Carlson critiques funds: no-load stocks vs. no-load mutual funds

Black Enterprise, Oct, 1995 by Charles B. Carlson

Yes, you will avoid a sales fee when investing in no-load mutual funds. But don't believe for a second that investing in no-load mutual funds is truly "no-cost" investing.

From an NLS Perspective. How do the costs of investing in no-load stocks compare to the costs of no-load mutual funds? The clear winners are no-load stocks. Not only do you avoid any sales fees on the initial purchase of no-load stocks, but your annual costs to maintain your account are usually zero. All of your money works for you each and every year, making no-load stocks the only "no-cost" investing vehicle available to equity investors. Also keep in mind that the cost advantage of no-load stocks versus funds means that a typical no-load mutual fund must outperform a portfolio of no-load stocks by at least 2% every year in order to generate the same "after-fee" returns. That gives no-load stocks a big edge in terms of long-term performance.

MYTH: I KNOW EXACTLY WHAT SECURITIES MY FUND HOLDS

Knowing what a mutual fund has in its portfolio, if you go solely by the name of the fund, is extremely difficult. A mutual fund can use a certain name if, under normal market conditions, as least 65% of its assets are invested in that category. However, that also means that 35% of the fund's assets may be invested in totally different instruments carrying perhaps more risk.

But what about the quarterly reports in which the fund lists its holdings? Isn't this a useful source to find out what a fund holds? Perhaps, although this information is often out-of-date and fairly meaningless. Indeed, in funds with high portfolio turnover, what was reported as a substantial holding in a fund two months ago may not even be in the portfolio today.

Well, can't I call the fund manager to find out the fund's top holdings at any given time? The fact is that you'll probably get the runaround if you call your fund to find out the biggest holdings. Most mutual funds are very close-mouthed about the securities they hold. Fund managers don't want others, especially big, institutional investors, to know what they are buying or selling because that information may affect prices.

Finally, even if you know what's in the portfolio, it may not help you to assess the real risk of the fund. Financial derivatives are a popular investment for funds. Derivatives are hybrid securities designed by Wall Street rocket scientists. Many fixed-income funds have been employing derivatives in their portfolios in order to boost returns. The problem is that these newfangled investments have tended to be extremely risky and volatile in the wrong hands. Therefore, even though the overall maturity of your bond fund may be very short--which would make it less susceptible to interest-rate movements--the inclusion of certain financial derivatives may actually make it riskier than you think.

The risks of financial derivatives were evident in 1994 when several money-market mutual funds registered losses due to derivatives. In a number of cases, the mutual funds, fearing a major backlash from investors who don't expect to see losses in "safe" money-market funds, kicked money into the funds to cover the losses. But investors shouldn't expect fund groups to always be this benevolent.