Hey, revisionist history buffs, guess what?! Pre-abolition America — where the rich were rich and the poor were chattel — was an Eden of social equality. When the 106th Congress voted to abolish the federal estate tax last week, they returned us to that ancient paradise.
That’s just one of the howlers right-wing think tanks have devised in their shockingly successful attempt to sell the country on a tax cut that benefits the wealthiest 2 percent of the population.
Granted, some tax relief is in order. The federal budget surplus keeps climbing and the economy seems to be cooling: the perfect time for a cut. The just-passed end to the so-called “marriage penalty,” for example, is a decent proposal that (though slanted to favor wealthier couples and destined for a veto) would give a break to a broad cross section of people.
But after a decade of unprecedented economic gains for the nation’s wealthiest, you’d think a gift-wrapped $850 billion (the Treasury Department’s estimate of what the repeal would cost over the next two decades) targeted mainly at millionaires would be election-year poison. After all, people only pay estate tax on property worth more than $675,000; family-owned businesses are exempt from paying the taxman a dime until they’re worth over $1.3 million. In 1997, the last year for which the IRS provides figures, only a few thousand families had to pay any estate tax at all. It seems only President Clinton, who has vowed to veto the bill, understands the identity of the true beneficiaries.
An extraordinary 60 percent of Gallup-polled citizens support the measure. “There have been stories on network news that just didn’t make sense,” laments Michael Ettlinger, the director of tax policy at the relatively liberal Citizens for Tax Justice. “They found people being impoverished by the estate tax, which just can’t happen.” But, he contends, almost no one saw through that because, ironically, “most of the country has no experience with paying the tax.” Bruce Bartlett, senior fellow at the National Center for Policy Analysis, offers a different explanation. “As the nation’s wealth rises, more and more of those clearly in the middle class are affected by the estate tax,” he recently wrote, before adding, “or at least believe that they might be.”
Where do middle-class voters get their misinformation? Perhaps from the same folks who really do have something to gain. But much of the right’s propaganda has been far-fetched at best. Perhaps most gallingly, Bartlett demands not just that we tolerate the rich, but we feel grateful for them. “The rich perform a public service. Since it’s not much fun to be rich if even the riffraff can enjoy the same products, the rich aid innovation by pushing the limit of what is possible.” His main example: appliances. The estate tax has to go because it prevents the privileged citizenry from buying next-generation microwaves, which we riffraff may someday be able to appreciate.
As though our seeming lack of adequately glorious kitchen equipment weren’t enough to convince us of the tax’s injustice, Bartlett adds that it is also anti-women. Why are women the levy’s “chief victims?” Because wives usually survive their husbands, and one pays no estate tax on money inherited from a spouse. The family’s estate tax doesn’t come due until she passes on. First she dies; then she is victimized. Twisting words, Bartlett attempts to portray his fellow repealers in, of all things, a progressive feminist light.
The Heritage Foundation, the arch-conservative think tank, summarizes the issues in a similar way, focusing first on another of the estate tax’s great victims: minority businesspeople who supposedly “suffer anxious moments wondering whether the savings they have built … will be destroyed.”
Appealing to core liberal constituencies is a crafty rhetorical move … and awfully cynical. The fact remains that the overwhelming majority of estate taxes are coughed up by richly endowed Caucasians. That’s not to say the Beltway-based foundation has forgotten the rich, who it says invest fewer of their ducats in productive enterprises because, thanks to the estate tax, the government grabs more than half of whatever they don’t spend in their time on this earthly plane. And this — not, say, simple lust for material goods — is what forces them to “buy vacations in Vail and fine art in Lisbon.”
But according to Heritage’s own numbers the tax doesn’t take more than half the assets of any estate that has less than $5 million in taxable dollars. We’re not talking about a lot of people here. And furthermore: Lisbon? Heritage also states that killing the death tax would not, as one might expect, increase the budget deficit. Why? Because there would (they assume) also be matching cuts in social spending. A nice ‘n’ tidy fix. And also stark proof that poorer families would, under this right-wing plan, suffer directly in order to pay for richer folks’ increased fortunes.
