pay decent dividends and have strong fundamentals backing them.

Even the non-financial firms in their top holdings — looking at Emerson Electric, Eaton and Marriott for example — are also strategic and relatively worry free choices. All three companies have seen year-over-year quarterly results improve, they continue to have strong balance sheets and they are among the leaders in their industries and, as evidenced by their returns, have been worthwhile investments for the fund.

As for dividend funds, we continue to favor the Vanguard Dividend Fund given its smart investment style and consistency. But with an entry level of $1,000, this Invesco comes with an entry level that is 1/3 of the Vanguard fund, making it more accessible to more investors. And with the performance record that it enjoys, it will obviously appeal to a lot of mutual fund investors as one of the easiest dividend funds one can own.

The Mutual Fund Site has done this before: gone out on a limb and made a fairly wild claim that if you do X, you will enjoy Y. As far as the variables, X is normally what mutual fund to buy and Y is usually enjoying some kind of returns. Well, to get more specific, we claimed at the beginning of the year that if you bought a particular Janus High Yield Fund, you would enjoy steady returns in 2010. We were right. If fixed income is not your cup of tea, we said the same about the Ivy Small Cap Value fund. Again, we were right.

Today, the story is much of the same. Only those variable have changed (although we are not suggesting you drop those two investments). But for investors who want to see less volatility than that the Ivy Small Cap and for those who are really starting to get nervous about how interest rates might impact the Janus High Yield Fund, then why not do what makes the most sense?

Invest in a Dividend Growth Fund ahead of the economic recovery

Here’s the thing. We know there is an economic recovery on the horizon. The yield curve tells us as much. Even the most bearish investors realize that a recovery will take place. It may not happen today (although it very well might) and it may take several years before equities that enjoying the wild growth they have seen in the past, but it will happen.

And until/when it does, then the Vanguard Dividend Growth (VDIGX) is one of your safest best. As a dividend fund, this Vanguard has been recognized by Morningstar as a top performer for its Overall, 3-year and 5-year performance, earning a coveted 5-star rating for those period.

But what really impresses us is that this dividend fund achieved maximum returns with nearly no risk at all. The dividend yield alone is a decent 2.32% and while several of its slimly-held 49 securities have performed poorly (take ExxonMobile, for example, a top 10 holding contributing -12.3% on a YTD basis), the balance of the securities continue to perform the point that this fund is set to gain just as soon as the markets get a whiff of that recovery.

Among the fund’s top holdings are Johnson and Johnson, ADP, UPS, Mcdonald’s, Wells Fargo, ConocoPhillips, Wal-Mart… all companies that continued to produce during the toughest economic moments.

These strong holdings of course are the fund’s biggest downfall; everyone knows that most investments that performed well were not these larger, well-capitalized companies. Instead, smaller cap stocks tore up the markets in 2009 and into 2010. Quality is not so much an issue as the speculative opportunities for growth that the small cap value play offered.

At this point, the fund remains in the red to the tune of roughly 3%. This makes it somewhat uncertain for some investors. However, it leads its peers by a hair and its track record sure says a lot about how well Donald Killbride of Wellington Partners has done with this fund. With a low turnover, the Mutual Fund Site recommends holding this fund for the long-term (3-5 years minimum) and adding it as a core holding to your portfolio; with a $3,000 minimum investment to get in, this is not a specialty fund.

The lagging small cap category this year has been the small cap growth category. At the Mutual Fund Site, we decided to take a quick peek at a fund that fell into this category and like the top performers we examined last month, the Marshall Small-Cap Growth Fund (MASCX) is an above-average fund. Rated at four stars by Morningstar, it is considered one of the better performers in this category.

Small Cap Growth funds have been lagging behind Small Cap Value and Small Cap Blend funds on a year-to-date basis

In looking at the risk adjusted rating, this fund hold the coveted 5-star rating for its 5 year performance record, which should not go unnoticed. Not surprisingly, the latest management addition happened in 2007, possibly a large contributor to the fund’s 5 year rating.

Another note about management is that the previously high turnover was noticed by Morningstar in 2009 and mention was made. Ironically, the same author noted caution about the fund in 2009 (due to turnover) but less than 1 year later made not of how the “fund is making a name for itself.” More on this later.

One of the things that we feel is most important to a fund’s long-term track record is its underlying portfolio. With the Marshall Small Cap Growth fund, 38% is in small cap securities, another 38% is in Micro Cap securities and the rest is in mid-cap securities. This spread of risk is important because it ensure the right balance, particularly in periods of heightened volatility. We like this kind risk mitigation for a small cap fund; the spread is nice, but there does seem to be enough money invested in mid cap securities that one might question whether the manager is comfortable with the small cap sector in the first place. Why so conservative?

Digging deeper, however, we see that nearly 19% of their assets is invested in Healthcare; followed by 13% in IT Hardware and lastly they have just a little less than 12% in Telecom. The risk in these sectors may be enough to point to that heavy mid-cap presence and get the justification one needs.

