Mutual funds' first days lack the allure of IPOs

Your Funds

March 12, 2000|By CHARLES JAFFE

Among the hottest topics in my mailbag for the last month have been two interesting new funds that opened this month.

Yet, few wanted to know how Janus Strategic Value or Baron iOpportunity funds will run money. Instead, their questions ran to whether the first sale of a mutual fund is like the initial public offering of a stock, complete with the potential for shares to skyrocket on opening day.

The answer is no.

Proof of that should start rolling in this month as both funds start putting their money to work. Janus has raised more than $1 billion; Baron is not yet saying how big its new fund will be.

While studies have shown that new funds often perform well right after opening, there is no guarantee. And no one expects any new fund, no matter how sexy, to have an IPO-like "pop."

"New funds don't have the same allure as an IPO, because they don't take off like a stock can," says Steve Lacey, editor of the IPO Reporter newsletter. "Your reason for buying a new fund should be that you have confidence in the manager's ability to generate value, so you want to get in on the ground floor."

Still, investors seem intrigued with buying a new fund on its very first day, as if being first results in greater gains.

Some of that misguided sense comes from the "subscription offerings" of firms including Janus, Baron, Warbug-Pincus, Acorn, Invesco, and others, which generate an IPO-like feel to a new fund.

Subscription periods generate a lot of "Gee whiz," although they tend to be only a so-so proposition for investors.

These preopening periods let a fund handle heavy in-flows, meaning it won't have to temporarily shut down if cash floods in. Closings have hurt some nonsubscription openings.

The new fund starts with more money to invest, making it easier to diversify or take advantage of the investment ideas built up while the fund was in formation. (Nondiversified funds such as Janus Strategic Value forsake some of this edge, however.)

This bigger investment pool also cuts the trading costs paid when the fund first buys stocks.

Perhaps most importantly, investors get a specific, known price for their purchase, instead of getting the price of the fund -- as determined by the market -- on the day the money arrives. Owning the fund from its start-up date makes performance easy to track; most funds quote gains not only in terms of recent years but also "since inception."

Some firms that sell loaded funds reduce or waive those upfront sales charges during subscription periods. This is the only tangible financial incentive to getting in on Day One.

Why subscription offerings may not be such a good deal is that the first investors pick up all initial trading costs. Brokerage commissions -- what funds pay to buy and sell stocks -- are not part of a fund's expense ratio but are taken off the top. The money raised during the subscription period cuts these costs, but they are borne entirely by the first investors.

(Latecomers actually pass some of the cost of investing their deposit onto the shareholders who were in first.)

In addition, subscription deposits sit idle or earn a money-market return while waiting for the fund to open. If you want a fund because it invests in a hot market sector, letting that cash sit for a few weeks may defeat your purpose.

If a fund subscription interests you, avoid the down time by waiting to invest until a few days before the fund goes live.

Remember, too, that a new fund could lose one of its big advantages if the subscription is popular. Virtually every study examining new fund performance indicates that small asset size could be the driving factor behind initial success.

Ultimately, the pros and cons of a new fund tend to level out, so the best advice is to buy funds for which you believe the manager or the firm's research point toward success.

Don't just invest because the fund is new. There are plenty of proven performers out there, so new funds must inspire confidence or they aren't worth taking a chance on.

In the case of Janus Strategic Value, for example, you must believe that a company whose stellar track record is in growth investing can find the same success with a value fund. For Baron iOpportunity, it means buying what amounts to a sector offering from a firm whose success has been in more-diversified funds.

"Special subscription periods clearly benefit the management, and shareholders don't get so much out of it," says Jerry Tweddell, publisher of Tweddell's New Fund Focus newsletter. "The buzz on a new fund is not what makes it worth buying. It may be what brings a fund to your attention, but you need more than that."

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, Mass. 02107-2378.

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