And even further to the right, the libertarian Cato Institute claims that the estate tax encourages a spendthrift, “die-broke” mentality — a problem 98 percent of the country can only dream of having. CATO conveniently ignores that no one starts paying until they have $675,000 in assets. To someone with tens of millions in stocks, bonds and real estate, $675k may sound like “broke.” But to most Americans, broke is a lot closer to zero. Yes, most of us are getting richer as the years pass. But the exemption is rising, too. By 2006 you won’t have to pay estate tax unless you are, literally, a millionaire.
There are many ways of making the estate tax fairer and less threatening to whatever portion of the upper-middle class might be lucky enough to ever have to deal with it. And the tax should be simpler, with fewer loopholes and rates that make collecting it unduly complicated and expensive. Congressional Democrats have already made a few proposals, such as greatly raising the exemption level for family-owned businesses.
But ideologues on the other side rejected such notions without a thought. (To his credit, Bartlett has criticized the Republican leadership for not compromising.) The GOP Congress insists on getting rid of the tax wholesale: a lopsided sop for the wealthy at the one time in American history when they need it least. If the estate tax is repealed, will they buy fewer Colorado condos and Portuguese paintings? No — they’ll buy more. And the rest of us will foot the bill.
That’s why repeal really is about opportunity — an opportunity for the Democrats to aggressively expose their rivals’ abject fealty to money. People want a tax cut, but not one that disproportionately jeopardizes most Americans’ financial future for the continued enrichment of the gilded minority. If the Democrats get their act together, they could make a strong case that an overzealous GOP has shown us their true motivations — and send them running for cover.
Yahoo proved worthy of its exclamation point last week, when the Web bellwether reported second-quarter income 20 percent better than Wall Street’s official expectations. That triggered a tech-stock surge that sent the NASDAQ to levels not seen since antediluvian April. The Yahoo hoopla also set the stage for the coming two weeks, when a flood of companies will open their books for investor scrutiny in the latest quarterly earnings season. With the Fed’s next interest-rate chitchat still five weeks off, the market will focus — at least momentarily — on the numbers that should matter most: profit performance.
Quarterly earnings reporting tends to create volatile times on the stock market, with seemingly small departures from anticipated results causing steep, swift swings in share prices. (“Black October” came about partly because that’s when traditionally lackluster third-quarter results arrive.) To get a read on the market, it’s critically important to know what the Street’s fortune tellers expect from the most-watched companies.
When Wall Street talks about earnings expectations for a particular stock, it’s referring to analysts’ consensus of estimates. But it’s an open secret that Wall Street’s army of prognosticators takes a conservative tack when putting together their “official” guesses. CEOs and CFOs often will coax analysts toward lower numbers to increase the possibility of hitting the goal. And analysts, loath to appear overly optimistic and risk steering clients into stocks that fall short, won’t publish their true expectations. Instead — in informal conjunction with private investors, company insiders and others closely following a stock — they privately rely on an additional number, known as a “whisper number,” which reflects their real thoughts.
The market increasingly evaluates a company’s performance in comparison to this mystically derived figure. But since they’re unofficial, whisper numbers can be hard to come by.
Along comes WhisperNumber.com, which compiles its namesake figures from points throughout the investing universe. (For a full discussion of whisper numbers’ source and accuracy, check out a past Salon article.) Because whispers are intrinsically secret, the site’s methodology is less than airtight. But its figures seem to be better predictors of how the market will react to earnings announcements than the official consensus. Its whisper estimates have come as close or closer to the actual reported figures about 70 percent of the time, according to site co-founder John Scherr.
Below are several tech stocks whose near-term fate hangs on how their imminent quarterly reports stack up against expectations — especially the behind-the-scenes ones. Like Yahoo, these companies could stir up other parts of the market. So watch closely.
Tuesday, July 18
Microsoft
Consensus: $0.41 Whisper $0.41
Convicted monopolist and (not coincidentally) history’s greatest profit machine, Microsoft moves the market, plain and simple. As a Dow component and the biggest single piece in the NASDAQ pie, MSFT on a down day could cause an earthquake on Wall Street. Historically, Gates & Co. haven’t disappointed (aside from its less-than-stellar results last quarter), so today’s announcement should prove a neutral event. However, if Windows 2000 did better than dour early rumors suggested, look for the stock to fly. In light of its intense legal battles, the software king would have proven it executed amid huge adversity and be promptly rewarded. An earnings number higher than $0.42 a share this evening also could spell a market-wide rally tomorrow. Merely hitting the mark likely would revert the stock’s direction to a function of whatever new break-up scenario emerges.