With just 82 stocks under management, roughly 28% of their holdings are in the top 10 holdings. Their biggest holding, Energy XXI (Bermuda) Ltd., is an energy play; Ebix Inc. is a software play (number 3 holding) and Heckmann Corp is a financial play (number 6). Let’s look closer at these holdings:

Energy XXI (Bermuda) Ltd (4.52%)
This is the fund’s largest holding. It is also one of the top contributors as far as the fund’s returns go. The interesting thing with Energy XXI is that it reported a loss for 2009 of over 1/2 Billion. Since then, their revenues have been a lot more promising, enough so that the analysts polled by Thompson/First Call have a hold rating on it (recently, analysts have been a little more bullish on the stock).

The biggest problem facing this company is its liquidity. Current assets are insufficient. However, their property holdings conrtibute considerably to their overall positive equity position and the stock price speaks for itself. We would not be surprised if Marshall (which also owns this company in its Mid Cap fund) starts to trim their position, especially after the run up it has experienced on a YTD basis.

Ebix, Inc (3.22%)
This number 3 top holding is a software play. This company focuses on helping insurance companies with their management of independent agencies, policies, administration and claims management processes as well as accounting, reporting and rating tasks.

This stock has skyrocketed in 2010. Currently trading in the $15 range, this stock has been as low as $1. (That is not a typo). Likewise, it has been as high as $51. A recent share buying announcement, increasing revenues on annual and quarterly basis as well as positive analyst opinion will certainly continue to drive this stock price upward.

Heckmann Corp (2.6%)
One of the worst performers in the portfolio with YTD returns of -19%, Heckman is the fund’s 6th largest holding. Although it is officially listed as a “financial” company, this company is actually a holdco for China Water and Drinks and Heckmann Water Resources. Both companies are involved in the delivery and transportation of water (like an oil pipeline, transport company, shipper, etc., except water).

Although this company has been losing a tremendous amount of money over the past 2 years, its concept remains sound and with greater demand for water, it may actually have a viable business model. Of course, the two analysts that cover this stock rate is as a buy and the firm not only has a ton of cash on hand, but virtually no debt whatsoever. In other words, it is a strong, viable company.

Our biggest beef with this holding is that the stock does not move all that much, thereby limiting potential gains. This could also be a selling point in that, as a top holding, its relative stagnant levels can provide stability to an otherwise fairly volatile portfolio (standard deviation is over 25%).

Overall, we like this fund. It’s low entry level, its low fees and decent Beta (at 1.1) suggest a medium risk investment (Morningstar rates it this way as well, giving it an “average” rating for risk and an above average rating for returns.

Provided that the fund remains closely managed, it could very well fit in a portfolio for someone with an apetite for volatility with the potential payoff of good returns.

The markets are down, making mutual funds all that much more important for risk averse investors. That is not to say stocks do not have their place, but the reason I love mutual funds so much is because they offer so much diversification (some would argue over-diversification) that risk becomes somewhat limited. So what does that mean for a mutual fund investor? It means greater participation in specialty funds like gold funds, small cap funds, BRIC funds, and so on. What this ultimately means for your every day investor is:

• yes, the markets will tank and bring down their investments. But when core investments drop, other investments hold down the fort. Which investments will it be? Bond funds? High Yield Investments? Small Cap funds? If I or anyone else could predict such things ahead of time, we would never both with those core holdings in the first place, would we? By being properly invested, the risk of being wrong is reduced or eliminated… something’s gotta win.
• opportunities to rebalance. Maintaining a proper asset mix is essential to long-term success (compared to chasing the winners every time a winner is identified). This means that as markets increase or decrease, the asset mix will shift. This calls for rebalancing, trimming those assets that have done well and dumping money into smart mutual funds that have not fared so well. This achieves two things: it reduces over-exposure and it allows to buy assets when they are considered “lower.”
• buy more when markets suck, buy less when they are heroic. This is the basis of dollar cost averaging, something we should probably stress more often at this site. Still, when markets tank, it reminds us of the importance of never throwing all of our money on the table at once. It reminds us to ease into a position(s) gradually.

Now what does this all mean to how I would invest 10,000? It means that if I was given $10,000 today and told that I had to invest it (instead of spending it on a bunch of toys for the summer), I would:

1. Determine my asset allocation model. You can do that right on this site if you want, or you can ask your advisor to help you figure it out for you. Mine will show: 60% Equities and 40% Income (this is after I decided to ignore the cash recommendation and invest instead in fixed income). Seems conservative unless I am a balanced investor, yes. But let’s take a closer look…
2. Research the following mutual funds; a good Balanced Fund like the PIMCO All Asset fund, which is a medium risk, high return 4-star rated fund. I would throw $7,500 at this fund because it is not only well managed, but the underlying assets are those that I actually believe in. And then I would invest in the Ivy Small Cap fund (a fund I have been laughed at for picking and sticking to, but one that maintains all of the fundamentals that I personally believe in and trust). This fund will allow me to invest $1,500 of the remaining $2,500, leaving me with $1,000 which I would throw at the Franklin MicroCap Value fund, another 4-star fund but one that has virtually no risk associated with it and a track record that would make old pros blush.
3. Review, review, review. Yes, three times.  Per month, that is. Because I think these assets are placed so well, the portfolio would fall out of balance fairly quickly.

