No value, only gimmickry when fund shares are split

Your Funds

Dollars & Sense

October 24, 1999|By Charles Jaffe

CUT A PIZZA into 16 slices instead of eight and the result is not a bigger pizza -- it's just smaller slices.

Similarly, split a mutual fund's shares and you don't get more value, just more shares. What's happened is a meaningless gesture, done in the hope that it will fool somebody.

That is why fund firms don't split shares often, and why it's good to examine the rare fund that tries to gain notoriety by making a cosmetic move like this and selling it as substantive.

Monument Internet Fund has announced a 3-for-1 split, calling it the "first-ever split for an Internet fund" -- hardly surprising since the few other Internet funds seem more focused on the market than on gimmickry.

In any given year, about a dozen mutual funds split their shares. While there is the occasional big-name fund -- most recently the Franklin Mutual Series funds in 1997 -- splitting is rare because the practical impact is zero, zip, nothing.

There are no tax consequences; the fund is no more investment worthy; and the value of your holdings doesn't change.

That fund groups sometimes feel compelled to split is a sad commentary about the ignorance of some investors. That a fund group would promote a share split says that the firm is banking on some common misconceptions to sucker up some new cash.

Here's why:

A typical stock split gives an investor new shares at a lower price. So if a $30 stock has a 3-for-1 split, the investor winds up with three shares valued at $10 each.

That makes shares more affordable. Most investors trade in "round lots" of 100 shares, because tiny "odd-lot" trades come with heightened commission costs. After a stock splits 3-for-1, an investor who previously could afford just 33 shares can buy 100 -- and qualify for better trading costs.

But funds and stocks are not the same.

When Monument Internet splits 3-for-1 Friday, the price of each share will fall to about $10. But Monument's minimum initial investment will remain at $1,000.

And while investors may want to believe that a fund might grow faster at a lower price (the logic being that it's easier to go from 10 to 20 than from 50 to 100), that's a misguided attempt to put stock logic into play on funds.

A fund's net asset value, or share price, represents the assets in the fund divided by the number of outstanding shares. That said, the price itself is kind of an arbitrary number.

Say two funds start with $1 million in assets each, one issuing 100,000 shares at $10, the other 10,000 shares at $100 each. If both funds earn a 10 percent return, investors are rewarded equally. The $10 share hits $11; the $100 share grows to $110. And $1,000 invested in either fund is now worth $1,100.

The $100 share price may look high and the $10 price swing steep, but the returns and volatility are the same.

For proof, look at three Standard & Poor's 500 index funds that opened within a few weeks of each other in 1990. According to Morningstar Inc., Vanguard Institutional Index, Fidelity Spartan Market Index and T. Rowe Price Equity Index each have gained about 17.6 percent annually since inception. Yet the Vanguard fund now trades at roughly $116 per share, the Fidelity fund at $88 and the T. Rowe Price fund at $35.

Hmmm. Three funds, three identical portfolios and strategies, three nearly identical returns (differences due to expense ratios over time), three completely different price points and not a share split for any of the funds since they opened.

What that tells you is that each company picked a different price per share at which to start the fund. It also shows that the share price did not affect the annual rates of return.

Fund companies usually downplay the occasional split; they are simply calming Nervous Nellies who don't understand pricing.

But Monument Funds Group President David A. Kugler said in a news release that his firm received "numerous requests from shareholders and financial advisers who missed our fund when it was originally priced in the $10 per share range." The split panders to those naive requests; the news release clearly hoped to excite new investors and cash in on ignorance.

"For a company to trumpet a split as being good for investors is misleading," says Russ Kinnel, senior editorial analyst at Morningstar.

"And if there is no real good that comes to investors out of this, then this kind of announcement is clearly meant to attract idiots and suckers."

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, MA 02107-2378.

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