Wednesday, July 19
Qualcomm
Consensus: $0.27 Whisper: $0.28
Last year’s highflier lagged in the first half of this year, though you can hardly blame it after its stock’s absurd 28-fold gains. The recent loss of its technological monopoly in the burgeoning South Korean market hasn’t helped. Still, the wireless industry’s bright prospects amount to an article of faith among tech investors. (Witness Monday’s 10 percent run-up as investors salivated over future earnings fueled by freshly secured international patents.) Qualcomm isn’t just an important wireless stock, it’s the wireless stock when it comes to next-generation mobile phone chips. Motorola reported good numbers last week, which bodes well for QCOM; good numbers likely would give a boost to other mobile-equipment makers.
Thursday, July 20
America Online
Consensus: $0.11 Whisper: $0.13
This is one stock where the whisper number certainly will influence how investors judge earnings data. If analysts were intent on making estimates conform to true expectations, they would have raised their official numbers after Yahoo’s blowout report proved that Web ad dollars still were flowing strongly. No analyst had the guts. Considering AOL’s stock already has risen about 10 percent since Yahoo’s announcement, the market has priced in some potential upside. But if the Internet provider edges past the $0.13 whisper, it should pop another few points. It could also fuel a second-burst rally in other Internet stocks, which tend to trade in a pack behind Yahoo and AOL. Also, look for subscriber growth. Last quarter, the company added 2.1 million subscribers, for a total of 25.8 million worldwide. Another 2 million subs added in the June quarter and the company will be on track, especially if it reports good international momentum.
Wednesday, July 26
Amazon.com
Consensus: $0.35 Whisper: $0.28
June 23: Lehman Brothers analyst Ravi Suria issues a report saying the leading e-retailer will run out of money shortly after Christmas; Amazon falls 19 percent that day, from $42 a share to $33 7/8.
July 14: Salomon Smith Barney analyst Tim Albright says Amazon’s CEO Jeff Bezos has plenty of money; Amazon jumps 21 percent from bell to bell, up from $35 to $42 1/2.
Two things such round-trip confusion makes clear: (1) Everyone is nervous about this stock, which represents the entire concept of e-commerce. (2) These days, AMZN traders think as much about the company’s balance sheet (how much money it has) as its income statement (how much money it makes). Hard evidence only comes out four times a year. The critical number next Wednesday: cash. If Amazon is burning bucks faster than Salomon’s Albright expects and says it had less than $920 million in the bank at the end of June then the share-price yo-yo will head back where Lehman’s Suria first sent it.
I’ll make a bet the short-sleeve stretch shirts now available for $38 in rainbow colors at your local Gap will hit the sale rack by early August.
I’m working on a tip. Gap Inc. announced last week that it would fall short of its expected second-quarter earnings, largely because it had to mark down an unusually high number of its more-fashionable clothes. More surprisingly, budget-bonanza Old Navy — seen as an essential growth engine for the roughly $13 billion-a-year company — stalled; its same-store sales dropped 9 percent. Despite Banana Republic’s solid results, dire reports of the Gap’s demise were not exaggerated.
Two ironies here. The first has to do with how the Gap got into this pickle. After all, it did just what Wall Street wanted it to do.
Last summer, the Gap caught analysts’ flak for failing to offer more exciting and innovative apparel, unlike such competitors as Abercrombie & Fitch and American Eagle Outfitters. The Gap’s incessant emphasis on the same basic stuff just wasn’t drawing in customers, who last year wanted racier, trendier styles. So, the famously flexible company decided to take more risks with its product line.
That, of course, was then.
The Gap fumbled by putting itself in an unfamiliar position — chasing trends rather than setting them. As Deutsche Banc Alex. Brown analyst Marcia Aaron said: The Gap was “definitely a victim of fashion problems; they tried to take their fashion too young.” The company’s warning revealed that store managers had to put lots of stuff on sale to move it out the door. Aaron also attributed the Gap’s shortfall to a lack of exciting spring fashions, uppity gas prices, chilly spring temperatures, high credit card interest rates and the fact that “it’s a strong music year, so kids are spending more money on music.” (Hey, Metallica, call off the dogs! Turns out Napster isn’t your problem, it’s the rag trade’s!)