If permitted, I would add a 4th point: split the $10,000 into ten $1,000 contributions. This would not be possible in the case of the funds I chose here, but if I had, say, $40,000 to invest, I would invest 10K now, the remaining $30K over the next 2 years. And all of it would be in mutual funds; small cap funds and a balanced fund, maintaining as close to a 60/40 split as I possible can given that balanced funds will not report in real-time what their holdings are.

The idea that one mutual fund company can be better than another is not a new one. Because so many investors remain on edge after the market “correction” that took place in the last few years, deciding to jump in bed with a small cap fund is even more difficult than normal. And small cap funds, as we have discussed elsewhere on this site, are really not all that risky in terms of their long-term performance track records. So just imagine how people with the right risk tolerance might feel about investing in other types of mutual funds; likewise, how low risk investors will feel about Balanced Funds or Income funds.

Can Big Fund Companies Eliminate Risk?

While large mutual fund companies will have more assets under management than smaller companies, it does not necessarily mean they will eliminate risk better than small fund companies. This statement is supported by the following:

• it can be argued that smaller fund companies (based on assets under management) have “more” to lose than larger companies and will therefore take a more conservative approach to security selection.
• large mutual fund companies might have better access to top talent, but like all big companies they will be more heavily focused on their own bottom line profitability. This can translate in underpaying their talent or working with less progressive and astute analysts and managers.
• large mutual fund companies are often able to offer better incentives to the sales force; smaller companies will be restricted by their budgets.
• at the end of the day, both large and small companies worry about beating the index and their peers. Failure to do so will often result in cash outflows. Therefore, smaller mutual fund companies will be more sensitive and therefore more intent on making the right investment decisions.

So does it make sense to choose a Fidelity mutual fund over, say, an Adirondack fund?

Tough to say. The best performing Fidelity small cap value fund (which is unrated by Morningstar.com) actually under-performs against the top performing Adirondack small cap fund. Both funds have the same risk profile.

However, many people will find things with each fund that either works or does not work for them. Which makes the argument that choosing the best fund for your portfolio should really boil down to how well the fund, its management and performance compliment your own asset management strategy. Taken one step farther, the best mutual companies will be two different companies for two different investors. And, of course, this is why it is impossible to say, one way or another, whether bigger mutual fund companies are better or worse than smaller mutual fund companies.

A mutual fund’s expense ratios essentially tell an investor how much money the fund spends in terms of, well, expenses. And when all of us in the rest of the world are so concerned about expenses, how we spend our money, should we not be concerned about the way people who come up with our investment strategy spend theirs? Or does the expense ratio even matter, especially if the mutual fund itself provides spectacular returns?

There are plenty of arguments that suggest one over the other. And it makes sense that expenses, regardless of the business (whether you invest in mutual funds, equities, or even your own business), be kept under control. But in reality, a fund’s returns are measured post-expenses. Take the following as an example:

Fund A has an expense ratio of 1.25% yet its 3-year annualized rate of return is 12.5%. Fund B has an expense ratio of 0.55%, yet its 5-year annualized rate of return is just 8%. Is Fund A worth the premium, or is Fund B the better fund?

Measured strictly on rates of return (RoR), Fund A is the better performer. However, there could be many different considerations that need to come into question before deciding whether one should invest in Fund A or Fund B. Assuming each fund is in the same category and sub-category, one would have to consider the number of securities under management and the fund’s turnover ratio (the higher these numbers, the higher the expense should be), the level of risk (maybe a better performing fund is not what an investor wants if it means considerably more risk) and the tenure of management (a longer, more tenured management team suggests positive returns are more sustainable than a fund that has just recently returned good rates under a new management team).

Yes, these other considerations are the very reason for why sites like the Mutual Fund Site (a watered-down conversational site) and Morningstar (a straight, by-the-numbers site), etc., exist.

In our opinion, expense ratios do not matter when rates of return alone are an investor’s main concern. However, expense ratios do matter when one investigates why it is seemingly higher or lower than its competitors’. Because above the expenses, an investor needs to make sure that any mutual fund, regardless of expenses, aligns with his or her overall investment strategy.

To find get started, find out what your Asset Allocation Model is, right here at MutualFundSite.org.

The small cap growth category is an interesting one. Since small cap mutual funds are an interesting breed to begin with, investing in small cap growth funds implies less risk in a category that is abundant with risk anyway. The Wells Fargo Advantage Small Cap Growth fund illustrates just how it can be that a small cap fund can be less risky than others in its category.

The Wells Fargo Advantage Small Cap Growth fund illustrates how you can have less risk in a category that has an abundance of risk.

