Playboy's Guide to Mutual Funds

The Mutual-Fund business came of age last summer when a New York industrialist purchased $7,000,000 in mutual-fund shares. This transaction (which, incidentally, generated about $75,000 in commissions for a happy Long Island fund salesman) epitomized a trend that Wall Street insiders had already noted: Big money, not just small change, is flowing into mutual funds. When very rich people make an investment, the rest of us should take notice.

Traditionally, mutual funds have been the bailiwick of the less-than-wealthy, and the vast majority of fund investors are still relatively unrich. At last count, 4,500,000 Americans--with an average annual income of $11,000--owned some 9,000,000 fund accounts. The value of the average account is somewhere between $4000 and $6500, but the size increases almost every year, which presumably means that the typical fund holder is prospering. And well he ought to be. Today, mutual funds are worth more than ever before; new funds are cropping up at the fastest rate in a generation; funds are attracting more investors than ever before and, in some cases, making money for their shareholders at a rate that wasn't thought possible a few years ago. So much is going on in the mutual-fund game these days that virtually every investor--current or prospective--should know the ground rules. He may want to play--for fun as well as profit.

Mutual funds are companies that specialize in investing other people's money. They are managed by professionals who supposedly know a great deal about the stock market. They use the pooled cash of many investors to purchase a broad array of stocks, bonds and the like. The individuals who provide the money own the fund's shares, having purchased them through their stockbroker, through a mutual-fund salesman or directly from the fund itself. Each share represents a fraction of all the securities that the fund owns, so that the share owners benefit from a widely diversified investment portfolio. The theory here is that diversification, by spreading the proverbial eggs among many baskets, lessens the risk of having them all broken. Professional management provides top-notch market expertise, and diversification adds an element of safety because the fund managers are prevented by law from blowing all the fund's assets on one hot tip. The Securities and Exchange Commission requires that funds have no more than five percent of their assets in any one stock--which, for all practical purposes, means that funds invest in a minimum of 30 or 40 situations simultaneously. If such caution were forced on individual investors, they would probably profit from it.

While it might be profitable, they probably couldn't afford it. For an individual to invest his relatively small stake in so many stocks would run up a fortune in stockbroker fees. At the brokerage house, every different stock you buy is counted as a separate purchase, and commissions are assessed on each purchase. Brokerage fees, in fact, are a sort of inverted income tax: The larger your purchase (i.e., the wealthier you are), the lower your bracket. Not only does the broker's percentage grow as purchases get smaller but there's a minimum charge of around $5 per $100 transaction. To spread $1000 among 30 stocks would thus run up substantial commissions. Mutual fund, by combining the money of many investors, get to buy stocks at rich people's rates: The commission on a large stock transaction can be as low as one fifth of one percent.

Of course, professional management and diversification both have their drawbacks. Professional investors, even if they are paid six-figure salaries for devoting their waking hours to tedious corporate reports, are not necessarily better investors than anyone else. And to the extent that diversification reduces risk, it also lessens the chances of large profit. But professional investors do, in the aggregate, perform better than amateurs; and the people who invest in mutual funds, in the aggregate, are not out to make a killing. They just want to see their money grow: slowly, perhaps, but steadily and in relative safety, year after year. For this type of person, mutual funds over the years have proved an excellent investment. For the man who couldn't care less about the intricacies of high finance but still appreciates wealth and all the freedom it implies, mutual funds may be the best investment of all. And even the market-wise young pro, confident he can run a few thousand into a small fortune without the aid of outside assistance, might do well to sink a small portion of his hard-earned speculative profits into a well-chosen fund; it won't provide him many thrills, but neither will it break him.

Until a few years ago, a strong recommendation for mutual-fund investment was its convenience. There were so many stocks that the chap who was unwilling to spend more than five minutes each Sunday with the financial pages couldn't hope to make an intelligent choice. Investing in a mutual fund, on the other hand, was a paragon of simplicity. All one had to do was fill out a coupon in a magazine or newspaper and a salesman would soon be calling to talk about the fund he represented. Often it wasn't even necessary to fill out the coupon. Especially for the youngish investor--or anyone else seeking large but relatively distant gains--the funds were all vaguely similar, making the decision even easier. You just bought one and forgot about it.

But nowadays, picking a fund seems almost as difficult as selecting a first-class stock. In fact, the number of funds is increasing faster than the number of listed stocks. In 1968, owing mainly to the astonishing rate of corporate disappearance through mergers, the number of different shares available on the New York Stock Exchange actually diminished. Mutual funds, which are not sold on the stock exchanges, increased in number by about 100. Fund assets have multiplied a hundredfold since 1940 and now total some 53 billion dollars. Within the past decade, the number of mutual funds has almost doubled; there are now over 500 active and readily available funds, which means that the investor's choice is anything but limited.

There's a fund for doctors and dentists (Pro Fund): for farmers (Farm Bureau Mutual Fund); for teacher (N. E. A. Mutual Fund); for airline pilots (Contrails Growth Fund); and even for cemetery owners (Cemetery Care Investment Fund). There are funds that invest only in other funds (Pooled Funds, and First Multi-fund of America) and funds that invest only in specific industries. Oceanographic Fund and Ocean Technology Fund, for example, are pledged to invest almost exclusively underwater; International Investors, among others, keeps a fixed percentage of its assets in gold-mining stocks; Life & Growth Stock Fund offers a portfolio of growth stocks and life-insurance companies; Century Shares Trust concentrates on insurance and bank stocks; and Conglomerate Fund of America and Convertible Securities Fund concentrate on--you guessed it--corporate conglomerates and convertible bonds. Corporate Leaders Trust holds only the biggest and best-known companies, making it similar to Founders Mutual Fund, which is rather arrogantly pledged to "full investment at all times in 40 common stocks selected because of dominance in their own industrial classification." There's a fund that specializes in the sophisticated investment technique called arbitrage (First Prudential Arbitrage Fund), a fund open only to $20,000-a-year-and-over employees of General Electric (it's called Elfun Trust and has 10,000 shareholders); and there's even a fund for German subscribers to The Reader's Digest. Since this is available only in Germany, American Digest fans might want to investigate Vanderbilt Mutual Fund, which "does not invest in liquor, tobacco or drug stocks"--or Provident Fund for Income, which "does not invest in liquor, tobacco, gambling, drug or foreign securities." Mates Fund, the top performer for most of 1968, shuns tobacco and booze, and also avoids firms in any way connected with the munitions industry; it may or may not be significant that the fund found itself in grave financial trouble around the end of the year and was forced to curtail operations. Followers of Jeremy Bentham's economics will be delighted to see the free-enterprise ideal apotheosized in Competitive Capital Fund, which pits five managers in an intramural battle for investment performance; the fund is barely a year old and already one underachieving management team has been thrown out of the ring. Among the 175-odd funds awaiting SEC clearance at this writing was one that would enjoy all the usual fund prerogatives, as well as the ability to buy controlling interest in other businesses, to develop real estate and to speculate in commodities. And yet another fund now in registration plans to concentrate solely on companies in the environs of Rochester, New York.

Besides the bewildering array of mutual funds, each fund offers a variety of ways in which the investor can purchase it, an equally perplexing number of tricks to be played with the profits whenever they arrive, and a surprisingly broad spectrum of charges that the investor must pay for the privilege of getting into the fund in the first place, for supporting those professional managers year after year and--in some cases--for ultimately getting out. The annual management charge and the getting-out cost are not terribly significant to the small investor (in the mutual-fund dictionary, that's anyone with under $10,000 invested), but the entry fees--which consist largely of salesmen's commissions--can be formidable. Most funds charge an initiation fee amounting to 9.3 percent of your investment; some charge less (between one and eight percent) and around 60 funds charge nothing at all. (Examples will be discussed later.) The funds that charge no fee have no salesmen to pay; this makes them all the more attractive to the investor who likes to make his own decisions; but it also means that these self-service funds are more difficult to learn about, though often it's worth the extra effort.

