Fund Times: Fidelity Fines Itself

Fidelity traders who received improper gifts from brokers directed trades to those brokers, an investigation by the independent trustees of Fidelity's fund board has concluded. But the trustees couldn't find proof that investors were harmed.

The trustees' investigation was prompted by ongoing NASD and SEC investigations into "travel, entertainment, gifts, and gratuities," including Super Bowl tickets and various junkets, given by brokers to Fidelity traders. Even though the trustee investigation didn't prove that the misdirection resulted in higher trading costs for the funds, they nonetheless recommended that Fidelity Investments pay a $42 million fine to Fidelity funds. Fidelity chairman Ned Johnson took the unusual step of posting a letter on Fidelity's Web site in response. He apologized for the behavior, acknowledged that the funds were put at risk, and agreed to pay the fine.

The irony of this more than two-year old trading scandal is that Fidelity has been a leader in bringing down trading costs, the benefits of which have flowed to fund shareholders. Fidelity has used its huge trading volume as negotiating leverage over Wall Street. Fidelity has driven down brokerage commissions and struck groundbreaking deals with brokers like Lehman Brothers and Deutsche Bank to pay for research out of its own pocket, "unbundling" it from brokerage commissions. We viewed this as a shareholder-friendly step, as "soft dollar" arrangements, which are still commonplace in the mutual fund industry, force fund investors to pay excessively high brokerage commissions, when research costs should come out of an advisor's management fee.

Since the scandal broke, we have been encouraged by Fidelity's handling of the allegations. An internal corporate investigation found that traders violated internal policies prohibiting employees from "giving or accepting any gift, worth more than $100 per calendar year, to or from any person or entity who is a current or prospective vendor, customer, or supplier of Fidelity." Fidelity disciplined 14 traders, firing some. Scott DeSano, the subject of considerable media attention for his efforts to drive down commissions, is no longer the head of equity trading. And Fidelity has tightened its policy regarding gifts. The fact that independent trustees, who are entrusted with advocating for shareholders, launched an investigation (paid for by Fidelity) was encouraging (read more about Fidelity's board in our Fidelity Fund Family Report).

Still, we await the findings of the SEC and NASD investigations into whether shareholders were harmed and whether Fidelity should pay additional fines.

Vanguard Plans to Offer Fixed-Income ETFs
Vanguard has been a big player in the rapidly growing ETF market, but thus far, it's stuck to equity ETFs. That could be about to change. In October, the fund family filed with the SEC for permission to create ETF share classes for  Vanguard Total Bond Market (VBMFX),  Vanguard Short-Term Bond Index (VBISX),  Vanguard Intermediate-Term Bond Index (VBIIX), and  Vanguard Long-Term Bond Index .

It's anyone's guess when these bond ETFs will hit the market, given that the SEC must first grant exemptions from the Investment Company Act of 1940 before Vanguard can formally register them. There are a couple of things investors should expect when they do arrive, though. Vanguard is known for its low expenses, and its ETF share classes are generally priced below the Admiral share classes of the parent funds. In this case, the Admiral share classes of the parent bond funds charge about 0.11%, so these ETFs will likely be cheaper than their closest fixed-income ETF rivals from iShares, which charge between 0.15% to 0.20%. Also, the parent bond funds are well diversified and own more securities than the iShares rivals. That should help the proposed ETFs hew closer to their respective indexes. Finally, since the parent bond funds track indexes with exposure to government, corporate, and agency bonds, these ETFs will cover more ground than the iShares ETFs, whose indexes include only Treasuries.

For more on Vanguard's foray into fixed-income ETFs, check out our Vanguard Fund Family report.

Vanguard to Launch New International Index Fund
In the first quarter of 2007 Vanguard also hopes to launch what is essentially a new total international stock market index fund and ETF.

On Dec. 15, 2006, Vanguard registered the Vanguard FTSE All-World ex USA Fund with the SEC. The fund will offer institutional, investor, and ETF share classes and will track the FTSE All-World ex USA Index, a market-cap-weighted index holding more than 2,000 large- and mid-cap stocks from 48 developed and emerging foreign countries outside of the United States. "The fund will provide exposure to the world's developed and emerging stock markets in a single, low-cost vehicle," said Vanguard Chief Investment Officer Gus Sauter.

The new offering would add another total foreign stock offering to Vanguard's conventional mutual fund line up and plug another key hole in the family's ETF share class. Vanguard already has a conventional retail share class for  Vanguard Total International Stock Index (VGTSX), but that offering's structure as a fund of the firm's other international index funds made it hard to offer a ETF share class because there are no exchange-traded funds of funds.