Starting with rates of return, the Wells Fargo Advantage Small Cap Growth fund has outperformed the Index every year since 2003 except in 2008. It has outperformed its category every year since 2003 except in 2008. And up to April 30, 2010, it has also outperformed. Each year’s performance has deviated wildly from the Index, meaning that in all but one year, it provided exceptionally greater returns than the Index and Category.

The reverse is true for that one year, in 2008, when it underperformed.

Yet on a 10-year basis, Morningstar considers the fund’s returns as just “average.” (Overall, and its 3 and 5 year returns are considered Above Average, High, and High, respectively).

Wells Fargo Advantage Small Cap Growth has taken a clear position with its portfolio make up.

When it comes to this small cap fund’s portfolio, it is evident that this Wells Fargo fund has taken a clear position in certain securities. With just 104 stock holdings, the fund can be considered average in its size. With 69% of its total $ under management invested in Small Cap, this fund has remained true to the Small Cap Growth sectory. The fund also invests 21% in Micro Cap and another 10% in Medium cap securities to round out the portfolio.

Most small cap funds that we have seen this month have spread the risk equally among different sectors. Wells, on the other hand, is pretty deep into Business Services with 23.6% of holdings. The second largest sector is Healthcare at 16.8%, and the third largest is Software at 11.3%.

In terms of individual holdings, the Fund’s Top 10 (22.4% of total holdings) consists of just one Business Services firm, one Healthcare firm, two software firms, and three Consumer Services firms. Interesting approach, one that has worked well for the fund.

The three top picks we will examine are GSI Commerce, Gartner Inc., and Live Nation.

GSI Commerce (2.97%).
At nearly 3% of total holdings, GSI represents a fairly significant holding. So what does GSI do, exactly? Well, it creates and operates over 100 e-commerce websites for retailers, manufacturers, entertainment companies, etc. It earns revenues from sales made through these sites, earning a commission for each transaction. This business model has proven profitable. This company has earned 3 years of consecutive year-over-year growth. This company also generates good cash flow that is nearly 3 times greater than it was previously. As a “Software” company, there is little reason to question why GSI makes up such a large percentage of the fund’s total holdings.

Gartner, Inc. (2.62%)
Gartner provides analysis and forecasts for IT planning for companies that would prefer to outsource this task. Overall, they provide a valuable service, mostly to chief technology officers and chief financial officers to help budget for IT programs. However, with the economic slowdown, such services have not been in high demand. With that said, Gartner has been able to maintain a relatively stable revenue level as well as maintain their equity level. For firms in this space, Gartner is definitely the one to own.

Live Nation (2.08%)
Live Nation is the sixth largest security holding in the Wells portfolio. Considered Medium Cap, Live Nation is the world’s largest event host, owning booking rights to over 155 venues. The company generates revenues in excess of $4 Billion. However, the past few years have seen net losses to the tune of $350 million in 2008 and $7 million in 2009. With such a strong equity position, the company is likely to recover nicely once the economy gets back on track.

The top holdings outlined above are pretty strong, although some uncertainty is worth noting on the Live Nation holding. Overall, the Wells Fargo Advantage Small Cap Growth fund has certainly invested a lot of attention in picking its top holdings. This small cap mutual fund, while lower in risk overall than many others surveyed here at the Mutual Fund Site, would be best suited to a growth oriented investor who refused to hold value equities and who needs to fill a somewhat larger gap (say 10% to 15%) in their equity space and needs a small cap fund to achieve that.

With the Small Cap Value fund category holding a good second spot in terms of Year to Date mutual fund returns, it would make great sense for people to be taking a keen interest in this category. The top-rated funds are found easily enough, but what about those small cap mutual funds that are not top-ranked but show some decent, tangible promise? Well, we found one such fund – the RBC Microcap Value Fund (TMVAX).

The RBC Microcap Value Fund Shows Great Future Promise

One of the ways that mutual funds are measured is on their risk-adjusted rates of return. This fund, with an astounding 395 securities in its portfolio, has had many years where it buried its competition based on performance and rates of return. But since 2003, there were two years where it underperformed and one of those years has left the 3-year compounded rate of return seriously negative.

In speaking about rates of return, the RBC Microcap Value fund has returned more than 13.2% (as at May 19, 2010), more than 3.5% better than the category. This says a lot; but its negative 39.5% return in 2008 has been hurting its long-term performance, which is likely the big reason behind Morningstar attributing a 2-star (low) rating to this fund.

As far as asset management and asset mix, the fund currently has a relatively low turnover rate at 17%, meaning it holds its positions for the long-term. This could be one reason why losses were so substantial in 2008 and why returns are finally starting to turn around and pick up in 2010. And since 84.3% of total assets are microcap, it makes sense — these were among the hardest hit assets when the markets corrected. Let’s take a closer look at those top asset classes:

At 19.3% of total assets, the Financial Services sector represents the fund’s biggest holding; Consumer Services at 15.1% and Consumer Goods at 13.8% represent the second and third top sectors, respectively.