To invest in a fund, you can simply put up as much cash as you care to (though most funds demand a minimum); you can put up some money and declare your intention to pay more within a relatively short time; or you can sign a contract committing yourself to fixed payments over a much longer period, perhaps five or ten years, sometimes with the fillip of an elaborate insurance program to assure that the money will be there even if you are not. There are a few people for whom such contractual agreements may be a good bet, but most investors would do well to avoid them. The funds themselves like to emphasize that the future is unpredictable, and such contract plans will penalize the investor if, when the time comes, he doesn't care to fulfill his commitments. And no matter what the funds say, no investor should sign a mutual-fund purchase contract in which most of the salesman's commissions for the entire term of the contract will be extracted from the first year's payments. In such arrangements, about half the first year's "investment" goes not into stocks but into a salesman's pocket; the SEC--with some justification--is trying to make such deals illegal.

If this range of choices doesn't seem wide enough, there's also a broad panoply of fundlike institutions--discussed in detail later--that serve the same general purposes but can't call themselves mutual funds because they are differently constituted; unlike mutual funds, these are sold on the stock exchanges, just like (continued on page 164) Mutual Funds (continued from page 152) common stocks. You incur ordinary stockbroker costs to buy or sell them, but market fluctuations sometimes make these special shares available at bargain-basement prices. Like their no-commission cousins, these outfits also lack salesmen, so they, too, are more difficult to learn about.

Somewhere in this forest of alternatives, there's a fund for almost every type of investor and for almost every investment goal, but the search isn't made any easier by the fact that most information about funds is riddled with jargon and obscure phraseology. The term "mutual fund" itself is part of the jargon, and in some ways it's an unfortunate term, since it excludes a whole class of investment companies that shouldn't be excluded. "Mutual fund" is the popular term for what are properly called open-end investment companies, as contrasted with closed end investment companies (the ones sold on the exchanges, just like stocks). From the investor's point of view, there are two types of open-end investment companies: those that charge commissions and those that don't. The commission funds far outnumber the noncommission funds, and the two comprise about 90 percent of the investment-company business. Mutual funds are "open-ended" because they create new shares on demand for any investor who is willing to pay for them; then they use this money to make more investments. They will cash in shares (redeem them, in financial jargon) whenever shareholders request it. The shares that are turned in simply cease to exist, and the fund's capitalization shrinks accordingly. In other words, the number of shares in an open-end investment company is not fixed; it rises as new shares are sold and diminishes as unwanted ones are redeemed.

Ordinary corporations could never get away with this, because they can't place an accurate value on many of their assets--such as real estate, whose worth depends largely on how eager someone might be to buy it, or good will, which is about as tangible as virtue. This is why corporate shares are sold in the various stock markets. The markets permit the investing public to set its own value on what it thinks each share is worth. However, since mutual funds' assets consist solely of stocks and bonds (and usually some cash), and since all these investments have a specific stock-market value at any given moment, mutual funds can compute their net asset value instantly, right down to the last penny. Usually, the funds make these computations once or twice each business day, and the figures are published in most daily newspapers. On one afternoon, for example, all the investments and cash in a fund's portfolio might be worth $10,000,000--quite modest for a fund these days--and the fund might have 2,000,000 shares in the hands of the public. The net asset value of each share (assuming the fund has paid all its bills) would then be precisely five dollars. Any of the fund's investors could redeem his shares and receive five dollars for each; and anyone who wanted to buy into the fund could purchase shares at five dollars each--plus (in most cases) the commission, which, doubtless because of its size, is called a load. The funds that charge commissions at or near the legal maximum rate of 9.589 percent are called load funds. Those that charge somewhat less than the full rate are called low-load funds, and those especially interesting ones that charge nothing at all are called no-load funds.

A good knowledge of how mutual-fund commissions actually work is extremely useful to anyone who hopes to make an intelligent investment. Unfortunately, a discussion of commissions touches so closely on the funds' self-interest that reliable information is extremely hard to come by. We will consider the commission question at some length: but for the nonce, it's sufficient for the reader to understand that the commission money he pays when he buys into a fund does not go to the people who run it. It goes to those who sell the shares, usually stockbrokers or salesmen, who often have no connection with the fund itself. The people who run the fund are paid not from commissions but from the fund's investment income. Typically, the fund management takes an annual fee equal to one-half percent of the fund's total asset value. That doesn't sound like much, and for most investors it isn't. If you own $5000 worth of a fund, for instance, you're being charged about $25 a year for all that diversification and professional management. For smallish investors, this is certainly a bargain--less, in fact, than the cost of a year's subscription to The Wall Street Journal. But if the fund has assets totaling one billion dollars (there are currently ten funds over that mark), management fees can come to $5,000,000 a year--which ought to buy most of the experts in the country. Some funds have belatedly recognized that management costs do not rise directly with the size of the assets supervised, and these enlightened funds reduce the management percentage as the fund grows. Other funds reward management not just according to size but on the basis of how well the fund performs; such an arrangement is commendable not only because it rewards excellence but because it provides the fund managers with an incentive to do more than just lure in new shareholders.

Mutual funds make money for their shareholders in two ways: from dividends (or other income from their investments) and from selling their investments at a profit. Like most companies, funds pay dividends to their stockholders, usually quarterly. Each investor in the fund gets his portion of all the dividends the fund receives from the various investments in its portfolio, after operating expenses (including management's cut) have been deducted. Tax law all but compels the funds to pass such dividend income along to shareholders. The fund pays no taxes on this money, because it simply acts as a pipeline channeling the dividends to its investors, who then pay taxes on it. (Under current tax law, however, each taxpayer's first $100 in dividends--including dividends passed on by mutual funds--is tax-free, a point well worth the consideration of those who don't currently receive dividend income. Interest income--such as the interest from savings bonds or bank accounts--is fully taxable.)

From time to time, a mutual fund will also run up profits or losses when it sells investments from its portfolio. If the fund has held such investments for more than six months, the profits are long-term capital gains. Long-term capital gains, as every investor should know, are taxed at lower rates than ordinary income: at half the taxpayer's ordinary rate or 25 percent, whichever is less. The mutual-fund shareholder must pay this lower tax on his portion of the fund's capital-gains profits each year. Though the fund has the option of retaining the profits (and paying the tax on the investor's behalf), it usually returns the money to the shareholders in what is called a capital-gains distribution, which is made annually.

However, funds strongly urge shareholders to accept capital-gains distributions--and even dividends--not in cash but in additional shares of the fund. This provides the fund managers with more money with which to make new investments, and it also gives them an everlarger pie from which to extract their cut. More important, however, are the advantages that reinvestment provides for the shareholders themselves. Funds usually permit shareholders to reinvest all their profits without paying additional commissions. Mutual-fund profits can thus compound in a most rewarding manner, and the fund share owner who reinvests all his profits is reasonably assured that inflation will not erode the value of his original investment. More than 70 percent of all fund shareholders elect to take their capital gains in additional shares; the percentage of investors taking their dividends in shares is lower. (continued on page 186)Mutual Funds (continued from page 164) but increasing. Fund shares, incidentally, are not purchased in round numbers, nor even in whole numbers, but in dollar amounts. After deducting the applicable commission (if any), the fund simply credits the investor with however many shares the remaining money will buy--computed down to four decimal places. If the shareholder elects to reinvest his dividends and capital gains, these, too, will be converted into shares to the nearest ten thousandth, guaranteeing that every penny of the investor's money is always working for him.