Whatever the reasons, the Gap already is responding as it best knows how — with fresh marketing. Its men’s department on its Web site offers a glimpse of what I expect to see a lot of this fall: an emphasis on the office. Trendy stretch shirts were just a transitional item, something the company introduced for “fashion” that it has now recast as “wear to work.” That utilitarian imperative will be the Gap’s big theme in the coming months. Look for more clean-cut, conservative designs that no boss could question and fewer bright-pink Capri pants (now on sale at Gap stores nationwide).
The second irony is that the pickle the Gap got into seems to be remarkably unsour. After last Thursday’s announcement that June’s same-store sales declined by 2 percent, Gap stock actually jumped more than 26 percent, to 37 7/8 at Monday’s close. The shares had hit a 52-week low of $28 less than a month earlier.
You see, the key to investing in fashion is to be forward looking. (Just not too much, lest you risk overexposure.) Before last week’s mea culpa, investors knew the Gap would be making some type of confession, they just didn’t know how bad it would be. Now that everything’s out in the open, and the news wasn’t as bad as some had thought, they’re looking ahead to the retailer’s promise that it will meet analysts’ expectations for the second half of the year.
If you play the fashion stock market, you can’t always rely on a company’s new products to match mercurial consumer tastes. You can only count on its management’s ability to adapt quickly and consistently. Industry insiders almost universally regard the Gap as a well-managed company, its current troubles notwithstanding. Now that prodigal CEO Mickey Drexler has returned to play a role comparable to the one Steve Jobs filled at Apple, investors expect a Gap renaissance. (Granted, a less flamboyant renaissance, with designs just left of boring rather than barely right of radical.) So look for the Gap’s flagship chain to become less teen-centric, and instead saturate us with a five-day-a-week casual campaign. Also, expect more family-friendly messages from Old Navy. As for Gap stock, consider this a pre-back-to-school sale. It’s a good time to buy, especially below $35 a share.
The 200 or so soldiers at the Silicon Alley Reporter’s annual Rising Tide Summit — a New York Web establishment confab — had just weathered what should have been the spring of their discontent. Since mid-March, the Internet industry has experienced its greatest thrashing ever, with most Net stocks sinking by at least 50 percent. Amid company closings, fire-sale share prices and Wall Street profit warnings (non-profit warnings, really), new media no longer looks like a sure thing. And many a paper fortune in attendance at last year’s gathering had vaporized.
But rather than commiserating in wound-licking mutual consolation, the crowd seemed utterly relaxed: almost perversely confident in their industry’s future, and by extension, their own destiny. The Alley’s first-generation true believers pride themselves on having gotten into the business before the money flooded in. And now that the tidal surf appears to be at least temporarily receding, many of them are glad to have their turf back to themselves.
“This period has made my life so much easier,” says Jason McCabe Calacanis, conference organizer and Silicon Alley Reporter’s CEO, referring to the time “after the crash” — a phrase on few lips here, but on the tips of many a tongue.
At 29, the self-made duke of the Alley has made it his business to know everything going on in New York’s Net industry. “I don’t have so many idiots banging down my door to tell me why they’re the next Yahoo,” Calacanis says. “I have serious businesspeople explaining how to own and run effective growth businesses.”
Such a spiel would sound like pure spin if the attitude weren’t so pervasive. Attendees spoke of 2000 being “another ’97″ — the last time money got tight in the Alley, but before the Internet-IPO craze. The difference with this round of consolidation is that this time the world is watching: unshaken optimism mixed with gallows humor. One woman introduced herself at a seminar as a former employee of the famously demised Boo.com. “So did you cash in your stock?” jibed someone in the room. Big laugh.
“No, I framed it,” she shot back. Huge laugh. And no wonder. Here’s a woman who endured the worst the industry has to offer — bankruptcy, a highly public closing, worthless options — and survived. With style, even — she had the darkest tan in the room.
The failures, near-failures and impending failures have been … well, choose your rejuvenating metaphor: a tonic, needed pruning, brush fire or coffee enema. One Alley headhunter reports that entry-level salaries have already begun to descend — no more $50,000 gigs for B.A.-holding 22-year-olds. She predicts mid-level executive compensation also will level off in months to come. Senior talent, however, should remain in tight demand. Great news for a group of long-standing industry veterans: They’ll still get top dollar although they’ll pay their staffs less, making it easier to run a business in directions other than into the ground.