With no single security representing more than 0.75% of the total portfolio, it appears that the RBC Microcap Value fund has adequate spread its risk. It further demonstrates that no single asset or asset class can by itself cripple the fund and destroy investor returns.

In reviewing those assets:

1. Consolidated Graphics (0.75%) represents the fund’s top holding. Having contributed 29.61% to the fund’s total return so far, this company’s security has been an aggressive asset for the fund to hold. As a Business Services firm, this company provides high quality printing services to corporations (annual reports, multi color brochures, etc.). Although demands for this type of service and product is highly volatile and seasonal, Consolidated has a solid customer base and has proven its ability to survive cutbacks in business spending. Compared to other business services firms, Consolidated has enjoyed three years of positive revenue growth, but its equity position has suffered on account of higher costs (in 2009). This becomes a speculative play.

2. Willis Lease Finance Corp (0.59%) holds the number 3 spot among the top holdings. As a business services firm, this company has yet to provide investors with positive returns. Year to Date, it has returned a negative 18.13%. In terms of revenues, Willis has remained relatively flat over the past couple of years, but it continues to report fairly stable net income and its equity position has grown thanks to smart asset choices. Although Willis remains in a negative cash flow position, its position as a provider of operating leases on spare commercial aircraft engines (aftermarket) will help it enjoy greater returns as cost-conscious airlines start spending more money on aircraft engines, airframe and engine components.

3. National Western Life Insurance (0.56%) is the first financial services firm in the portfolio. Although its Price to Earnings ratio is attractive, it has not performed at all year to date (to be precise, it returned -0.33%). In terms of its financial strength, National remains well positioned to take advantage of a recovery in the US market. With an equity position in the billions, the company has started to generate positive cash flow in 2009 and it is expected to continue into 2011. A growing asset base combined with well managed liabilities has helped keep total equity fairly high, even though 2008 saw revenues drop by over 13%. Although speculative in nature as a microcap financial services firm, National stands to benefit from the economic recovery currently underway and with its P/E ratio as low as it is, the security provides decent value within the RBC Microcap fund.

Without question, the RBC Microcap fund is the most aggressive and risky small cap mutual fund we have reviewed this month. However, its total asset allocation suggests that if the underlying assets have been properly researched and analyzed, the fund can stand to see continued, above-category level gains, particularly as more recovery from an economic standpoint happens. With this in mind, this mutual fund should be purchased only by investors with a higher risk tolerance who fully understand the risks.

There is a difference between investing in China and investing in China’s growth. This is a careful distinction that a lot of investors fail to make, yet it is a necessary one if one is seeking to profit from the undeniable growth that the Chinese people are expected to enjoy in the years to come.

Investing in China

The act of investing in China is the same as investing in domestic companies. The process involves narrowing down a large field of potential companies and ideas to a handful of prospects and then digging even deeper to determine whether that company meets fundamental basics to earn your investment.

These fundamentals would include such things as an appropriate equity level, satisfactory growth rates, margins and so on. The key difference is that such companies are actually based in China, so our everyday experience with them would be virtually non-existent (compared to investing in, say Wal-Mart or Ford or Apple, etc.).

Another key disadvantage to investing in foreign companies is that most people are unfamiliar with their political alliances, which becomes increasingly important in countries like China. To make an investment in a Chinese company, one should understand their political standing and how that bodes for their future growth and sustenance.

Investing in China’s Growth

In contrast to the above, investing in China’s growth is quite different. This involves taking positions in domestic companies that have the potential to profit from China’s growth. For example, companies that outsource key manufacturing processes would fall into this category. Such companies will be able to reduce their cost of goods sold (manufacturing costs) since labor in China is at a discount to domestic labor.

Another example would involve companies that are positioned to enjoy part of the expected growth in the middle class. This class historically creates a deeper demand for certain products and services, such as discretionary and luxury goods. Companies that have been allowed to establish a presence in China obviously stand to benefit from this and could offer great investment potential as well.

Summary

It is unquestionable that China is set to enjoy an aggressive growth rate in the years to come. Positioning one’s portfolio to take advantage of this growth is a little more complicated — does one invest directly in companies that have little relevance domestically and operate in a foreign political climate, or does one invest domestically in companies that have taken the steps necessary to enjoy part of this aggressive growth?

As often happens, the question becomes one of risk tolerance and investment knowledge. Knowing that there is a difference between the two surely helps.

The Fidelity Small Cap Discovery Fund (FSCRX) is an aggressive small cap mutual fund made up of mostly small cap securities (70.81%) with some assets invested in micro cap (15.75%) and even less in medium cap. As far as mutual funds go, Fidelity has been a steady performer even though their risk is marginally above average compared to other mutual funds in its category.

The security composition is mostly value but since 2009, they have shifted to more of a blended approach. As a result, this small cap mutual fund has been able to outperform the index in 4 of the past 5 years (failing in 2008 miserably), as well as the category (also failing in 2008).

