Ignore investment's label, focus on how well it works for you

Your Funds

Your Money

September 12, 2006|By Charles Jaffe | Charles Jaffe,Marketwatch

Google has been called many things, from the world's greatest search engine to the next mega-media giant, to the best new stock to hit the market in decades.

But no one has called Google the stock equivalent of a balanced mutual fund.

No one except the government, that is.

In the eyes of the Securities and Exchange Commission, Google might actually be a mutual fund, and not a stock at all.

You read that right.

It's not a status that Google wants, nor is it a comparison company officials would ever make on their own - in fact, no one in the mutual fund business would suggest that Google should be considered a balanced fund - but it's a quirky story that reminds investors to ignore the labels that are put on investments, and to focus on the underlying assets.

Here's the skinny on Google, the would-be mutual fund:

Google has little in common with the typical fund or management firm (think Fidelity, Vanguard and any of their individual funds). What Google does have is massive amounts of cash, enough to represent about 40 percent of the company's total assets.

Ideally, management would put that money to work, investing it in anything from other stocks to a range of government securities so that $10 billion in greenbacks can become a significant contributor to the bottom line.

The problem is that the SEC's Investment Company Act of 1940 - the defining legislation for the mutual fund business -defines an "investment company" (that's "mutual fund" for the non-lawyer set) as being any firm with more than 40 percent of its assets tied up in non-controlling stakes of other investments or companies.

Google has been living with this problem practically from the moment it went public, forcing the search firm to plunk most of its cash into U.S. government securities. (That's a very "old economy" investment for a "new economy" stock.)

If the firm morphs into a fund under the regulatory rules, life would change dramatically, and in ways that affect more than the $10 billion cash stash.

Regulated as a fund rather than a stock, Google could say goodbye to stock options as compensation, and would say hello to greater shareholder say in who serves on the board of directors. Moreover, mutual funds must pass along virtually all capital gains, dividends and income they earn in a year, forcing Google to make an enormous distribution from the cash alone.

Now that we have imagined the possibilities, forget about them.

Last month, Google asked the SEC for an exemption to the 1940 law, so that it can invest "in a broader range of short-term securities" without being considered a mutual fund. Management wants to use the cash for things like muni bonds, not speculative stocks. In asking for the exemption, the company suggested that failure to diversify and generate slightly higher yields on the cash " ... could have a direct implication on our ability to invest in the business and stay ahead of our competitors."

Google is hardly the first technology stock to face this problem. Microsoft ran up against it - and received an exemption - in 1988, and Yahoo! got around this same kind of issue in 2000. There have been some other, lesser-known cases, but no stock was tagged with the mutual fund label to the point where operations ever changed.

For investors, however, the issue is one of labeling, strategizing and buying.

Multinational corporations often are as diversified as a mutual fund in terms of the number of businesses they own, the countries they operate in and the industries or sectors they work in. Conversely, many focused and closed-end mutual funds are less diversified than big conglomerates.

There are some individual real estate investment trusts (REITs) that are as diversified as real estate sector funds, and some exchange-traded funds are based on new index products that change and move so much that they perform more like an actively managed fund than a traditional index fund.

And while investors don't think of Google as a balanced fund, they should recognize that a stock with $10 billion in cash reserves will perform differently than one that has little cash on hand. (Over time, the difference may have more to do with volatility than total return.)

In the end, investors need to make the case for every investment in their portfolio based on what it does, not on how it's labeled. They should look less for a specific investment type, and more for the kind of assets they want to own; portfolio construction should be less about "Stock or Fund?" and more an issue of "What investment will best help me reach my goals?"

jaffe@marketwatch.com

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

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