Despite such advantages, many younger investors have tended to shun the funds, in the oft-mistaken belief that they can fare better on their own. In the short run, they possibly can. Given a pinch of savvy, almost anyone could conceivably pick a stock that would outshine a mutual-fund investment--for a month, a year or even longer. Not a single mutual fund so much as doubled its investors' money in 1968, but literally hundreds of stocks did. In fact, on the over-the-counter market alone (it's not really a market but a collection of them, where brokers buy and sell little-known stocks), 52 stocks advanced by more than 1000 percent in 1968. At least a few investors must have been fortunate enough to own the year's best performer, Diverco Inc., a company so obscure that diligent research has failed to unearth the nature of its operations, other than that it was "formerly in the swimming-pool business." The company doesn't seem to have so much as a telephone, but it does have lots of tax losses, and these were sufficient to propel it from 1 cent a share (January 2, 1968) to $2.12 (December 31, 1968), for an impressive gain of 21,100 percent. The odds against picking a winner such as this are formidable: Who in his right mind would buy a stock in a company that doesn't even have a phone? And if the odds against making one such investment are steep, the odds against making a series of them--taking the profits from the first stock and sinking them all into a second, taking the proceeds from the second and investing them all in a third, and so on--are impossible. It would be easier to pick a 12-horse parlay, something no one has ever done. The problem with stock pyramids, as with 12-horse parlays, is that no matter how lucky or perspicacious the bettor might be, sooner or later the whole edifice is bound to collapse, and when it does, the ultimate bad bet wipes out the profits from all the previous good ones.

But there is a sort of parlay that investors can and do make money on, and it's a technique that's at once rewarding and prosaic. The only requirement is patience and the leverage of compound interest. For investors gifted with patience, funds can provide scads of compounding, by virtue of the aforementioned commission-free reinvestment of dividends and capital gains. Essentially, compounding means that after the initial investment has produced dividends of one sort or another, the investor then begins receiving dividends on his dividends, then dividends on the dividends on the dividends, and so on, ad infinitum. How this actually works for the fund investor is best understood through an ancient and well-known financial formula called the rule of 72. For a reason that is knowable but not worth knowing, the number 72, divided by the prevailing rate of compound interest, will reveal the number of years required for a sum of money to double. An investment that increases at 18 percent a year, for instance, will double every four years--because 72 divided by 18 equals 4. Eighteen percent may seem a bit steep, but it's theoretically quite achievable in funds these days. In fact, it's very close to the gain that the average mutual fund racked up last year. In the past decade, the 25 top-performing funds each year, with capital gains reinvested, have produced average annual returns as high as 33 percent, and never lower than 14 percent.

The funds deserve credit for this performance, but not quite as much credit as one might think. An exhaustive computer survey, conducted a few years ago at the University of Chicago, showed that the average annual profit (before taxes) on any New York Stock Exchange investment held for one month or longer--regardless of what the company was, when the shares were purchased or when they were sold--was 9.3 percent. If a random investment in stocks returns 9.3 percent, it seems reasonable to expect that highly touted and highly paid fund managers can produce twice that. Assuming a compound-interest rate of 18 percent, the rule of 72 reveals that a young man could invest a paltry $1000 in funds at the age of 20 and at 60 emerge a millionaire. If he's not willing to sweat out 40 years, he can up the initial ante to $30,000 and watch it run to almost $1,000,000 in only two decades. Of course, this example is wildly theoretical, in that it makes several assumptions of a future-predictive nature. The future, as we all know, is never predictable. But still, the example does emphasize a basic point: that compound interest is not to be derided.

Given the manifest advantages of compound interest, the problem of picking a mutual fund seems to be simplicity itself: The investor should select whichever fund will give him the largest percentage of return, year after year. This is actually an iffy, even an impossible, proposition, but it's still what many fund investors (probably a majority of relative newcomers) actually attempt. These investors will confess that they have only one goal: to make as much money as they can in as short a time as possible. Needless to say, a good many funds have sprung up to accommodate them. Seven years ago, the SEC was worried that mutual funds were being managed too conservatively, but it now thinks the funds aren't conservative enough. Former SEC chairman Manuel F. Cohen recently expressed his concern, in a national business magazine, about an increasingly speculative climate that has been enveloping the mutual-fund business; and Cohen's successor, Hamer H. Budge, complained to Congress last February about a cult of performance among fund managers who focus on short-term profits in order to make their shares more salable.

The cult of performance certainly exists--not only among fund managers but among fund investors. Investors, like everyone else, have no way to predict the future, so they usually rely on the evidence of the past when selecting the fund they think will make the most money for them. In other words, they buy funds that have a past or current history of success. Several firms specialize in rating mutual funds periodically--ranking them according to how well they are doing in the performance derby--and whenever new ratings are published, investors fall all over themselves for the privilege of throwing money at the top-ranked funds. Mates Investment Fund, the one that refuses to invest in the munitions industry, learned the hard way just how anxious the public is to invest in a winning situation. About a year ago, Mates was performing so much better than any other fund that it was literally inundated with investor money--so much so that the fund couldn't keep up with its paperwork and had to stop selling new shares. Mirabile dictu, Mates Fund actually rejected some $50,000,000 in investor money. On the strength of its top rating alone (Mates Fund is a no-load fund, without commissions or a sales force), its size had grown by a factor of ten in six dizzying months. By the end of the year, the fund was so successful that it was almost forced out of business; one of the stocks in its portfolio had gone from $3.25 to $33, and suddenly comprised about one fifth of the fund's assets. As noted, the securities laws insist that no single investment constitute more than 1/20 of a fund's assets, so Mates Fund had to sell. Unfortunately, for reasons too complicated to discuss, the zooming stock was such that it couldn't be sold on the open market. Lacking a market, it was impossible to evaluate. As a consequence, Mates was forced to stop redeeming its own shares--almost an unprecedented event in the mutual-fund business. The fund now hopes to resume normal operations shortly, though one is not entirely certain what normal means in this case.

The ratings that sparked all the initial interest in Mates Fund are published periodically in some of the financial magazines. As published, however, they are often incomprehensible, and a better source is usually a brokerage house. Any reputable broker will be able to lend you abundant material from Wiesenberger and Company, a New York firm that publishes a huge annual compilation of data (including easy-to-read charts) about past and current fund performance. The best of the rating services is probably the Lipper list, published in various forms (including a weekly ranking of the hottest funds) by the Arthur Lipper Corporation, a brokerage house in New York. You can buy the big Wiesenberger book for $40, but the Lipper service costs up to $500 annually, so it's best to borrow a broker's copy.

The unhappy experience of Mates Fund notwithstanding, one of the interesting aspects of the mutual-fund performance derby is that success breeds success, at least in the short run. Once a fund rises to the top ranks, it tends to stay there for a while. The reasons for this are obscure (for anyone who's interested, the subject is discussed in detail in the June 1968 Fortune), but they definitely relate to the influx of cash from new investors that usually accompanies a high position in the fund-performance list. A high ranking means new investors, and new investors mean new money. Once a fund management is blessed with new money, it is free to buy good new stocks whenever it finds them; it can buy when the market goes down (obviously, this is the best time to buy) and it can count on receiving useful research about hot new stocks from brokerage houses eager to get their hands on some of that incoming cash. Funds not blessed with new money, on the other hand, must dip into their reserves to make new investments or to meet redemptions. If they are fully invested and have no cash (most funds try to keep some in reserve), they must sell old investments, often at a loss, or at least at a time when they should not be sold. To the extent that a fund enjoys a steady stream of new money, it will be able to make the sort of good new investments that will keep it high in the rankings; and when a fund stays high in the rankings, it keeps getting more new money. Portfolio managers--the men who actually make the funds' investment decisions--generally admit that a steady influx of new cash is crucially important to their own well-being, financial as well as psychological. It's not simply to appease their egos that fund managers are engaged in a no-holds-barred battle to get into the top 10, or at least into the top 25, on the ranking lists.

Watching all this jockeying, the casual observer might guess that most funds share the same objective: to make as much money as possible for their share-holders. This, unfortunately, is just not true. A great many funds, especially the newer ones, and most especially the ones that the reader will be looking for, do try to maximize profits--but by and large, the scope of their investment goals is much broader. Some funds, for instance, are interested only in the preservation of capital--to accommodate investors who have reached that lofty state where their primary concern is simply keeping what they already have. Other funds pursue the maximization of income--for widow and orphan types who must live

on whatever they can best squeeze from a fixed sum of money. Most other funds can generally be ranked according to their willingness to take risks.