Given its strong and steady performance, the Fidelity Small Cap Discovery fund has been a favorite over at Morningstar, achieving a 5-star rating in all categories except ten years since it has not been around quite that long.

In terms of the fund’s composition, there are just 52 holdings in total. This is where investors will either take comfort or become unsettled, the fund’s top listed sector is the Financial Services Sector, with 21.9% of its holdings in this group. This group has clearly been instrumental in providing great returns recently, with a YTD return (as at May 12, 2010) of 18.98% versus just 5.44% for the category and 13.17% for the Index.

Strong returns — YTD of 18.98% beat the Index by more than 40% and kill the Category by nearly 250%

The Mutual Fund Site likes its top holdings — it became something of a challenge when it came time to deciding which top holdings to look at most closely. This is partially the result of the fund not taking an obvious bias toward any given top holding; the risk is spread expertly among its top 10 holdings. This, of course, makes for a good thing in terms of asset allocation.

Since we are mostly bullish on the Financial Services sector, we chose the top, 3rd and 5th largest holdings.

1. Meritage Homes Corporation (MTH) at 2.86%
As a homebuilder, Meritage had its shares of problems, adjusting poorly to the changes in homebuilding that began in 2007 and up until 2010 was extremely challenging. However, with the real estate markets starting to show signs of bottoming out, Meritage seems poised to make great strides. Thus far, it has contributed impressive returns of 24.42% YTD to the portfolio.

Meritage operates in those higher risk areas of California, Arizona, Texas, Nevada, Colorado and Florida. Although they have reduced their home prices over the past few years, the company is still facing an uphill battle (in our opinion) with shrinking revenues, systemic problems in some of its largest markets as well as its overall size.

However, the company remains solvent with a decent equity position, and the financials have been very well managed over the years with expense management allowing for a considerable improvement to net income in 2009 over 2008 despite gross revenues shrinking by nearly 40%.

Fidelity likes this company, holding nearly 4.8% of it in another fund. T. Rowe Price, owns a over 6% between two o its funds.

And of course, the Mutual Fund Site believes that this homebuilder will indeed profit well once the housing market turns around. With its good equity base, ability to generate cash flow, this is clearly a smart homebuilder to own, despite the current-day risks.

2. RTI International Metals (RTI) at 2.83%
As a Titanium-mill and other specialty metals producer, RTI is an interest small cap play. With $410 million in sales, it does not compare equally to larger players like, say, Rio Tinto, but the company is fairly well managed and should perform well in the medium term.

In terms of revenue diversification, RTI is heavily involved in aerospace, defense and energy. Each of these sectors is heavily dependent on private and government funding, which may account for some of its poor revenue showings in the past 3 years.

Problems facing RTI include negative growth over the past 3 years. With such a higher concentration on sectors that depend on government funding, RTI could be one of the larger risks in the portfolio, yet to date it has already returned 3.62%. As well, in 2008 it was voted as one of the 100 fastest companies in the US.

Analysts are also bullish on this stock, declaring it a buy.

3. Wesco International Inc. (WCC) at 2.79%
A distributor of electrical supplies, Wesco is his heavily involved in construction (36%) and industrial (40%) sectors. Unlike many of its competitors, its reliance on utility sales (17%) is muted compared to the private sector, positioning Wesco to gain from a construction and manufacturing turn around, a true value play.

In addition to its strong positioning in the market, Wesco has contributed 46.7% on a YTD basis to the funds overall returns. This has not gone without notice; 16 analysts covering this stock have progressively ranked it as more of a buy over the past year.

Financially, Wesco remains in a strong equity position despite falling sales and a tighter market, yet it continues to generate cash on a year-over-year and quarter-over-quarter basis. Clearly, this is a sign of strict and disciplined management.

Risks facing the security include negative sales growth over the past 3 years. Of course, this is not uncommon given its concentration on the construction and industrial sectors, which have also been hammered but which, on the whole, are showing positive signs of recovery.

For investors with the Risk Tolerance, Fidelity Small Cap Discovery makes good sense.

Overall, we like this small cap mutual fund. It performs well and, despite the higher risk rating, its holdings position the fund to enjoy fairly substantial gains during the upcoming years of economic recovery and expansion. While flaws can be found in virtually all of its top 25 holdings, those threats or weaknesses also present the most compelling opportunities.

Buffalo Small Cap Growth (BUFSX)

Overall, this fund has been a top performer in its category for many years. since 2000, it has been in the Top 5 for 4 years. Its worst year was in 2007 where it was ranked 84th; to date, it ranks 4th in the category.

In terms of returns, it has only underperformed the category in 3 of the past 10 years (since 2000). This kind of consistent makes for an appealing fund.

Morningstar also seems to like the fund, having it ranked currently as a 5 star fund overall. This says a lot about its risk-adjusted returns; in fact, the fund has a beta of just 1.05 when measured against the S&P 500. This means that for every point the S&P 500 moves, this funds should move 1.05 points. Ultimately, the closer to 1, the less risk. But the closer to 1, the less likely the fund is to outperform that index… in theory. Clearly, Buffalo Small Cap has no trouble outperforming by a large margin without having to take crazy risks.