This is Vanguard's seventh international index fund, and its first international FTSE fund.

Vanguard TIPS Fund Says, "No Dividend for You"
 Vanguard Inflation-Protected Securities (VIPSX) won't be handing out a dividend in December. That bad news doesn't end there. Vanguard will be treating 5% of the income distributed to investors in the first three quarters of 2006 as return of capital, which essentially means investors get some of their original investment back. That's upsetting news, but don't blame the fund's management. Blame the market. TIPS are tied to the non-seasonally adjusted Consumer Price Index (CPI) and move up when it rises, which it often does. However, from August through October, falling oil and gas prices pulled the CPI down. This fund followed suit. The deflationary impact on the fund's principle was enough to offset the fund's real interest income for the fourth quarter.

We wouldn't write this occurrence off as an anomaly. Other TIPS-only funds have similarly disappointed investors.  IShares Lehman TIPS Bond (TIP) has a spotty dividend record and has frequently paid out returns of capital, for instance. So invest with care. TIPS are excellent diversification tools, but their heavy dependence on inflation makes them hard to use by themselves, particularly for investors seeking steady income.

First Trust Converts Closed-End Fund to ETF
On Dec. 18, 2006, First Trust Value Line Dividend Index (FVD) began trading on the American Stock Exchange as an ETF. Only a few days before, it had traded as a closed-end fund. Shareholders approved the reorganization earlier this year, in part to rid the fund of its perennial market discount to net asset value. Closed-end funds often trade at significant discounts or premiums to their NAVs, but ETF shares have benefited from an arbitrage mechanism that has, for the most part, kept their market prices close to their NAVs.

Oppenheimer Changes the Guards
OppenheimerFunds recently announced that Chris Leavy will assume the role of head of equities in the coming year. He's not giving up portfolio managerial duties, though. There are no plans for him to step down from  Oppenheimer Value (CGRWX),  Oppenheimer Select Value , or  Oppenheimer Equity . 

Leavy succeeds Bill Wilby, who has headed the equity group since July 2004.  Wilby will continue to comanage  Oppenheimer Capital Appreciation (OPTFX).

Evergreen Small Cap Value Reopens
We were pleased when  Evergreen Small Cap Value  closed in April 2005 with $350 million in assets. It showed managers Jim Kaplan and Paul Weisman were more concerned with practicing an effective investment strategy then with gathering more assets. Recently, though, the fund reopened to investors, even though it's grown to $430 million since its 2005 close. The fund's management team says it is comfortable with the current level of assets and thinks additional inflows won't hamper the fund's strategy.

Doors Close at Aston Fund
Aston/River Road Small Cap Value (ARSVX) will no longer accept money from new investors. The soft close comes just a year and a half after the fund's inception. In its short tenure, the fund has racked up impressive gains. Its 29.2% climb for the year to date ending Dec. 20, 2006, makes it a top performer in the small-value category. Assets haven't bloated this fund, though. It has just $188 million. But managers run nearly $800 million in the small-value strategy as a whole, so we're pleased to see management take steps to ensure this fund stays flexible.

Managers Funds Shifts More Assets to Loomis Sayles
At the start of 2007, the fixed-income portion of world-allocation fund Managers Fremont Global  will be allocated to Managers Global Bond (MGGBX), which has been subadvised by a team from Loomis Sayles for nearly five years. In order to avoid charging shareholders of the Global Fund at two different levels, Managers will waive the management fee for the Global Fund for the portion of its assets run by Global Bond.

More Sector Funds from Fidelity
Fidelity recently launched Fidelity Advisor Consumer Staples (FDFAX), Fidelity Advisor Telecommunications (FSTCX), Fidelity Advisor Gold (FSAGX), and Fidelity Advisor Materials (FSDPX). Fidelity Advisor Consumer Staples is managed by Robert Lee. Lee was also recently named portfolio manager on Fidelity Select Consumer Discretionary (FSCPX). Fidelity Advisor Telecommunications is managed by Brian Younger. Younger also runs  Fidelity Select Wireless (FWRLX). That fund has returned 32% since he took charge in May 2003. Fidelity Advisor Gold and Fidelity Advisor Materials are managed by Daniel Dupont and Jody Simes, respectively.      

Note: We revised our previously published item on Managers Fremont Global  in order to correct errors within the story.