Since the funds can make money in two ways--from dividend income and from capital gains--the most sensible way to classify them would be to divide them into two groups: income funds and capital-gains funds, which might better be called growth funds. But even here, we're forced to add a third category, special funds, to pick up everything that doesn't fall into the first two categories. (Many of the funds listed earlier would qualify as special funds.) Income funds are for anyone who has a specific sum of cash and doesn't want to risk diminishing it in the process of trying to make it grow. But the lure of tax-favored capital-gains profit is so great that even income funds sometimes don't seem terribly interested in income. Of 15 income-oriented funds recently tabulated by Fundscope, only two paid dividends higher than five percent in 1968. The highest dividend payer of 375 funds examined is called Keystone B-4 (most funds have more evocative names) and it returned 5.69 percent. Since even short-term Treasury notes are now paying around six percent, the objective observer must conclude that people solely interested in income shouldn't be dabbling in funds at all.

In fact, the straight-income funds have a relatively small following: They account for less than five percent of the mutual-fund business. One of the reasons they attract even this much attention is that the conservative nature of their portfolios makes them relatively safe investments and sometimes, in periods when speculators are disenchanted with high-flying growth stocks, makes them good sources of capital-gains profits as well. The year 1968 was such a period, and it embarrassed a great many funds because their declared intentions simply did not reconcile with their actual performance. Funds that claimed to be investing primarily for growth wound up producing nothing but income--and not much of that. And funds set up to invest for income were beset with embarrassingly large capital gains. Charming Growth Fund, for example, "grew" a modest two percent, while its conservative sister fund, Channing Income Fund, grew about 13 times faster, increasing the value of its investors' holdings by 25-1/2 percent. In outfits like the Channing group, the managers run different but similarly named funds designed to achieve different results. (One of the happy aspects of such multiple arrangements is that the managements usually let their shareholders shift their holdings from one fund in the family to another, without having to repeat the hefty commissions.) Of nine such management groups this author knows about--each offering one fund dedicated to growth and another dedicated to income--the income funds outgrew their growth counterparts last year in all but one instance. Fundscope's list of 15 income funds, which includes virtually all income funds of any consequence, averaged 17.9 percent growth in 1968. A comparable group of 173 growth funds averaged just 12.3 percent.

But at least they grew. While stocks on the average went up four to eight percent in 1968 (depending on which index you read and how you read it), Manhattan Fund, one of the largest and best-known of the growth funds, declined seven percent. As the fund's president, ex-wizard Gerry Tsai, Jr., admitted to his shareholders: "Our investment judgment on growth stocks was faulty. Put simply, we tended to overstay better-known growth stocks." In business, as in life, faulty judgment can hurt. Manhattan's Hamletlike tendencies to overstay lost it $134,000,000 in profits that it could have taken but didn't. Tsai may be more candid than most growth-fund presidents, but his fund was not alone in its less-than-meteoric performance. Of 375 well-established funds tracked by Fundscope through 1968, 48 wound up trailing the Dow-Jones Industrial Average. The D.J.I.A., as most investors are well aware, is a widely followed market index comprised of 30 somewhat stodgy blue-chip stocks not noted for their volatility; last year, assuming reinvestment of dividends, the Average gained 7.3 percent. Of the 48 mutual funds that did less well than this, 30 of them--almost two thirds--bill themselves as growth funds. Besides Tsai's Manhattan Fund, four other growth funds grew negatively.

In fairness to the growth funds, 1968 was a very peculiar year, and their average 18 percent increase is not to be faulted, being precisely the figure needed to compound $1000 into $1,000,000 (in 40 years) according to the rule of 72. However, before any readers rush out to make $1,000,000, they must be cautioned that it's highly unlikely that any growth fund--even the best, whichever that might be--can sustain such a growth rate for 10 or 20 years. The best-performing funds each year will probably gain more than 18 percent, but the ranks of the best will change as time goes by. This is because while success breeds success in the mutual-fund business, it also carries with it the seeds of ultimate failure. To the extent that a fund's current prosperity lures money from new investors, the fund itself must suffer sooner or later, because it will someday be too large to manage nimbly. The Federal laws that govern mutual-fund activities assure this. Not only can funds have no more than five percent of their money in any one company but they also can't own more than ten percent of any single company's shares. These restrictions were designed to keep funds from exercising a management role in the companies in which they invest (a role they often exercise anyway), but their real effect is to cramp the style of a fund once it has grown beyond a certain size. Consider a hypothetical billion-dollar fund. The five percent rule says the fund may own up to $50,000,000 worth of any one stock (five percent of a billion). But most potential investments, especially the smaller, more promising companies, where the biggest profits are often to be made, have less than $50,000,000 in shares--and the fund is limited to owning only ten percent of them. The result, quite simply, is that as a fund gets larger, it is forced to diversify increasingly or to invest more and more in well-established firms with vast numbers of shares outstanding--the very companies that, because of their large size, usually provide the least action. Common sense indicates that the number of small, hot companies is limited; and even if a large fund elects to confine itself to these, sooner or later it will own as much as it can of them and will have no place else to go. In the process, it will also pick up a number of small, promising companies that fail to live up to their promise. The message should be clear: Once a fund gets past a certain size, its activities are increasingly restricted. It can diversify by buying an ever-larger number of small-company stocks; it can buy ever-bigger chunks of the well-established companies; or it can do both. But whatever it does, it is not likely to keep making the profits that attracted most of its investors in the first place. Last year, the ten largest funds gained only 6.5 percent, slightly less than Standard and Poor's broad composite stock average. Massachusetts Investors Trust, with assets over two billion dollars, has for years acted very much like the Dow-Jones Industrial Average.

Perhaps the most interesting illustration of the dilemma of success is provided by Enterprise Fund, a growth fund headquartered in Los Angeles. Without qualification, Enterprise has been the most consistently successful of all mutual funds in recent years. It has been the only fund to rank among the top 25 for each of the past six years. No other fund has accomplished this feat since 1940, when new legislation changed the structure of mutual funds and meaningful statistics began to accumulate. A $10,000 investment in Enterprise Fund at the beginning of 1963--deducting the 9.3 percent load and assuming subsequent reinvestment of all capital-gains distributions and dividends--was worth close to $70,000 at the beginning of this year. In the case of Enterprise, success has assuredly bred success. The fund's assets increased by a factor of several hundred during the period discussed, growing from $3,000,000 to almost one billion dollars. Most of that was new money, attracted by the fund's impressive performance. Enterprise's philosophy, as enunciated by its portfolio manager, Fred Carr, is to invest in "emerging growth situations"--small companies that promise great success. How many such companies there are is open to question: At last count, Enterprise had some 350 stocks in its portfolio, which surely makes it less flexible than when it was a $6,000,000 fund and could invest in the most promising 35 of those 350. Carr, in fact, has recognized the problems of bigness and has divided the Enterprise portfolio internally into a number of different bundles, each tended by a separate manager. Whether this attempt at self-imposed smallness will work remains to be seen, for the five and ten percent rules still apply to the fund as a whole, not to the individual bundles. Yet the fund increased over 40 percent in per-share value last year--an unprecedented gain for a fund so large. In fact, Enterprise was outperformed by only a few other funds, one of which was the ill-starred Mates Fund. But no matter how well Enterprise does in years to come, it will certainly not duplicate its record of the past six years. If its size were to increase that much again, it would wind up owning almost 80 billion dollars' worth of securities, which wouldn't leave much for the rest of us.

The dilemma of Enterprise Fund is also the dilemma of the man who wants to invest in funds. Few people would want to buy into a fund with an unproven track record, but a fund with a good track record may have grown too large to sustain its previous rate of success. Most printed information about mutual funds will tell you, in one way or another, that the only real measure of value is how a fund has performed over several years. Unfortunately, this just isn't true, and most of the mutualfund rating services admit it. After arming the reader with endless pages of statistics about past performance, the services will note, with some coyness, that past results should under no circumstances be construed as an indication of future performance.

Despite contradictions such as this, there are a few guidelines that would-be mutual-fund investors can follow. First, it never hurts to know how a fund's management is being compensated. Besides the growing number of funds with sliding compensation schedules (which means that the managers get a smaller cut as the pie expands), some funds, especially newer ones, reward their management on the basis of how well the fund performs in comparison with the broad stock-market averages.