“No one’s getting funded right now, so everyone’s reengineering their companies to make them work before the cash burns down,” says one e-tailing company chief, a seven-year new media veteran who’s moving his now-$1-a-share company out of retail and into direct marketing. His worst-case scenario? He runs out of money, sells some software assets, spends a few months in his Hamptons house and brainstorms the next idea. By that time the money will be flowing again.
And David Bennahum’s ready to supply it. A journalist-turned-VC at a firm called New Things, Bennahum claims it’s a much better time to have a venture fund than six months ago. “I’m getting better deals.” He says the unspoken crash “separates the really committed people from the bandwagoners who used to be in the garment business and will be in whatever else tomorrow.”
Taking a breather before the second night’s cocktail party, Calacanis sat at a patio table and surveyed the grounds at the suburban mansion where the Alley decampment took place: rolling hills, lush trees, a pool and a big white tent with open bar. “Nothing that happened in the last five years is even going to matter,” he says. “It’s only going to get bigger — soon we won’t even talk about the Internet industry, it’ll just be everywhere. I’m feeling more inspired than ever.”
To locate blame for our nation’s petroleum addition, we might want to start with our $35,000 Explorer addictions. Nevermind that inflation-adjusted pump prices aren’t even high enough to merit whining: The current freakout over gas prices is less about economics than psychology.
OPEC, which has only been behaving like a good capitalist, drew fire last week after its token production boost did little to lower crude oil prices. Meanwhile, the GOP demonizes too-strict environmental laws, while Dems vilify oil barons. Any of these straw-man targets sure beats talking about the real problem, which is that when it comes to oil, we’re a nation of brats. We don’t like to be told we can’t have cheap gas. The last time someone tried, we promptly shipped him back to Plains, Ga., like he was a defective product.
But one thing has changed since the Carter era. Two decades ago, most alternative energy technologies were little more than pipeline dreams. Now, many are much closer to reality, and within reach by mid-decade. Vice President Al Gore today is expected to call for billions in tax breaks, low-interest loans and other federal subsidies to encourage consumers to buy clean-energy products, such as alternative-fuel cars, to reduce the country’s dependence on foreign oil.
And earlier this month, DaimlerChrysler announced that it would invest $1 billion in fuel-cell research and development. The carmaker’s venture shows how alternative energy has evolved from a lefty fantasy to economic viability. And the faster oil prices rise, the better alternative fuels will look to ordinary consumers.
As usual, the stock market picked up on the trend early. From January to mid-March, eager buyers sent several alt-fuel companies’ shares skipping sharply higher — more than 100 percent in some cases. But with the subsequent tech sector decline, most returned to their January levels.
Then a few weeks ago, as news of drastic inflation at the pump recaptured headlines, these stocks began another run-up — a rally we’re in the midst of today. And with air conditioners to run, gas tanks to fill for summer vacations and an election cycle to endure, we’ll have oil’s intractably high price weighing upon us for the next few months.
Speculators are bound to seek out ways to profit from drivers’ high-profile ire, and some will surely flock to alt-fuel stocks. “It has a ton to do with all the energy commodities having spiked,” says Eric Prouty, an energy technology analyst at Robertson Stephens. “As much of this is investor perception as it is reality, but people are thinking that higher oil costs bring other sources’ costs into line.”
A few companies are particularly prominent in efforts to bring different fuels to market. They’re all “pure plays” — i.e., 100 percent involved in this area of business. They’re stocks for investors looking to profit from the alternative-energy trend before it really gets underway.
(A cautionary note: They are volatile, high-risk stocks. Anyone considering these investments should do a good deal of homework first.)
British Columbia’s Ballard Power Systems (NASDAQ: BLDP) produces fuel cells that combine hydrogen and oxygen to generate electricity. These cells don’t produce particulate pollution or carbon monoxide, so greenheads love ‘em. Ballard’s potentially breakthrough business is in the automotive industry, where it has deals with DaimlerChrysler, Ford and others to develop fuel cell cars. Ford and Daimler’s latest Ballard-propelled prototypes can travel about 300 miles without refilling.
