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Fund Spy

New Funds We'd Like to See

Forget the gimmicks; give the people what they need.

When it comes to fund launches, less is invariably more. For example, the Dodge & Cox lineup, at just four funds, is the epitome of utilitarian: It plays to the firm's strengths and gives investors pretty much everything they need to build a long-term portfolio. Why can't more shops keep it simple like that? On the flipside, firms that are always rushing trend-chasing, "ripped from the headlines" funds to market are invariably doing so to make a quick buck, not because investors will benefit from them.

However, there are a few fund types that we wouldn't mind seeing fund shops embrace, particularly if they have the wherewithal to manage them well and at a reasonable cost. Fund marketing and product development types, listen up: We're not usually in the mood to give free advice.

Tax-Managed Target-Maturity Funds
Target-maturity funds have zoomed in popularity over the past few years, bolstered by their all-in-one simplicity and the Pension Protection Act of 2006, which enables employers to opt retirement-plan participants into age-appropriate investment vehicles. Wouldn't it be great to give investors a similarly stripped-down, age-appropriate way to invest their taxable assets? Granted, target funds are by their nature tax-inefficient, because they need to sell stocks and buy bonds as an investor reaches his or her retirement date, no doubt realizing capital gains along the way. However, it seems like you could model the tax-managed target funds along the lines of  Vanguard Tax-Managed Balanced (VTMFX), which combines municipal bonds with a tax-conscious equity strategy. In that case, rebalancing on a security-by-security basis is more tax-efficient than doing so on a fund-by-fund basis.

More Tax-Managed Funds, Period
Are you picking up on a theme here? It's hard to get anyone excited about taxes and mutual funds. Investors and the media usually don't pay attention, and fund managers are typically paid based on their pretax returns so that's the number they gun for. (I'm often shocked by the number of managers who a) pay no attention to taxes and b) haven't bothered to check the percentage of their investors who are in taxable versus tax-sheltered accounts.) Even so, most investors have a limited set of options for sheltering their investments from taxes, which can take a big bite out of take-home returns. That would argue for a far bigger share of the fund universe that's paying attention to taxes than is the case currently. Vanguard's suite of tax-managed funds is superb, and there are also some actively managed funds that have been quite tax-efficient, such as  Oakmark Fund (OAKMX) and  Third Avenue Value (TAVFX). Even so, there should be many more funds managed with an eye toward tax efficiency.

More Subadvised Funds
Subadvised funds--those run by outside managers--appear to be gaining in popularity and number, but I'd still like to see more of them. The key reason is that firms opting for outside managers are (at least in theory) choosing them at arm's length based on their investment merits. That stands in contrast to other fund shops (and their boards), which too often stick with the home-team managers through thick and thin: terrible performance, manager departures, and heightened management fees. Funds that employ a subadvisory model also arguably have a better shot at managing asset growth than funds run by a single firm, because they can add another manager if the original skipper becomes overburdened with assets to invest.

Subadvised Target-Maturity Funds
The target-maturity space would appear to be particularly ripe for the subadvisor approach. (A handful of firms, including John Hancock, have embraced this model.) After all, target funds bundle together domestic and international stocks as well as bonds, and how many firms truly excel at every asset class? Not many. A fund shop might manage in-house the sleeve of the target fund in which it truly excels, then farm out the other pieces to outside firms. The key to making this system attractive is keeping expenses down; too often, firms strap on high management fees for putting target funds together.

Smid-Cap Funds
I'll be the first to concede that the term "smid," which refers to funds that invest small- and mid-cap stocks, is cringe-worthy; I'd be happy if I never heard it again. Nonetheless, the concept is a good one. If a manager is focusing on small-cap stocks and some of the successful ones happen to "graduate" into the mid-cap space, is there any reason that he should be forced to sell them simply because of arbitrary market-cap parameters? I don't think so. Of course, managers have to sell stocks when they no longer fit their style discipline, but I don't think there's any good reason a manager should sell a company he likes simply because it's not the right size. Doing so racks up unnecessary tax and trading costs and could mean a manager sells a company he knows and likes.

Global Index Funds
There are now a handful of global index ETFs, but so far there are no traditional mutual funds based on global indexes. Why? Beats me. As Mike Breen ably noted a few weeks ago, the distinction between domestic and foreign companies has blurred substantially over the past few decades. That means that keeping the two types of companies in separate silos is seeming more and more archaic by the day. Moreover, indexing is built on the precept that it can be difficult to separate the market's winners from its losers, especially when the extra expenses, trading, and tax costs of active management are factored in. Those who buy into that logic should also buy into the concept of leaving it to the markets to determine the appropriate allocation between U.S. and foreign stocks. To my mind, global index funds should not only become more plentiful; they should also be the new standard as the index choice for 401(k) plans.

Absolute Return Funds
I used to have such an easy time recommending  Clipper Fund (CFIMX) to seniors who told me they wanted market participation but were concerned about being invested in an overheating market. That's because the fund's previous management team looked for companies that were cheap on an absolute basis and would let cash build when they couldn't find enough to buy, a strategy that provides a built-in buffer against frothy markets. (I'm still a big fan of Clipper, by the way, but its current managers tend to stay fully invested.) I've no doubt that many investors and advisors want their fund managers to stay fully invested at all times so they can more tightly control their asset allocations. A lot of other folks, however, wouldn't mind seeing a little cash in their funds if it were an outgrowth of the manager's valuation discipline.


Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.