Currently rated 5-stars, this small cap fund can brag about a YTD return of 17.88% vs. 13.2% for category. This is quite promising since the risk rating of the fund is considered below average.

As for the investments, this fund has a small cap, growth-oriented portfolio, which has remained consistent over the past 3 years, if not longer. This provides the investor with a fair degree of comfort, knowing that the manager is not simply chasing the popular money for the sake of short-term returns at a cost of long-term returns.

Speaking about the make up of the fund, 31.93% is invested in Medium cap stocks while 56.67% is in small cap and 11.41% is in micro cap stocks. With such a heavy weighting in medium cap stocks, investors will need to make sure this fund does not deviate too much from its mandate as a small cap fund. However, with so much in small and micro cap, this does not seem to be a substantial area for concern.

With just 56 stocks in the portfolio, the manager has taken some fairly considerable positions with the fund’s assets. But with turnover at 15%, it is evident that the manager is committed to seeing those picks return appropriate gains.

The three largest sectors held within the fund are: Business Services at 21.22%; Consumer Services at 18.79% and; Health Care at 17.17%. The three largest holdings are:

1) WMS Industries
-is the largest individual holding; they are a leading slot machine supplier to the larger casinos.
-while some see risks in holding this type of security, others see an inevitable demand for slot machine replacements, an expense that many casinos have been putting on hold for several years. WMS, which aims to be the largest supplier, can benefit.
-even during “tough” past years, WMS has managed to increase sales on an annual basis and continue reinvesting into the company. Its equity position remains strong and has been getting strong with every year.
-According to Thompson/First Call, the 13 brokers that cover this stock rate it as a strong buy and the current price remains below the lowest 1-year price target.
-However, given the conflicting belief and information about the growth rate of this industry, including machine demand, it becomes a speculative investment based on one’s personal views about machine demand.

2) Life Time Fitness
One of top 5 largest holdings, Life Time Fitness targets a higher end fitness group. Its clubs are considered spa like and aim to provide an escape for its members.
-Financially, this company is well managed. As at the end of 2009, sales continued to increase and the equity position continued to grow through good capital management. The company has done well by paying down short-term and long-term debt.
-Overall, the 12 brokers who cover this stock according to Thompson/First Call rate this stock a hold.
-Some concerns facing this company is competition and potentially waning demand for this kind of niche (expensive) fitness club.

3) Waddell & Reed Financial
-An asset management and advisory firm, Waddell and Reed has fared quite well given the market turbulence. While they have seen lower revenues, the firm has been able to maintain a healthy equity position. They currently provide investment management services for Ivy (one of their largest clients).
-Overall, there are 10 brokers who cover this stock and the average rating is HOLD.
-Fears about a high concentration of revenue coming from a small percentage of clients has some investors/analysts more neutral on this stock.
-However, as the economic situation improves and the market cycle starts to improve, Waddell and Reed should see a growing demand for their services.

Evidently, Buffalo has taken a bold position in these firms, trusting that their belief (remember that for every position they take there is another position that feels otherwise) will yield positive results for the investors.

At the Mutual Fund Site, we feel there is simply too much emphasis placed on assets that have an uncertain future for 2010. If slot machine demand remains stable or drops, if high-end fitness club membership sales ease and if demand for investment management and advice services drop, the firms above could be easily and negatively impacted. There simply seems to be too much emphasis on service-based assets here.

However, there is no disputing the performance of the Buffalo Small Cap Growth fund. This fund has an extensive history for shooting past its competitors in terms of returns and safe performance.

Depending on an investor’s Asset Allocation Model, we would limit exposure to this fund to 1/3 or less of the specialty equity class.

One of the things that a site like the Mutual Fund Site should aim to provide is sufficient analysis of mutual funds. With that in mind, we will endeavor to analyze a couple of mutual funds every week, starting with small cap mutual funds in the month of May 2010. We will post our analysis in a new area of our website, probably titled “Mutual Fund Analysis” or some such truly unique heading.

When evaluating these small cap mutual funds, we will take a look at its risk rating, rate of return and a few other key features that can help investors decide whether such a fund is where to invest. Of course, these will not change our current Top Pick 2010 funds, nor will favorable reviews necessarily lead to a Top Pick rating. We simply would like to provide commentary on the funds, highlight the risks and provide details on what we see those risks as noteworthy enough to help shape an investment decision one way or another.

With our objective in mind, we will aim to review the following types of mutual funds for the next few months:

May 2010 – Small Cap Mutual Funds

June 2010 – Value Mutual funds

July 2010 – Real Estate Mutual Funds (we are looking forward to seeing how the summer month’s housing reports will impact this sector).