Along with high gas prices, state laws are driving Ballard’s new-model engine technology. A California law, for example, calls for 10 percent of new car sales by 2003 to be “low-emissions,” or at least partly dependent on alternative fuels. But many in the industry doubt that will happen. not least because Ballard doesn’t expect to have engines ready for mass production before 2004. At a minimum, though, automakers have to show they’re trying, which means continuing to support Ballard’s R&D.
If — and it’s a big if — Ballard ever does capture 10 percent of California’s automotive engine market, its current $7.5 billion market cap (at $89 a share) will look like peanuts. Getting there will take even-higher gas prices in tandem with some crafty design and marketing from carmakers.
Think of Ballard as equivalent to an Internet play: Profits remain pretty far off, but if it works, it works big.
Fuel cells from PlugPower (NASDAQ: PLUG) use the same chemistry as Ballard’s, but instead of cars, the upstate New York company focuses on homes. By early 2002, the company will begin selling a natural-gas-based fuel cell to supply the electricity needs (and heat as well) to a 3,000-square-foot house. The cells, roughly the size of small refrigerators, sit outside and connect to the main power circuit, similar to a utility line. But once a PlugPower cell gets running, it’s off the grid — impervious to power outages.
PlugPower, like similar companies, has profited from a peace dividend. Both the Defense Department and NASA heavily subsidized early fuel-cell research and development, and today companies can redirect those technologies to consumers.
The five Wall Street analysts who cover PLUG expect the company to lose $1.31 per share this year; that loss will nearly double to $2.45 in 2001 as production expenses mount. Sales should jump substantially in 2002 when its residential fuel cells hit the market in earnest.
Unless, of course, they don’t. Product delays are the biggest near-term risk. After the company announced a delay in May, Merrill Lynch, Goldman Sachs and Bear Stearns immediately downgraded the stock to “hold,” clipping its share value by more than 35 percent in the following days. Another such glitch could shake even long-view shareholders’ confidence. The stock closed Monday at 57 1/16, up 3 1/16.
OK, so the notion of solar energy has an admittedly ’70s crunch to it. And the photovoltaic (PV) cell business has pretty much reached technological maturity. But that doesn’t mean demand has slackened. In fact, worldwide sales will grow by a steady 20 to 25 percent for many years to come.
AstroPower: (NASDAQ: APWR), in Delaware, which makes some of the world’s most popular PV cells, will do better than that. Its profits grew about 55 percent in each of the last two years and show no signs of slowing. Analysts expect the company to earn 42 cents per share this year and 66 cents in 2001. Trading at about $30, the shares have a forward price-to-earnings ratio of 44, which is not bad for a company growing more than 50 percent annually.
AstroPower’s cells are in demand from telecom firms that need to power remote equipment such as wireless phone network equipment, as well as construction firms. Road signs, for example, increasingly get their power straight from the sun.
Robertson Stephens’ Prouty has a “buy” rating on the company. “Just because you don’t see solar cells on your neighbor’s roof doesn’t mean they’re not out there,” since three-quarters of its sales go to Europe and Japan, which have embraced alternative energy much faster than the United States has.
At least in the short term, AstroPower, Ballard and PlugPower stand to gain from this season’s oil-price obsession. What happens when that obsession subsides? Check the astrology column.
Buy a can of soup and you’ll know every last ingredient. Buy a typical mutual fund and you may never discover exactly what you own.
Most funds disclose their holdings just twice a year. Few tell anyone how often they trade, which can seriously impact after-tax returns. The result: Mutual fund investors get left in the dark, says Don Luskin, an investment industry veteran of more than 15 years and co-founder of a company called MetaMarkets.
But slowly, fund companies have begun to crack open their books.
MetaMarkets’ OpenFund (which trades under the symbol OPENX) lives up to its name. This maverick operation makes its entire portfolio open for inspection.
No other fund flirts with so much disclosure, though others have started moving in the same direction. Montgomery Funds markets its brand-new Stock Solutions portfolios to “today’s savvy investor” who wants good returns and a little insight into its manager’s investment decisions. Other smaller funds, including Munder NetNet and Firsthand Funds, also offer Web updates of their holdings.
