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Insider-Trading Investigation Stirs Fund Anxiety

Plus, largest mid-cap value fund to close, Vanguard CIO cautions bond investors, more.

Morningstar Analysts, 11/29/2010

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A new insider-trading scandal that could ensnare the mutual fund industry broke this week. Some prominent fund companies and asset managers, including Janus and Wellington Management, have been named in news reports of the imbroglio, but it's still not clear if or how they will be implicated or if other fund firms will get dragged into it. Stay tuned for further developments.

Largest Mid-Cap Value Fund to Close
Perkins Mid Cap Value JDPAX, the largest fund in the mid-cap value category, with $13 billion in assets, will close to new individual retail investors Dec. 31.

The fund has taken in more than $928 million in new money this year alone, after taking in $1.1 billion in 2008 and $1.4 billion in 2009.

Strong results explain the significant shareholder interest. Through Nov. 23, the fund's 10.3% annualized return over the past 10 years puts the fund in the top 5% of the category and easily outpaces the 7.3% return that the typical peer has experienced over the same period.

During 2008's financial meltdown, the fund stayed nearly 10 percentage points ahead of its typical rival, and it performed similarly well during the bear market earlier last decade.

The fund has continued to take in money this year because of its excellent long-term performance and despite recent results. Its 8.1% year-to-date return lags those of the Russell Mid Cap Value Index and 92% of the mid-value category.

Current shareholders can still invest in the fund as well as reinvest any dividends or capital gains distributions.

Vanguard CIO Expects Modest Bonds Returns
Vanguard CIO Gus Sauter recently warned investors that bond returns over the next 10 years will be nothing like the roughly 6% annual return experienced over the previous 10.

In a question-and-answer letter posted on Vanguard's website, Sauter wrote that he thinks the average annual rate of return for the broad U.S. bond market will be about 3%. His forecast is based on long-term projections that were generated by the Vanguard Capital Markets Model, a proprietary financial simulation tool used in Vanguard's investment methodology and portfolio-construction process.

Sauter's forecast also means that he expects a sharp reduction in bond returns after the effects of inflation are taken into account. The U.S. bond is currently forecasting 2.15% annualized inflation over the next 10 years, which means he expects bonds to return less than 1% a year in real terms, or after the effects of inflation. Inflation has averaged approximately 2.3% per year over the past 10 years.

Other managers have low expectations for bonds, too. Rob Arnott, manager of PIMCO All Asset PAAIX, a global tactical allocation strategy that invests in other PIMCO funds, recently wrote that he expects bond returns in the neighborhood of 2.5%.

Sauter also notes that the return offered from Treasury Inflation-Protected Securities has declined quite dramatically over the past year. He notes that, historically, the average real return has been roughly anywhere from 2% to 3% for TIPS. The decline in real returns in recent years has boosted the overall return of TIPS because of the increase in principal value. But this means prospects for future returns are meager. Short-term TIPS bonds are yielding 0%-1%, and the 30-year TIPS yield is 1.64%.

Despite this outlook, neither Sauter nor Arnott think investors should abandon bonds. Sauter writes that investors should think about bonds the way they always have: as a way to provide stability and reduce volatility with a reasonable rate of return. Meanwhile, Arnott thinks investors should focus on investment-grade credit, high-yield, emerging-markets debt, and long TIPS.PAGEBREAK

Vanguard Lowers Investment Minimum for Advisors
Vanguard recently eliminated the $1 million to $5 million investment minimums for its Signal share classes of 25 of its index funds. You still have to be an institution or an advisor to use Signal shares, which offer expense ratios as low as 0.07%. Vanguard said it eliminated the minimums to make it easier for advisors and institutions.

Vanguard recently has been passing along economies of scale by lowering the barriers to the lowest-cost share classes of its funds. In October, it dropped the threshold to qualify for its low-cost Admiral shares for individual investors to $10,000 from $100,000 for certain index funds and to $50,000 for select actively managed funds.

Transamerica to Launch 'Quality' Strategy
So-called "quality" mutual funds are lagging the broad stock market indexes once again this year after trailing the indexes last year. But that isn't stopping fund companies from launching new strategies focused on quality stocks, or those with household brand names or big competitive advantages, such as large caps Coca-Cola KO and Johnson & Johnson JNJ.