The reason for the change is simply that we want to provide even more value to our site visitors. We do not want to be a purely investment site (there are plenty of those around). And given that our site is called, well, the Mutual Fund Site, we figure we should post more about mutual funds, less about investment management concepts and investment strategy.

Please feel free to post your comments at the end of this post… we look forward to receiving your feedback!

Christopher Fitch

Mutual Fund Site

There should be little surprise that so many investors are interested in learning more about China Mutual Funds. While the Mutual Fund Site has only spoken about China in a round-about reference to one of the world’s greatest portfolio managers (Anthony Bolton), it makes some sense to review some of the risks associated with an Investment Strategy that is so bullish on China as well as some of the potential rewards. But if we were asked where to invest in China, we would probably take a really long time to respond to such a question. The reason will reveal itself below.

It is generally well known and accepted that China represents a tremendous investment opportunity. For most investors, however, that means investing in China in order to sell one’s product or, less likely, services to the Chinese population. Think of General Motors, for example. They own Cadillac and, with a growing middle class in China the demand for discretionary luxury goods like Cadillacs will increase. The growing middle class is not a reason for General Motors to go and purchase or invest heavily in one of the nearly one hundred manufacturers. With this in mind, investors should be cautious about whether they want to invest in Chinese companies or invest in domestic (US) companies that are well positioned to profit from China’s rapid development.

It goes without saying that China continues to censor and control much of the local industries. Recently, Google pulled out of China as a result of this (it can be speculated that Google became frustrated with China’s insistence that Google operate in a manner satisfactory to the China government). Luckily, Google had the resources to call it quits; other companies might have been forced to alter their business model and integrity and comply for financial reasons. Given Google’s frustration, it should be seen as rather risky to invest directly in China.

In terms of China Mutual Funds, there are but three that Morningstar considers 5-star. One of them, the Templeton China World Fund has returned nothing (okay, it returned -0.17% as at April 19, 2010) and still manages to outpferform its peers. AllianceBernstein’s Great China ‘97 has performed similarly and is currently ranked as a 2-star fund. Clearly, even the professionals are having difficulty finding the right securities to invest in. And when highly regarded professionals like those running these two very similar (yet greatly diverse by Morningstar rating) funds, then it goes almost without saying that individual investors will have a tough time making money in China Mutual funds.

On the positive side, China growth translates into a hunger for many of the resources found domestically. This results in a strong demand from one of the world’s largest populations and potentially soon-to-be wealthiest nations. This was evidenced when China recently announced a multi-billion dollar investment Venezuela in exchange for future delivery of oil.  Such an investment suggests that perhaps it would be more wise to invest in some of Venezuela’s larger oil companies and not China itself. As well, both funds listed here returned more than 40% for their 1-year performance. Obviously, there was some growth to be had.

Perhaps the popularity of China mutual funds is just that — popularity. And when we think back to high school, not all of the popular kids were among our best friends. Maybe the same holds true for investing there. Maybe it is smarter to invest in less popular areas and enjoy the future growth potential that comes with a contrarian approach.

It appears that a lot of people who find the Mutual Fund Site are looking for help with investing $10,000. Although we cannot “tell” people how to invest 10,000 dollars, we can certainly help them along in their investment journey, whether through our Free Asset Allocation Model service or our specific fund recommendations like our Small Cap Fund Top Pick for 2010 and our High Yield Investment Top Pick for 2010.

Ultimately, figuring out how to invest $10,000 (why 10K and not 20K or 50K, I don’t know) wisely will involve a lot more than visiting just this site. It will involve spending some time at Morningstar and sifting through the data there, particularly when it comes to your core holdings. It could also involve spending time at Fundalarm, a website that “warns” people about the fund they have invested in or are considering investing in. But first things first:

Start with your Asset Allocation Model

Knowing what your asset mix should look like will obviously provide a great starting point for all investors. Whether you are a Balanced investor, a Growth Focused investor or even an Income investor will tell you just how much money you should be “risking” in any given asset class, starting with Cash, then moving on up to Income and then finally Growth, with the risk levels increasing correspondingly. And then, if your risk tolerance allows it, consider specialty funds.

In fact. our Top Picks for 2010 are both specialty funds — the High Yield fund is not considered a core fixed income holding by any stretch (even though it offers a below average risk profile, it is still focused enough to fall outside the mainstream) and evidently our Small Cap Value fund is nowhere near being part of the main “Growth” class (even though it is consider low risk among its peers).

Once you have your asset allocation model figured out, you can further drill down and see how much of your $10,000 can be invested in the types of investments we look at fairly regularly. But keep in mind that the bulk of that investment should be in core holdings — a fixed income component, a growth component as well as (usually) a small cash component.

So, to get started simply click on the link titled “Asset Allocation Model Recommendation” as shown below:

Withing a couple of days, we will have your Free report to you so you can get started to see just how much of your $10,000 can be invested in which asset class and, of course, how much can go into those terrific specialty funds (whether they are the ones we recommend or not) that have the potential to improve your portfolio’s performance tremendously.

Best of luck and we hope to see you back again soon!