Compared to other relatively candid funds, the tech-heavy OpenFund is a flagrant exhibitionist. OPENX, which has performed roughly in line with its aggressive-growth peers since its inception last August, lists every trade on its home page moments after it happens, along with a nugget of color commentary. Last Friday, when chipmaker Rambus (RMBS) was up 50 percent on news of a deal with Toshiba, anyone could go online to see OpenFund taking some healthy profits on its RMBS shares. On Monday, Luskin weighed in with a broader analysis of the Rambus deal and what it meant for the market.
Other unique features: Investors critique the day’s buys and sells on MetaMarkets’ discussion boards, and anyone can make suggestions about what to trade next. The boards’ contributors — an unusually knowledgeable group — get peer-rated, so an investor with a run of good ideas can catch the fund managers’ attention. Luskin says the fund routinely researches little-known companies mentioned on the boards, and even has made a couple investments based on discussion-board discoveries.
More disclosure, openness and better-informed investors certainly sound like benefits. But while Luskin and his band of self-proclaimed financial libertarians lobby to bring fund holdings, trading patterns and other key stats out of the closet, some of the industry’s biggest names profess a different take: Don’t ask, don’t tell.
“I work in this business 12 hours a day, six days a week,” says Vanguard spokesman Brian Mattes, “I have a huge portfolio, and I could not begin to tell you what specific stocks are in there. It’s not a productive use of my time.”
Fund selection, Mattes says, shouldn’t hinge on the specific equities a manager holds, but on the fund’s overall approach, philosophy and performance. In fact, he and other defenders of the status quo say more disclosure ends up hurting investors.
Their argument? Fund owners usually reap bigger gains when they hold shares for a long time. Releasing blow-by-blow trading data would divert investors’ focus to the short term, and possibly encourage them to buy and sell mutual funds like fund managers buy and sell stocks — that is, often.
More insidiously, Mattes says, frequent disclosure would sap managers’ ability to trade effectively. Say a fund manager wants to add eBay to his portfolio. The market trades about $200 million worth of eBay shares a day. To have eBay become a meaningful part of his $1 billion in overall holdings, he would have to buy a big chunk — maybe $20 million worth.
What he shouldn’t do next is buy $20 million of eBay in one gulp. If he hits the market with such a huge buy order, traders will see that there’s a motivated buyer and rush in to buy the same stock. It’s known as “front running.”
Instead, hungry funds should play things close to the vest — nibbling anonymously over several days or even weeks. Ten thousand shares here, 15,000 shares there. Really huge funds, those with more than $10 billion in assets, may need many months of fine-tuned trading to build or liquidate significant positions.
And there’s the rub. If Fidelity Magellan or Vanguard Windsor told the world exactly what they owned at the end of each day, it wouldn’t take a Harvard MBA to figure out what they were buying, or to take advantage of those stocks’ rising prices.
Yet, that doesn’t entirely excuse the secrecy. Morningstar research director John Rekenthaler says that 99 percent of funds could publish their holdings monthly without exposing themselves to front-running risk.
Luskin dismisses the financial establishment’s anti-disclosure arguments as having less to do with protecting investors than with an old-vs.-new money cultural bias. Big brokerages and fund families, he says, believe buy-and-hold strategies aren’t just bottom-line better than day trading; they’re ethically superior. “There’s this almost moral tone to what people say,” Luskin says. “How often have you seen articles explicitly comparing day trading to gambling? There are all these charged words with religious connotations.”
He attributes this attitude to a benign paternalism — an assumption that most investors don’t know what they’re doing and need rules to protect them from themselves. This thinking inspired much of the Investment Company Act of 1940, which was written in the wake of the Great Depression and still is in effect, and which closed riskier investments such as hedge funds to everyone but “accredited,” i.e. wealthy, investors.
This well-intentioned if patronizing stance still informs much of what the old-school financial community believes. Vanguard’s Mattes, for example, says fund managers employ complicated hedging strategies where they buy stocks that seem to superficially go against common sense. “Will the average investor understand that? I would suggest not.”
Mattes isn’t a snob; funds are legitimately complex. But such complexity doesn’t excuse secrecy. When the Securities and Exchange Commission established disclosure standards decades ago, compiling and mailing fund data was far more time consuming and expensive. The Web has changed the equation, making it relatively simple to keep investors informed.
The question now is whether investors want to bathe in as much data as OpenFund pours out. Most probably won’t. (A few sports fans read box scores while the majority just glance at the standings.) But investors are grown-ups; they should at least have the choice. OpenFund has taken a step in the right direction.
