Painful lesson of mutual fund that acted as irrevocable trust

Your Funds

Your Money

February 20, 2005|By CHARLES JAFFE

Nearly a decade ago, Kit Blue wanted to help her grandchildren save for college, so she went hunting for a mutual fund that would teach the kids a lesson about the power of investing.

Instead, the fund taught her - and thousands of people like her - a costly lesson.

And now, for the first time, she has a chance to get out of this difficult classroom to go searching for something better.

Blue, of Metairie, La., was like many fund investors in the early 1990s, wowed by the performance of American Century Giftrust.

Giftrust was - and remains - something of an oddity among mutual funds. Built to be given as a gift, the fund accepted money only as a present for someone else, and that money had to remain in place for a minimum of a decade.

The idea was to force investors to be patient, so that the aggressive growth strategy of the fund could kick in and pay off over time. Investors couldn't bail out during a bad stretch, which theoretically gave management the chance to take chances and aim high.

The fund opened in 1983, essentially as a way for company founder James Stowers to give gifts to friends and relations. By the time the first investors could remove money, in the early 1990s, there was little doubt in the public's mind that the concept had proven itself; the fund was up an average of about 20 percent per year during its first decade.

Investors saw those numbers and ignored the fact that this was an aggressive, bumpy ride without a parachute. After all, who wants to escape a fund that is posting great numbers? The answer to that question became evident when Giftrust blew up.

Blue's three accounts, for example, gained an average of just over 1 percent per year, or less than she could have made in an average money-market account.

According to Morningstar Inc., the fund has gained just under 3 percent per year during the past decade, lagging behind the Standard & Poor's 500 index by about 8.5 percentage points. The past five years have been particularly horrific, with the fund averaging an annual loss of more than 13.7 percent.

Investors tired of paying American Century's fees for such wretched results wanted to bail out, but there was no rip cord to pull.

Giftrust is not so much a mutual fund as it is a trust; each account represents an individual irrevocable trust. Investors who wanted to fight to break these trusts - established in American Century's home state of Missouri - were, in many cases, looking at having legal fees wipe out their Giftrust money just to gain their freedom. And their chances for success in breaking the trust were slim.

"By the time I realized the problems with the fund, I was stuck with it," Blue says. "My children kid me about how bad an investment it has been, and how I have no choice but to stick with it. It's embarrassing."

For Blue and others like her, however, there is finally some relief, thanks to the new Missouri Uniform Trust Code, which came into law Jan. 1.

Under the new law, if the grantor and all beneficiaries agree, the trust can be terminated prematurely. If the grantor has died - or if it was a couple making the gift and one spouse is deceased - the law does not allow for the trust to be terminated. (Blue heard of the rule and got the forms this month; "I'm not getting any younger or healthier," she says.)

To its credit, American Century is notifying shareholders by mail and has made the necessary forms readily available on its Web site (www.americancentury.com). The fund was not the focus of the law, but rather an offshoot of changes being made; American Century was not involved in the legislative process.

"I wouldn't say we are pleased, but we recognize that the inflexibility of this product has made people unhappy, and that certainly was never the intention of anyone at American Century," says spokesman Chris Doyle. "We still believe there is some validity behind the Giftrust concept, and that a forced savings program with the chance to create a legacy is a powerful idea, but we understand investors' frustration."

As bad as performance has been for a decade now, the concept remains so strong that Giftrust still adds about 300 accounts per year, that despite a 2003 change in the rules that requires current gifts to remain in the fund a minimum of 18 years.

But in the end, the real lesson of Giftrust is that investors can't rely on past performance and ignore a fund's negatives, assuming those trouble spots will never surface. While other funds don't have Giftrust's restrictive nature, every fund has a possible downside, and that has to be factored into the buying decision so that you don't wind up with regrets in the end.

Charles Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.

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