Holy Smokes! These Funds Might Get Barbecued!

Most of the time I use this space to share ideas for funds to buy, but today I'm going to share some ideas on what not to own. I started by looking for overvalued assets. I used the price/fair value estimates we get from rolling up our stock analysts' fair values into exchange-traded fund portfolios to find out which categories looked the priciest. 

Price/Fair Value ETFs
Today, the most overvalued ETFs on average are in technology, mid-growth, and real estate. In addition, I used our Ibbotson Associates' estimates for fair value for different stock indexes. They suggest that the small-cap S&P 600 is the most overvalued.

With that information, I then selected some really bad funds in those areas. Overvalued assets and bad funds are a pretty treacherous combination. There's no certainty that they'll lose money--just a greater risk that they will.

Van Kampen Technology  charges a steep 1.95% expense ratio for a fund that is in the tech category's bottom quartile over the trailing one-, three-, five-, and 10-year periods. The good news is that the current team is only responsible from November 2008 on. The bad news is that its one-year return is in the bottom 3% of the tech category.

I'm amazed that there's still nearly $200 million in  Firsthand Technology Value . A while back, I wrote about how it had painted itself into a corner with a big stake in private equity. This creates a nightmare. The fund has to set its net asset value every day, but private equity doesn't trade and it's not easy to estimate its value. In addition, it only makes the situation worse if management meets redemptions by selling only its liquid stocks.

The good news is that the illiquid private equity weighting is down to 22% as of April 2010 from 35% in March 2009. The bad news is that that's because the private equity stake is down because it has performed poorly--not because the managers were able to sell any. The recently filed prospectus says: "The Funds have for the last few years looked into ways to reduce the illiquid securities percentage but so far have been unsuccessful in reducing it to below 15% of the Fund's net assets." That's discouraging, as is the fund's 10% year-to-date loss, its 11.5% annualized three-year loss, its 0.4% annualized five-year loss, and its 10% annualized 10-year loss. And it charges a hefty 1.94% to boot.

Speaking of once-trendy funds,  Kinetics Internet (WWWFX) is another stinker. It is primarily a tech fund and is in our mid-growth category, so I figure it is really in an overvalued spot. Although the fund's expenses are similar to those above (high), the fund has had moments of decent performance that at least make the fund feel a little less doomed. Still, isn't it kind of an outdated cliche to focus on companies that use the Internet to reduce costs or tap new markets? Are there companies that don't qualify? Today that sounds kind of like investing in companies that have telephones.

Talk about bad gambles, ProFunds Real Estate UltraSector (REPIX) looks like a particularly unappealing one. REITs had a nice rebound in 2009, but they may have overshot as John Coumarianos wrote last week. So, do you really want a fund that is a leveraged play on an overvalued asset class? You can see the downside clearly in the fund's returns. It's down an annualized 12% over the trailing five years, and, if REITs really are overvalued, there's more pain where that came from.

I also wouldn't want a fund that's constantly under construction in an overvalued asset class like small caps, so I'd avoid  MainStay U.S. Small Cap (MOPAX). A year ago, MainStay merged MainStay Small Cap Opportunity with MainStay Small Cap Value to get a newly named MainStay Small Company Value. New managers from MacKay Shields came on board to manage the fund. Then after four months, MainStay had a Steinbrenner-esque change of heart and fired the new managers and changed the strategy, process, benchmark, and name. It also merged MainStay Small Cap Growth into this fund. The newish fund is now run by subadvisor Epoch Investment Partners. Believe it or not, the managers who were tossed aside after four months were not the shortest-tenured managers in the fund's history. Tony Elavia and Joan Sabella ran the fund from August 2006 to October 2006.

My final pan isn't driven by asset class so much as the crazy factor. Embarcadero Absolute Return  (nee Van Wagoner Emerging Growth) is almost 100% invested in a money market fund (as of December 2009) and charges 2.99% in expenses. For years this was run by Van Wagoner, then it switched to having Van Wagoner hire subadvisors--with equally poor success. So, you have an investment yielding a basis point or two and an expense ratio of 2.99%! That qualifies as crazy. Based on recent returns, I'd imagine the managers have by now sold the money market and are attempting some absolute-return strategy. But how can it overcome that expense ratio?

And would you feel good about its past selection of advisors if you knew that the fund's 12% 2009 gain would have been an 18% loss if it hadn't been for a one-time market-timing Fair Fund payout? The Fair Funds were created to compensate investors hurt by market-timing. If they have money left over after compensating everyone who originally owned the fund, they then make a one-time payout into the fund, which boosts NAV.

If this fund's board had any sense, it would liquidate the fund and allow shareholders to book a tax loss. It clearly hasn't had any success, and its expense ratio ensures that it will continue to fare poorly.

The Meaning of Memorial Day
Although I had fun with the subject of bad funds getting barbecued, I don't want to skip over the fact that Memorial Day has a much more important function than backyard grilling. I'm not an expert on charities, so I invite readers to share their favorite charities for supporting the families of the servicemen and women who lost their lives in service to their country. 

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