Transamerica became the latest fund company to offer new quality-focused funds when it said it would launch Transamerica WMC Quality TWQAX, subadvised by Wellington Management's 26-year-old Quality Value team, which is led by Matthew G. Baker. The actively managed fund will invest in 65-85 companies and will measure itself against the Russell 1000 Value Index.

Funds that invest in quality, or wide-moat, companies gained prominence thanks to their strong downside protection in 2008. The S&P 500 dropped 37% that year while the Morningstar Wide Moat Index, a market-cap-weighted index of high-quality companies, lost 30%.

Most quality funds have lagged ever since. Through Nov. 23, the Morningstar Wide Moat Index trails the S&P 500's 7.8% gain by 3 percentage points. In 2009, the index trailed the S&P's 26.5% gain by 8 percentage points.

Osterweis Capital Management estimates that its new Osterweis Strategic Investment OSTVX will have no distribution this year while Osterweis OSTFX and Osterweis Strategic Income OSTIX will have modest distributions primarily in the form of ordinary income.

The board of directors of Legg Mason Capital Management American Leading Companies LGAAX plans to merge the fund into Legg Mason Capital Management Value LGVAX, subject to shareholder approval.

On Nov. 11, 2010, the board of trustees of Driehaus International Small Cap Growth DRIOX approved the closure of the fund to most new investors. The closure will be effective Dec. 29, 2010.

In August 2010, the board of trustees of Columbia Connecticut Intermediate Municipal Bond LCTAX approved a proposal to merge the fund into Columbia Connecticut Tax-Exempt Fund COCTX. However, the board has determined to not proceed with the proposed merger.

Douglas Noland replaced Steven Lehman as portfolio manager on Federated Market Opportunity FMAAX Nov. 19, 2010.

Delaware Macquarie Global Real Estate DLRAX changed to Delaware Global Real Estate Securities on Nov. 24, 2010.

ING Index Plus International Equity IFIAX comanager Martin Jansen left Sept. 28, 2010. Herman Klein will replace Kris Hermie on ING Global Equity Dividend's IAGEX management team Nov. 30, 2010.

Ivy Mortgage Securities IYMAX will merge with Ivy Bond IBOAX by Jan. 21, 2011.

The board of trustees of JPMorgan Tax Aware U.S. Equity JTEAX approved the merger of the fund into JP Tax-Aware Disciplined Equity JPDEX. If shareholders approve the merger, it is expected to be completed March 25, 2011.

On Dec. 10, 2010, T. Rowe Price will no longer act as a subadvisor for Old Westbury Global Opportunities OWGOX. Current subadvisors Bessemer Investment Management and BlackRock Financial Management will assume responsibility for T. Rowe's assets.

Comanager Guarav Malik left SSgA International Stock Selection SSAIX. Didier Rosenfeld and new manager Stuart Hall remain.

The board of trustees of Turner Large Cap Growth TSGEX plans to merge the fund into Turner Core Growth TTMEX. Subject to shareholder approval, Turner Core Growth will be renamed Turner Large Growth on Jan. 31, 2011.

Putnam Management and the boards of trustees of Putnam Absolute Return 700 PDMAX, Putnam Absolute Return 500 PJMDX, Putnam Absolute Return 300 PTRNX, and Putnam Absolute Return 100 PARTX have agreed to limit the funds' total expenses through at least Feb. 28, 2012, so that the funds' total expenses (before performance adjustments and excluding brokerage fees, interest, taxes, investment-related expenses, extraordinary expenses, and payments under the fund's distribution plans) will not exceed 1.10%, 0.90%, 0.60%, and 0.40%, respectively, of the funds' average net assets.

Lord Abbett High Yield Municipal Bond HYMAX has reduced the front-end sales charge of its A shares to 2.25% from 3.25%.

Fidelity Southeast Asia FSEAX is renaming itself Fidelity Emerging Asia effective Dec. 1, 2010. At that point, the fund will switch benchmarks to MSCI All Country Asia ex Japan Index. During a period of transition, the fund will use a blended index of the old and new benchmarks to determine the fund's performance adjustment.

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