In addition, the potential investor should make sure that all the fine-print terms of the fund--such as those relating to reinvestment of profits, ultimate withdrawal of money, possible charges for getting out--are suitable. The fund's prospectus--which by law must be given to the potential investor before he commits himself--will yield all this information, though in many cases only reluctantly. The prospectus will also give the investor a relatively recent glimpse at the fund's portfolio--for whatever that's worth. In a typical growth fund, many stockholdings will mean nothing even to the most sophisticated investor; beyond that, the information will probably be stale. Funds are required to divulge the make-up of their portfolios twice a year, and most funds do it quarterly; but this information is usually months out of date before the investor gets it. Anyway, the law permits funds to hide five percent of their investments; so if they're into something really interesting, you probably won't find it.

All other things being equal, which they never are, it is wise to pick a fund with a good track record, though preferably one that hasn't been so good for so long as to bloat the fund to a point where it waddles rather than runs. Most fund literature tells the investor to pick a fund that's performed well in both up and down markets, but this advice is dubious. In general, stocks, have been rising for so long that most funds haven't had much experience in bad markets. Even if you do find a fund that did well in 1929 or in any of the more recent setbacks (1962 or 1966, for instance), there's no guarantee that the same canny men are still at the helm. Chances are they were so well rewarded for their perspicacity that they've now retired or gone on to better jobs. So don't pay nearly as much attention to past performance as you pay to present performance. That is, once you've decided on a fund, or once you've bought it, keep an eye on it; if, over time, you find it's not doing as well as many other funds, or if it's not doing as well as stocks in general, then you should consider selling out. Of course, the commissions you will have paid may make this more difficult. If you paid the typical 9.3 percent, for instance, unless the fund has increased 9.3 percent by the time you sell, you'll take a loss.

This is one of the big problems involved in investing in the load funds. Not only is the price of admission steep but, once it's been paid, it tends to lock you in. Of course, the investor is free to get out at any time; but if getting out means taking a loss due solely to the salesman's commission, then the investor would have done better not getting in at all. In fairness to the load funds, they do lower their commissions drastically on large purchases. This partially accounts for their increasing attractiveness to very wealthy investors, but it's small consolation to the less affluent, who generally have to pay at the top rate. Here's a sample of a mutual-fund commission schedule. It's taken from the prospectus of Fletcher Capital Fund (run by the Enterprise people), but similar rates apply to most others.

Amount of Investment

Sales Charge

$ 500 but under $ 25,000.. 8.50%

$ 25,000 but under $ 50,000.. 6.90%

$ 50,000 but under $125,000.. 4.90%

$125,000 but under $250,000.. 2.90%

$250,000 but under $500,000.. 1.80%

$500,000 and more ..... 1.00%

The larger figures are especially interesting in that they are entirely hypothetical; Fletcher won't allow any investor to purchase more than $50,500 worth of its shares. To get the lower percentages, investors must also buy other funds in the Enterprise group. Even the smaller figures in the table are somewhat mythical. In a form of mathematical legerdemain peculiar to mutual funds, the load funds compute their commissions not on the value of the shares purchased but on the entire transaction, commission included. As an example, say you want to invest $1000 in a fund. The commission, a salesman tells you, is 8-1/2 percent--$85. So $85 goes to the salesman and related middlemen, and the rest--$915--buys your fund shares. Suddenly, you're not investing $1000 at all. You're investing $915 and paying $85 for the privilege. Long division reveals that $85 is 9.289 percent of $915, and that's the typical commission on a small transaction: 9.3 percent. This is a trivial point, to be sure; so trivial that the funds should consider computing their commissions in a more straight-forward manner, rather than making potential customers resort to mathematics they haven't used since high school.

Short of writing for a prospectus and recomputing the figures, the easiest way of determining a given fund's maximum commission cost is to consult the mutual-funds listing in the daily financial pages. Many daily papers are woefully skimpy in their mutual-fund statistics, but even the worst usually publish some sort of listing, Which might include several hundred different funds, arranged in alphabetical order, with two prices after each name. In terminology more appropriate to over-the-counter stocks, the two prices are usually headed "Bid" and "Asked." The bid price isn't really a bid at all--it's simply the net asset value per share of the fund for that particular afternoon. That's the price at which the fund will redeem whatever shares it receives that day. The asked price is the price at which it will sell shares, and the difference between the two prices is the amount the investor will have to pay in commissions. From these figures, readers can compute precisely what commission they'll have to pay to purchase a particular fund. Nonmathematicians can simply examine the two figures to see if the difference (called the spread) is relatively large or small. If it's large, then the commission on that fund is high, and vice versa. If the two figures are identical, that means there's no commission at all. In other words, the fund is a noload, and you can buy into it at net asset value. A recent mutual-fund listing in The Wall Street Journal, which each business day publishes one of the most comprehensive of all such listings, showed 297 funds, of which 32 were in the no-load category.

It's almost incredible that so many mutual funds can flourish while there is such a gross disparity among their commission structures. In any ordinary business, the firm that charged the lowest commissions would very quickly garner most of the trade. But in the mutual-fund business, the opposite holds true. The firms with the highest commission rates, as a group, account for a majority of the business. One reason for this is that the mutual-fund product--future performance--is unknowable. A fund that you pay 9.3 percent to get into may, indeed, outshine a similar one that charges no commissions at all. There's no way of telling until after the fact--when the information is too late to act on.

A simpler reason is that high commissions attract good salesmen, and good salesmen sell funds. In fact, it's something of a cliché in the mutual-fund business that fund shares are not bought--they are sold. This is by way of establishing the crucial role of the fund salesman, and the equally crucial role of the ample commissions that seem necessary to sustain him. Lower the commissions and you will lower his incentive to sell funds. Having reduced his incentive, you will find new fund sales diminishing. We have seen how the absence of new money can curtail a fund's growth, but in extremis, it can do worse than that. If sales of new shares diminish to a point where redemptions exceed them--that is, if more shares are being cashed in than purchased--then a fund is in bad trouble, because it's forced to sell some of its investments to raise cash to redeem its shares. Funds don't like forced liquidation, because it makes them sell investments they'd prefer to keep, thus forgoing future profits. Moreover, since the redemption rate often rises when stock values are declining, such forced sales usually occur at just the wrong time, making funds sell stocks at the very moment they should be buying more.

In fact, the redemption--sales ratio (relating money going out to money coming in) is the Achilles' heel of the mutual-fund business. The danger of a run on mutual funds, similar to the bank runs that occurred with such disturbing frequency in the Bonnie and Clyde era, has never been real, because continuing growth--and an everexpanding sales force--has enabled funds to meet redemptions easily out of new cash. That is, in the aggregate, they've always had enough money from new sales to redeem the shares of current investors who, for various reasons, want out. But as the fund industry matures, it's at least possible to imagine a day when a relatively large number of investors, who might have purchased fund shares long before for the kids' college or for retirement, decide to get out. If, as seems most likely, this increased desire to redeem comes at a time when money is scarce, stock values are declining and sales of new fund shares are off, then the funds will be forced to sell many of their investments to raise enough cash to meet redemptions. A wholesale liquidation of this sort--especially nowadays, when monolithic institutions of one stripe or another control a sizable chunk of all common-stock investments--could cause a stock-market sell-off of major proportions, feeding on itself in a snowball effect, as more and more fundholders perceived ever-diminishing stock prices and decided that they, too, should unload. Such a situation actually occurred in Japan in the early Sixties; there, however, the government halted a potential snowball by creating a state stock-buying company to provide a stable market for shares that the funds were forced to liquidate.

Obviously, a fund sell-off of this magnitude has never occurred in the U. S. In a report to Congress 30 years ago, the SEC examined the performance of 40 open-end investment companies (that's all there were back then) during the boom-and-bust decade between 1927 and 1936. Those years were darkened by the worst stock marker in American financial history; but yet, the SEC discovered, not a single fund went bankrupt, and funds sold $564,000,000 in new shares and redeemed only $142,000,000 in old ones. In other words, sales outran redemptions four to one, even during the great crash of 1929 and the subsequent Depression. More recently, in the brief market crash of May 1962, when the Dow-Jones Industrial Average fell 8.5 percent, fund values deteriorated drastically, but people kept buying more; sales were $292,000,000 that month, and redemptions only $122,000,000. Fund buyers also predominated in the stock-market decline that began last December, though the precise figures aren't yet available.

