Van Wagoner fund investors finally catch a break of sorts

Your Funds

Dollars & Sense

March 16, 2003|By CHARLES JAFFE

SHAREHOLDERS feeling abused by the Van Wagoner funds can finally say the firm did something right by them.

It decided to liquidate three funds.

It's the rare case where something the embattled Van Wagoner group is doing can actually be a model for the rest of the industry, as there are plenty of other funds that could best help investors by simply closing up shop.

Earlier this month, Van Wagoner disclosed plans to close three of its funds, Technology, Post-Venture and Mid-Cap Growth, all of which rank among the very worst funds in their peer group. The "best" of those three funds, according to data tracker Morningstar Inc., has an average annualized loss of 55 percent over the past three years.

Moreover, those losses are so big that the tax benefit an investor could derive from them - using them to offset gains - almost certainly would have expired. (A fund has just eight years to use losses to offset gains; an individual can use losses indefinitely.) Assuming the funds couldn't generate eight straight years with gains of 25 percent or more, which is precisely what I assumed for a lot of funds in this space just a few weeks ago, shareholders in big losers can never get the full tax benefit of the losses they have suffered.

The same day Van Wagoner was disclosing its plans to close the fund, it said it will open a new fund, Growth Opportunities, and disclosed that the Securities and Exchange Commission has tentatively recommended the start of enforcement proceedings against it for allegedly failing to properly value private stock in the funds.

Obviously, the actions that raised the SEC's ire and spawned a flurry of class action lawsuits last year hardly serve shareholders well.

Likewise, the firm's new fund is dubious, at best, considering that Van Wagoner's two surviving funds also rank near the very bottom of their asset categories.

But closing the three funds, rather than merging them into the bedraggled survivors, was clearly the right move.

"In the final analysis, while Van Wagoner may have played games with shareowners and done things with questionable evaluations, at least they took the honorable route in the end and did something that is clearly in their shareholders' best interest," says Burton J. Greenwald, who does consulting work for fund company managers. "This is what's best for those shareholders."

Fund companies typically merge their losers out of existence. For the company, the good thing about a merger is that it buries a fund with a bad track record while keeping the investment dollars in the house.

From an investor's standpoint, the good thing about a merger is that it does not create a taxable event; if you have gains as a longtime holder in a fund that is merged, you will not have to pay taxes when the fund is merged.

For shareholders, the bad thing about a merger is that they pay for the proxy vote to make it happen, they may wind up owning a fund that is vastly different from what they purchased and they often suffer through a change in management.

Liquidations, by comparison, automatically create a taxable event, because the investor's holdings are sold off.

But in the case of the Van Wagoner funds - as would be the case with any big loser - a liquidation allows the investor to make the most of their losses, harvesting declines to be used by the shareholder to offset gains from other investments plus up to $3,000 of income per year.

By the losses being transferred from the fund to the shareholder, the decline is not diluted into an acquiring fund, and does not evaporate. Unlike funds, individuals can use losses to offset gains indefinitely.

Finally, because of the way Van Wagoner is structured, it didn't need a proxy vote to make things happen, saving the shareholders the cost of an election.

According to Van Wagoner Managing Director Peter Kris, management simply resigned the fund, which will allow it to shut down by April 30.

Kris says the firm is hoping shareholders will opt to move their money into the surviving funds or the new Growth Opportunities fund.

That may be wishful thinking, because, while liquidating the three funds was the right move, scuttling the whole lot might have been even better.

"There are a lot of funds out there where the best thing that could happen to shareholders would be that they just gave up and sent people their money back," says Roy Weitz, who runs the FundAlarm.com Web site, which examines when to sell a fund.

"In the case of Van Wagoner, if liquidation is the right step, you kind of have to wonder what took them so long and why they're not just giving up entirely."

Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, Mass. 02025-0070.

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