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Steer Clear of Alger Funds

Late-trading, market-timing, and obstruction of justice alleged.

Last week, James Connelly, head of fund sales for Fred Alger Management Inc., settled civil charges with the SEC for permitting market-timing, and he pleaded guilty to obstructing the investigation. According to New York Attorney General Eliot Spitzer, Connelly asked subordinates to delete e-mail messages relating to timing arrangements. In addition, Alger said "potential late trading activity by [a] hedge fund" occurred in three accounts from March 2003 to August 2003. (Click here for Alger’s statement.) It's a dramatic fall for Connelly who was named Fund Leader of the Year by Fund Action for 2002.

Given the serious breach of fiduciary duty implied by these events, we recommend that investors consider selling their Alger funds. We don’t think the compliance risk is one worth taking. These transgressions were led by the head of mutual fund sales for an extended period, indicating that there were some flaws in compliance procedures as well as cultural flaws that would allow this to go on for so long.

As always, though, investors should consider their own situation before making a change. If selling would trigger a big tax bill or an Alger fund is one option in a limited lineup in a 401(k), it might be prudent to hold on.

Prior to the news surrounding Connelly, we were lukewarm on Alger funds. Our biggest concern has been costs, as the firm’s average expense ratio is 2.54%. Even the firm’s largest fund, the $650 million  Spectra Fund (SPECX), charges 1.98%. In addition, performance and management were okay, but not outstanding. An asset-weighted average of Alger funds’ star ratings is a middling 3.0.

In the SEC’s settlement, it found that "From the mid-1990s until 2003, Connelly was involved in allocating timing capacity in Alger mutual funds to timing investors. Connelly regularly authorized select investors to time the Alger Fund. Connelly did this even though he knew that the timers were making substantially more than the permitted six exchanges per year." The funds' prospectus limited investors to six transactions per year.

This indicates there was a longer-running pattern of timing arrangements than any that have come out in Spitzer's probe of a number of fund companies so far. The size is also striking. The SEC said Connelly gradually developed a system for permitting timing in Alger funds that by 2003 had netted the complex $200 million in assets from more than a dozen investors. That’s a sizable amount for a firm with just $3 billion in funds. Overall, the firm runs $10 billion.

Alger suspended Connelly two weeks ago and he was asked to resign last week. Dan Chung, who became Alger president on Sept. 8, said the firm has now banned market-timing. Late-trading has always been illegal.

Former Manager of the Year Leaves Scudder
In news unrelated to Spitzer, David Baldt has left Scudder. Baldt was named Morningstar’s Fixed Income Manager of the Year in 1997. Baldt is setting up shop at Schroders where he will run some soon-to-be-launched muni funds.

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