One reason for this unflappable investor behavior is that a market collapse tends to lure new customers into the funds: shrewd investors who know a bargain when they see one, and lessshrewd investors who have been chastened in stocks and reach the belated recognition that they can't do as well on their own as they might have hoped. Ultimately, the fact the funds are purchases heavily even in bad market periods is a great credit to the individual investors responsible for the buying. They are bargain hunting, and doing it successfully. To the extent that they do their bargain hunting without the aid of a salesman, however, they are defeating the funds' case for high commission rates. In fact, for the intelligent investor, the most pernicious thing about mutual-fund commissions is not their size but what they represent. In load funds, as in life insurance, a salesman must be paid, whether or not the customer needs to be sold. To the investor who has spent week or even months doing just what the fund pundits tell him to do--reading dreary prospectuses, deciphering arcane charts, sitting in a noisy board room thumbing through the Wiesenberger books--and then, after all this is precisely right for him, it is rather galling to be forced to give up 9.3 percent of his money to the salesman who just happens to take his order. The investor didn't need to be sold and the salesman didn't sell him; the fund sold itself. If anyone is to be paid for the sales job, it should be the hard-working investor.

The load funds have an interesting answer to this. (Actually, they have several arguments to support their commission structures, but none as engaging as this one.) The notion is that a mutualfund salesman must be compensated for all his working time--not just the two minutes he might spend writing the intelligent investor's order, but all the hours he spends telephoning Young Republican membership lists, attending Kiwanis luncheons and making friends at suburban P. T. A.s. The salesman, as the funds see him, is a valuable pillar in the free-enterprise firmament, who spends much of his time praising the virtues of capitalism to those oft-neglected 174,000,000 Americans who, for various reasons do not care to invest. To resist the tide of revolution, the load funds may be justified in taxing those who have the wealth and intelligence to make a good investment, in order to subsidize a procapitalist propaganda effort directed at those who don't. But such a campaign seems to frustrate the very elements of choice that are so vital to our free markets. Besides, mutual-fund salesmen spend very little time with the people who really need conversion, and--in this writer's experience--fund salesmen are not particularly incisive defenders of capitalism anyway.

One of the reasons for this is that price competition, that bastion of free enterprise, is simply illegal in the mutualfund business. Section 22(d) of the Investment Company Act of 1940, which was written with the grateful cooperation of the fund industry, makes it a Federal crime to sell a mutual fund at a price less than whatever the fund's distributor decides it should be. Last year, both the Justice Department and the President's Council of Economic Advisors urged repeal of 22(d) and, more recently, Senator John Sparkman of Albama announced that his powerful Banking and Currency Committee intends to carefully consider repeal. The load-fund lobbyists are strong and well entrenched; but with this sort of opposition, they are bound to capitulate sooner or later.

While load funds certainly provide their salesmen with incentives to treat potential customers responsively and cordially, and while the constant influx of new cash generated by these salesmen may help the load fund's performance considerably, the would-be purchaser of load-fund shares must still include the commission cost in his investment calculus. Fund salesmen try to minimize the difference between their funds and their no-load brethren. In the long run, the salesmen will say, it's not the initial cost that counts but how well the fund performs. By and large, this is hogwash. As a famous economist once noted, in the long run we are all dead. In the meantime, the future performance of any mutual fund cannot be known. But the commission cost, since it is paid in advance, is manifestly knowable. It's the only cost in a mutual-fund investment that you can calculate precisely before you commit yourself. To justify taking the investor's money, the load fund should promise performance not just comparable with a no-load's but better, so much better as to compensate for the commission loss and what that would grow to if it were free to compound over the years. Certainly, many such load funds exist: Load funds outnumber the no-loads by about ten to one, and by twice that if you compare assets rather than funds. But at the starting gate, no one can tell which load funds will finish sufficiently in the forefront to justify their commission charges. In terms of what they offer the investor, most load funds have a 9.3 percent handicap to overcome, and the would-be purchaser must weight his bets accordingly.

Until a few years ago, fund salesmen --and even the prestigious statistical services such as Wiesenberger--tried to imply that load funds, despite their steep commissions, generally outperform no-loads. This is simply not true, and most likely never was. As a matter of fact, syndicated financial writer J. A. Livingston, in a long and perceptive series of articles published last summer, advanced impressive statistics--representing a tenyear period--to show that the no-load funds, mainly because they allow the investor to begin with his full capital rather than with only 90.7 percent of it, generally make more money for their investors. Recent statistics published in Fundscope tend to confirm this, and perhaps the simplest affirmation of all is that the best-performing fund, in the past two years, Neuwirth Fund, is a no-load. (In the first two and a half months of this year, however, only 4 of the top 25 funds were no-loads--which probably proves nothing except the protean nature of mutual-fund statistics.)

Because the no-loads, at least in the aggregate, do offer what seems to be better value, and because, lacking a sales force to beat the drums for them, they are more difficult to learn about than load funds, we present here an alphabetical list of well-established no-load mutual funds. All of them have been around for at least eight years, which gives them something of a track record. All are dedicated to growth, which makes them somewhat speculative and therefore more interesting for the younger investor, and all have performed creditably--or at least reasonably well--in the past few years. None charge redemption fees and--except where noted-- they all permit automatic reinvestment of both dividends and capital-gains income. The list is not a recommendation, nor is it by any means complete. It's just a representative cross section of what's available, and the reader might want to investigate some of these, or others not listed. Addresses are included because-- on request--any fund will send a prospectus.

American Investors Fund, 88 Field Point Road, Greenwich, Connecticut 06830, has been a top performer since 1962, and its assets are now well over $200,000,000. Many of its investment decisions are based on technical analysis-- which means that the fund's managers prefer charts to balance sheets.

De Vegh Mutual Fund Inc., 20 Exchange Place, New York, New York 10005, is relatively small, with assets around $50,000,000. Especially considering its size, it has a commendably low expense ratio, which means that its management is quite diligent in keeping costs down.

Drexel Equity Fund Inc., 1500 Walnut Street, Philadelphia, Pennsylvania 19101, is both relatively new (1961) and relatively small (around $42,000,000). It's done quite well in recent years and, like A. I. F., it often invests on the basis of chart action.

Energy Fund, 55 Broad Street, New York, New York 10004, has assets over $100,000,000 and favors energy-related stocks--oil, uranium and so on.

Ivy Fund, Inc., 155 Berkeley, Boston, Massachusetts 02116, was founded in 1960 and has been rated (by Fund-scope) an above-average performer in six of the past eight years; it all but doubled its investors' money in 1967 and showed a healthy 39 percent increase last year.

Penn Square Mutual Fund, 451 Penn Square, Reading, Pennsylvania 19603, has a respectable long-term record and now boasts assets around $170,000,000; however, its reinvestment program is slightly restrictive, and the would-be buyer should check this carefully.

Scudder Special Fund, Inc., 345 Park Avenue, New York, New York 10022, has been a top performer for the past decade, though it has been publicly available for only three years.

Would-be swingers might want to investigate the following three no-load funds as well. These are less seasoned than the previous seven; all were formed in the past few years and all fall into the go-go category; that is, they are designed for investors who are willing to entail substantial risk in hopes of substantially higher profits.

Hubshman Fund, Inc., 666 Fifth Avenue, New York, New York 10019, employs sophisticated investing techniques --short selling, leveraging its position by investing with borrowed money, and dabbling in sophisticated options called puts and calls--in the pursuit of greater profit. Results so far have been mixed; the fund did fairly well in 1967 but barely kept pace with the cost of inflation in 1968. Hubshman Fund recently declared its intention to become a load fund, so that by the time you read this, it may no longer be available without commission. And two months ago, the fund's chairman and president, Louis Hubshman, Jr., was chastised by the SEC, which charged that the fund had been overgenerous in rewarding its management.

