In a recent article titled Fund Managers Seduced by Facebook, Joe Light of the Wall Street Journal exposes some poor practices of actively managed mutual funds.
Some of the funds that bought shares wouldn’t normally be considered natural investors in a high-growth technology company like Facebook. For example, some of the demand for Facebook came from funds designed primarily to invest in dividend-paying companies or low-priced “value” stocks. Facebook is neither.
If Facebook doesn’t fit the fund’s profile, why would managers invest in it? Most were probably looking to make a quick buck in what many assumed was a hot IPO. Flipping IPOs is an unscrupulous practice that some fund managers use to gain a leg up on their benchmark. The idea is to leverage a fund’s status to get an allocation of a hot IPO. Fund managers then look to dump their IPO shares onto unsuspecting retail investors at an inflated price before ever disclosing a position in the stock. When the strategy works, it boosts performance and fund managers look like heroes for beating the market. But when the strategy fails, as it did with Facebook, a betrayal of investor trust is exposed.
The mutual fund industry’s near obsession with outperforming benchmarks quarter-in and quarter-out is to blame here. Why else would two value funds and a dividend-focused fund invest in Facebook? To wit:
Another value fund, Principal LargeCap Value fund, bought more than 124,000 shares of Facebook. In a statement, a Principal spokesman said the fund’s primary focus is to invest in stocks trading at a discount, “but it can opportunistically participate in names that we feel may offer value,” adding that the fund no longer holds Facebook shares.
Facebook doesn’t pay a dividend. Still, the Fidelity Dividend Growth fund bought 167,400 shares of Facebook in May, bringing its total allocation to 0.24% of its portfolio.
Facebook isn’t considered a value stock, for example, because those stocks normally trade at low prices relative to their earnings or assets. Nevertheless, JPMorgan Intrepid Value fund picked up 38,300 shares in May, according to Morningstar.
Most frighteningly, these funds are likely a small fraction of the total number of funds that actually bought the Facebook IPO. All the funds mentioned in the Wall Street Journal article disclose their holdings on a monthly basis. Most funds report quarterly or semi-annually giving fund managers ample time to dump Facebook shares before their reporting deadlines.
With such deceptive practices, it is no wonder that investors are flocking to the full transparency of registered investment advisors and low-fee exchange traded funds. If your portfolio is still cluttered with actively managed stock funds, it is time to consider a change.
Jeremy Jones, CFA
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