By Ann Coleman (TMF AnnC)
March 10, 2000

As you probably know, Fools don't suffer mutual funds gladly. We are often accused of being anti-mutual fund, which really isn't the case. Mutual funds are a great idea. I like the concept. It's the poor long-term returns that I object to.

Most stock mutual funds have a long-term average rate of return that is lower than the average return of the S&P 500. Ever since John Bogle started the Vanguard 500 Trust in 1976 to mimic the return of the S&P 500, and especially since 1993 when the American Stock Exchange created S&P Depository Trusts <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: SPY)") else Response.Write("(AMEX: SPY)") end if %> to do the same thing, any investor could have equaled the return of the S&P 500 with very little effort. But most investors haven't done that well.

It just astounds me that thousands and thousands of funds still exist, and are still aggressively marketing their service, when they can't even beat an unmanaged index fund. With management fees in the neighborhood of 1-2% per year, what exactly are those fund investors paying for?

Not all mutual funds fail to beat the market -- the problem is that last year's big winners tend to be next year's big losers. Chasing the latest, greatest mutual funds has largely proven to be an exercise in futility, although some people are pretty skilled at anticipating the next hot industry. For the last several years, computers, technology, and Internet stocks have done exceptionally well, and sector funds in those areas have rewarded their investors handsomely; although, to be fair, now that you can buy Nasdaq 100 Shares <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: QQQ)") else Response.Write("(AMEX: QQQ)") end if %>, which are depository receipts for a basket investment in the 100 largest Nasdaq companies, one should probably judge the tech and Internet funds against that rather than the S&P 500. In fact, "Q's" are a year old today. Since March 10, 1999, Q's have returned around 120%. Darn. It just gets harder and harder to beat the market.

Recently, though, I ran across a mutual fund that is so Foolish that I almost want to send them some money. No, they aren't beating those Q's either, but what's really outstanding is their disclosure statement, which seems to reflect a general philosophy that we would love to see more of. All mutual funds mumble about their investing philosophy, market conditions, and risk, but these guys shout about it in a most Foolish fashion. In fact, I have a bad case of thesis envy. I wish I'd written it!

But since I didn't, I will share it with you. The fine folks at IPS Funds graciously agreed to let me give them some free publicity. (For more free publicity, see Bill Barker's Fool on the Hill: A Foolishly Managed Mutual Fund.)

Bear in mind as you read this that most of it applies to ANY kind of investing. Even the stalwart Foolish Four. In fact, I suggest printing it out and taping it to a convenient wall. If you are going to invest, you need to keep the realities of investing firmly in mind.

Without further ado...

Plain Language Risk Disclosure

First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession most fund shares will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you've already gone bald from worry. It will insist on this even if Gandhi, Jefferson, John Lennon, Einstein, Merlin and Golda Meir all manage the thing. Stock markets show remarkably little respect for people or their reputations. Furthermore, if the fund has really been successful, you might be buying someone else's whopping gains when you invest, on which you may have to pay taxes for returns you didn't earn. Just try and find somewhere you don't, though. Dismal.

While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 - 4 years. It goes with the territory. Expect it. Live with it. If you can't do that, go bury your money in a jar or put it in the bank and don't bother us about why your investment goes south sometimes or why water runs downhill. It's physics, man.

Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don't read the Prospectus (this isn't aimed at you, of course, just all those other investors), we thought we'd try a more innovative way to scare you.

We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like pogo sticks on steroids. We aren't a sector tech fund, we are a growth & income fund, but right now the Internet is where we think most of the value is. While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn't always work. Even if we buy a lot of them. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The "we" is actually a euphemism for you, got it?

We also get killed if interest rates go up, because that affects high dividend companies badly. Since rising interest rates affect everything badly, we could get killed even worse if the Fed raises rates, or the economy in general experiences higher interest rates beyond the control of those in control, or gets out of control. Whatever.

Many of the companies we buy are growing really fast. Like, 50%-100% per year sales growth. Many of them also don't make any money, although they may be relatively large companies. That means they have silly valuations by traditional valuation techniques. We don't know what that means any more than you do, because we have never seen anything like the Internet before. So we might overpay for these companies, thinking we are really smart and can get away with it because they are growing so fast. It doesn't take a whole lot for these companies to drop 50% or more, because nobody else knows what they are worth either. Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff.

Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. If we sell them, you will get pretty irritated with us come tax time, so we try not to do any more of that than we have to. The pole of that strategy, though, is that if we are really successful, you will have a lot of downside risk in a recession or a bear market. Bummer.

Governments and politicians being what they are, they also tend to monkey with things. Sometimes it's good, sometimes not, but that's beside the point. Occasionally they take aim on an entire industry, like telecommunications or electricity power generation. Understandably, this makes folks jumpy. Jumpy people have a regrettable tendency to sell stuff until they calm down. Really jumpy folks sell lots of stuff, and some of it could be ours. If this line of thinking makes you jumpy too, then go see your banker. Bankers specialize in jumpy folks.

Finally, if you haven't already grabbed the phone and started yelling at your broker to sell our fund as fast as possible, you should understand the shifting sands of technology. It doesn't take billions of dollars to start a high tech company, like it did U.S. Steel or Ford Motor. Anybody can do it, and everybody does. Many of our companies are small, even though they dominate their market niche. It's much easier for a new technology to blow one of our companies out of the water than it was in the old days of canal, mining, railroad and steel companies.

Just so you know. Don't come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age.

Please e-mail us if we haven't scared you enough, and we'll try something else.