Neuwirth Fund, Middletown Bank Building, Middletown, New Jersey 07748, is only two years old and has so far compiled a record just short of incredible. The value of each of its shares increased 300 percent in 1967 and another 72 percent in 1968. As noted, this has made it the top-performing fund for two straight years, a feat accomplished by no other mutual fund of any description in modern memory. However, like most funds, it has fared poorly so far this year, losing 8 percent in the first ten weeks.

Gibraltar Growth Fund, 2455 E. Sunrise Boulevard, Fort Lauderdale, Florida 33304, is also quite new, and performed just about as well as Neuwirth Fund in 1968. In the first few months of 1969, however, the fund showed a loss of about 12 percent.

Two of these ten representative no-load funds--Energy and Hubshman-- deserve special discussion, because each of them exemplifies a particular genre of fund. Energy Fund is one of the very few no-loads that are also special-purpose funds. The most attractive thing about special funds is that they are very easy for salesmen to sell. A fund designed especially for doctors is presumably easily sold to doctors. And the salesmen of a fund pledged to specialize in oceanography, for instance, can capitalize on the glamor and the prospective riches of an industry that is just beginning to surface. But while these funds are easy to sell (that's why almost all of them are load funds--they're a sort of salesman's delight), they are hell to run, as any portfolio manager will attest. Imagine the frustration of supervising a fund pledged (as an improbable example) to full investment in the fried-chicken business, and suddenly discovering a genuinely promising company buried somewhere in the computer industry, an industry from which you are excluded by charter. The logic here should be clear: Unless the investor has some unique insight into the future of oceanography or fried chicken, he shouldn't be committing his money to a portfolio that is largely restricted to either. Generally speaking, the more latitude a fund has, the better off its investors are. When the time comes to get into the ocean or the frying vats, your fund will be free to do so; and when both businesses begin to go dry, your fund will be free to get out. On the other hand, to the extent an investor has a genuine insight into some particular industry, he would be well advised to buy individual stocks that he knows about.

Hubshman Fund is a "hedge" fund. Hedge funds, as a rule, are private investment pools in which wealthy investors combine their cash and entrust it to a hotshot manager, who can then play tricks with it. Because hedge funds are private, limited partnerships, they don't have to follow the SEC rules. Their name comes from their habit of hedging their investment position: At any given time, a hedge fund not only will own stocks but it will have sold other stocks short. Without getting into the intricacies of short selling, this means, for the hedge fund, that it can make a profit not only when stocks go up but (assuming it has chosen the right losers) when they go down as well. Keeping a continuing portfolio of both long and short positions has been a key to successful speculation in commodities for generations, but the technique has only recently come to the stock market. In fact, the hedge fund is the invention of one man, Alfred Winslow Jones, who is now approaching 70 but is still quite active--and quite wealthy. One of the most interesting things about private hedge funds--at least for those who run them--is that the manager generally gets 20 percent of the profits. A hedge fund that Jones runs has supposedly gained over 1000 percent in the past ten years; even considering the management fee, this would make it more successful than any publicly available mutual fund.

Because of performances like this, the hedge-fund idea has spread rapidly in the past few years. Hedge funds are private operations, so no one really knows how many there are; most likely there are hundreds, and they probably account for 15 billion dollars in investment capital--five or six times more than just three years ago. Rumor has it that there are more under-30 millionaires running hedge funds than there are in the entertainment industry. Given all this action, it's not surprising that a few resourceful souls would try to translate the hedge-fund idea to a mutual fund. Hubshman Fund is the first and--at least temporarily--the only one that's also a no-load. It was followed by the Heritage Fund, which had actually been around since 1951 but decided to transmogrify into a hedge fund two years ago; a third, Hedge Fund of America, appeared last year. The newer entries are both load funds, so the small investor will have to pay standard commissions to get into them. However, Hedge Fund of America lowers its commission bite to around eight percent for investments over $1000, and gives further breaks to investors who go in over $1600, over $3300 and so on. Hedge Fund of America has not been around long enough for meaningful statistics to pile up, but of the two that have, Heritage Fund--the load fund--has substantially outperformed Hubshman Fund, its erstwhile no-load cousin. According to Fundscope's figures, Hubshman gained 30.6 percent in 1967 and 5 percent in 1968, while Heritage was racking up gains of 58.7 percent and 17.9 percent. So, in this case, the load fund was the better buy, as its gains more than compensated for the initial commission cost. Parenthetically, an interesting fact about Heritage Fund is that its management is paid no annual fee whatever unless the fund outperforms Standard and Poor's broad stock index; this is the sort of meaningful incentive that more fund managements might emulate.

We noted earlier that the technical meaning of the phrase "mutual fund" excludes a whole genre of fundlike institutions that really shouldn't be excluded. These are the closed-end investment companies, oft-neglected elder brothers of the mutual funds. Like mutual funds, they are in the business of investing other people's money. Unlike mutual funds, they have a fixed number of shares outstanding and they neither issue new shares nor buy back old ones; that's why they're called closed-ends. The shares in these companies are traded on the various stock markets, just like stocks. Obviously, they don't have any salesmen: You buy them through your stockbroker, and pay normal stockbroker fees. These fees, unlike mutual-fund commissions, are extracted at both ends of a transaction (you pay to buy and then pay more to get out), but the commission cost of a closed-end fund is still considerably cheaper than the cost of a load fund. Moreover, because the market itself determines the price of closed-end shares, they sometimes sell at a discount from the actual value of the investments they own. Frequently, closed-end shares representing $25 in assets will be selling for $20. Such profits may be largely illusory, however, because when the time comes to sell, the discount may persist--or even be greater.

When the author first discussed these "discount" investment companies, in an article in these pages in March 1968 (Beating Inflation: A Playboy Primer), he listed half a dozen well-established closed-end funds then selling at substantial discounts from their net asset value. Alas, these discounts have now narrowed drastically and--in three cases--turned into premiums. When shares in these companies sell at a premium, it means that investors are willing to pay more for them than their assets are currently worth--presumably in anticipation of future profits. It also means that investors who purchased those shares a year ago now have hefty capital gains and should consider unloading. Since it's seldom wise to pay a premium for these shares (sooner or later, they'll all be selling at a discount again), they are not as attractive as they once were. Still, Barron's and The Wall Street Journal each Monday publish a table of closedend funds, giving the shares' market value, their actual asset value and the percentage difference. At this writing, a handful are selling at relatively small discounts, and the potential investor might do well to examine them. Three that have been in business since 1929 or earlier, that have assets over $100,000,000, that have more than doubled in value in the past decade and that are currently selling on the New York Stock Exchange at a discount are: Surveyor Fund (formerly General Public Service Corporation), Tri-Continental Corporation, and U.S. & Foreign Securities Corporation. But before buying the closed-end funds, it's a good idea to find out what's in their portfolios; perhaps they're selling at a discount because they're sitting on a bagful of pups. (A pup is the opposite of an emerging growth stock: It's an emerging dog.)

The most interesting of all the closed-end companies--and perhaps of all investment companies generally--are currently the dual-purpose funds. These are based on an idea that originated in Great Britain, and they might better be called two-for-one funds. The notion is simple: Some investors are interested solely in income and others solely in capital gains. The dual-purpose funds bring the two together and pool their money. When the investments from the pool begin to run up profits, the income investors get all the income and the capital-gains investors get all the capital gains. In a simplified example, say that Widow A, who has $1000 and wants all the income she can get from it, and Executive B, who also has $1000 and wants all the growth he can get, join forces. The result is $2000, which is duly invested and, in a year's time, has produced a not-unreasonable five percent in dividends and ten percent in capital gains. Five percent of $2000 is $100, and that would go to the widow, who finds she has received a ten percent return on her $1000 investment. The ten percent in capital gains amounts to $200, and that goes to the executive, who discovers he's blessed with a 20 percent return. Almost miraculously, both parties are making twice as much as they would if the fund hadn't brought them together.

The dual-purpose funds are obviously more complicated, but that's essentially how they work. Each fund has two classes of shares--income shares and capital shares. When the funds were started (seven are readily available and most of them began business two years ago), investors paid identical amounts for both classes of shares. But, as with other closed-end investment companies, their shares are traded on the stock exchanges. As noted, this means that you must pay stockbroker fees to buy them, and the whimsy of the market place determines the price. For some ultimately whimsical reason, the capital shares of six of the seven dual-purpose funds are currently selling at substantial discounts. Like their closed-end cousins, the dual-purpose capital shares are tabulated every Monday in the financial papers. Below is a recent (March 10) listing of all seven, showing the actual market price of each share, its net asset value and the percentage difference.

The discounts, as the table shows, range from 7.7 to 21.2 percent, with one fund--for no apparent reason--selling at a slight premium. In the case of the six discounted shares, the figures, as the saying goes, are only half the story. Remember, the capital shares account for only half the funds' assets, and the income shares take up the other half. But the capital shareholder gets all the gains from both. This means, in the case of Leverage Fund of Boston in the table on page 197, that while the net asset value of each capital share is $14.60, the capital shareholder also has another $14.60 working for him, because he gets all the capital gains from the related income share, which also is worth $14.60. In other words, on this particular day, the investor could actually buy all the future capital gains from $29.20 in professionally managed stock for the lordly sum of $11.50, plus broker fees. As an executive put it a few months ago in Barron's: "Owning dual-fund capital shares is just like operating on a 40 percent margin--without having to worry about margin calls from your broker."

It's difficult to explain why these discounts exist at all. Given the leverage factor, one would expect that premiums--even substantial premiums--are in order. Some observers--most of them associated with load funds--have claimed that the dual funds are ineptly managed, but this is a difficult claim to sustain. For one thing, the dual-fund managers are known quantities in the fund business (most of them have been successful running other funds); and, for another, the record simply doesn't bear this out. In terms of market value, the capital shares of the seven dual growth funds increased an average of 35 percent last year--substantially outperforming any other group of funds one cares to find; they did almost as well in terms of net asset value, increasing around 30 percent.

Yet all seven were selling at a discount from net asset value all last year, and six continue to do so as of this writing. A cynical explanation for this peculiar performance might be that the free market, supposedly the gathering place of informed buyers and sellers, is actually peopled by boobs. A more charitable explanation is that anyone who invests is relatively well off and therefore relatively conservative, and that it takes time for new intelligence to penetrate the conservative mentality. The dual funds are only two years old and, in fairness to the investing public, the discounts on their capital shares narrowed sharply during the month of February (the average dropped from 17.6 percent to 11.4 percent, and that's when that single premium first appeared). By the time this is read, the gap may have closed further. In Great Britain, most dual-fund capital shares now sell at a fairly large premium.

Equally interesting is the fact that discounts have persisted in U.S. dual-fund capital shares at a time when they are rapidly disappearing from the other closed-end investment companies. Logically, one would expect just the opposite. Ordinary closed-end companies enjoy none of the dual funds' glamorous two-for-one potential. Moreover, ordinary closed-end companies are set up to endure forever, so that their shareholders will always have to go to the market and find a buyer when they want out. The dual funds, however, have a builtin expiration date (between 1979 and 1985, depending on the fund), after which the income investors get their original money back (it ranges from $9.15 to $19.75 a share, depending on the fund)--and the capital shareholders get all the rest.

For younger investors, the expiration dates of the dual funds seem to coincide almost precisely with the distant day when they might most be needing the money. And even if those discounts persist for the next decade (assuredly, they won't), the dual-fund investor is guaranteed to get full asset value--whatever that might be--when the time comes. Of course, he can always get out beforehand, by selling his shares in the market place. Putnam Duofund--the one selling for a premium--trades over the counter, and the rest are listed on the New York Stock Exchange.

The six that are listed on the big board seem especially attractive, not only because of their discounts but because the N.Y.S.E. offers a "Monthly Investment Program" that allows small investors (or large ones, for that matter) to buy listed shares in fixed-dollar amounts. The transaction must be initiated through a broker, but after that, it's all done through the mails. The investor simply sends whatever amount he cares to whenever he feels like it, and the stock he's picked is bought for him at the opening price the day after his check is received. This program permits ownership of fractional shares (computed, as with funds, down to four decimal places), so that, as with funds, every penny he spends (less broker fees, of course) goes to work for him. In all stock transactions, the brokerage cost makes purchases of less than $200 or $300 uneconomical, though if the M.I.P. investor doesn't trust himself to accumulate that much, the program accepts lesser amounts, down to $40 a shot. The M.I.P. also allows automatic reinvestment of dividend or other income, though with the dual-fund capital shares there won't be any, since the income shareholders get all the dividends, and capital gains keep piling up to the credit of the capital shareholders until the fund is liquidated. (Incidentally, the M.I.P. technique can be used to purchase any closed-end investment company--or any stock--as long as it's listed on the big board.)

Before the investor rushes out to buy into the dual funds, however, he should be aware that their special make-up provides at least the possibility, in the event of a stock-market cataclysm, that the capital shares could become literally worthless, due to the funds' prior obligation to give the income investors their money back. The would-be investor should also scrutinize the funds' portfolios to make sure that the funds are investing in the sort of things he can live with. The dual funds are committed to paying their income shareholders minimal annual dividends; and to meet this obligation, some of them have relatively large amounts of money invested in income-producing stocks that must be called conservative. To the extent that these investments don't promise capital gains, the capital shareholders will suffer. Most of the funds have resolved their built-in schizophrenia by investing heavily in convertible bonds--a commendably clever solution, even though the bond market has been going to hell as interest rates break through record levels. The would-be investor should also know that management fees for all dual funds (except Hemisphere and Gemini) are extracted not from capital gains but from dividend income, which means, in essence, that the income shareholders are subsidizing the cost of management and the capital shareholders are getting a free ride; but it also means that management has an extra incentive to produce lots of income, which, once again, may not work in the best interests of the capital shareholder.

Both these problems should diminish with time. Once the dual funds have grown to a point where they can easily meet their income obligations, which are fixed, they can begin to cater to the dreams of their capital shareholders, which are probably limitless. These dreams might even approach fulfillment, because over the years, the double leverage effect--magnified even further for the investor who gets in at a discount--could conceivably accumulate into a minor avalanche of investment profits, which would redound exclusively to the benefit of the capital shareholders.

Of all the investment-company situations currently available, the deeply discounted dual-fund capital shares seem among the most promising. The younger investor, who's willing to accept both the possibility of total loss and the interim vagaries of market caprice, might profit handsomely from a well-placed investment--or investment program--in these two-for-one shares. Or he might do just as well (and incur less risk) in most of the other funds discussed: closed-end or open-end, no-load or even full-load. No matter which course the investor takes--assuming he chooses wisely and the market holds up--he'll find, in the near or distant future, that he has been well rewarded for his foresight.

Where to Learn more about Mutual Funds

Ordinary sources of investment information are generally deficient in their coverage of mutual funds. Both The Wall Street Journal and The New York Times (available at any wellstocked newsstand) occasionally run perceptive reports about funds. Barron's (available each Monday at the same newsstand) reports on funds irregularly, and four times a year ranks them and discusses what stocks they are buying and selling.

Forbes (published twice a month by Forbes, Inc., 60 Fifth Avenue, New York, New York 10011; subscription $8.50 annually) runs a regular column about funds and a complicated rating each August.

An otherwise dull magazine called Financial World (published weekly at 17 Battery Place, New York, New York 10004; $28 annually) features a regular column, by-lined by Edward Ryan, that discusses the fund business with perception and intelligence.

An expensive monthly magazine called Fundscope ($39 a year from Fundscope Inc., 1800 Avenue of the Stars, Los Angeles, California 90067) publishes more statistics about mutual funds than most investors would ever care to interpret.

The jazziest, most candid and most interesting of all the literature about mutual funds is a monthly magazine called The Institutional Investor; its editor is George J.W. Goodman, alias Adam Smith. Sad to say, this is a controlled-circulation periodical, for money managers only; but if your broker gets a copy, it's well worth borrowing.