Quarterly Letter BACK The economy continues to expand. A few months ago, some commentators complained that the expansion was unsustainable unless capital spending participated. Now we’re seeing capital spending beginning to pick up. The commentators now complain that the expansion is unsustainable unless employment picks up. Folks, I believe employment will pick up in due course. We’re seeing the normal pattern which the economy tracks as it recovers from recession. You can track this on your own. It’s hard to review radio and TV commentary, but it’s easy to review newspapers and magazines. Whatever source you use for print commentary, go to your local library and review a few issues from various times in 1991 – the recovery year from the prior recession. You’ll see that the current facts and the current commentary parallel those of 1991. This is the tenth time we’ve seen this same general pattern since 1945. Are there complicating factors? Of course there are; there always are. This time around, we think the rebound in the economy and in the markets has been delayed by the litany of bad news the American public endured from 9/11/01 through the Iraqi war. This litany includes the terrorist attacks, corporate malfeasance, snipers in D.C. and the Afghan and Iraqi wars. The economy is people — and people would have had to be comatose for these events not to have had an effect on their spending and on their investing. We believe that bad news (and good news) will now come at a more normal frequency, and the economy will continue to expand along the pattern that it has exhibited following the prior nine recessions. We do expect the stock and bond markets to remain quite volatile. —Ron Muhlenkamp Mutual Fund Expenses BACK The last few months I have read opinions on the mutual fund industry and how mutual fund shareholders have been misled and overcharged. The conclusion seems to be that if fees were lower, and there were more disclosure about those fees, then shareholder returns would be closer to what was available from investing in “the market.” And they are not just talking about the losses investors suffered from 2000-2002. They also talk about long-term investor performance being abysmal due to mutual fund costs. For example, from 1984 through 2002 the average mutual fund shareholder has earned average returns of just 2.7% per year, while the average fund has earned an average 9.3% per year, and the stock market has produced 12.2% per year.(1) I don’t agree that poor shareholder performance was due solely to fees. Other reasons the average investor earned 3% per year instead of 9% per year are because he insisted on buying at the top, and he insisted on switching in and out of his mutual funds half a dozen times in as many years. The whole debacle just makes me glad that Muhlenkamp & Company, Inc. isn’t in the mutual fund business. We are in the business of investing money for our clients and our shareholders, not in the business of marketing and selling mutual funds. (I define the mutual fund business as being in the business of marketing and selling mutual funds.) In fact, Dad started our company in 1978 so his investment expertise would not be subordinate to a sales agenda. The salesmen were telling him how to invest so the clients would be happy, as opposed to teaching the clients why his way of investing would make them money (which would make them happy). Some people think we are in the mutual fund business because we manage a mutual fund. Not so. The mutual fund is simply an efficient and cost effective way for people to hire us to invest their money. That is why we started it, and that is how we run it. That is why we only manage one mutual fund, and why it is a no–load fund with only one class of shares. If we are good at investing money for people, one fund is enough. If we aren’t good at investing money for people, one fund is too many. If we were in the mutual fund business we would have lots of funds, with lots of share classes, and we would have a broker-dealer license so we could sell lots of other mutual funds. We might also have insurance licenses so we could sell life insurance and annuities. But we don’t have any of those things. Shares of the Fund are available for sale but that benefits the existing shareholders. Selling more shares and having more money flowing into the Fund has helped performance the last few years by allowing us to buy more of what we want to own at low prices. Selling more shares has also reduced the potential capital gains exposure for existing shareholders. Selling more shares has spread the costs of the Fund over a broader base of shares, lowering the expense ratio the past few years. Everything we do is intended to benefit our existing clients, which is the mainstay of being in the business of investing other people’s money. (Click here for our article “How to Choose A Money Manager” for more thoughts on investing other people’s money.) However, since we do manage a Fund that is available to the public, we do receive some questions about the expenses. Our expense ratio, at 1.18%, is lower than the average equity mutual fund, but it is by no means the lowest expense ratio out there. In fact, last night at dinner my wife asked me why our expenses were higher than most of the other mutual funds on the Forbes Honor Roll (2), and she went on to ask for an explanation of what the expenses are for anyway. Which are all good questions. So…. There are numerous resources for learning the ins and outs of mutual fund expenses and expense ratios. Three of the best are listed at the end of this article. Each has a different perspective on the topic. I encourage you to read those articles to fill in any gaps you may find in the information I am about to share with you. By the time you go through all three you should have a good understanding of the basic concepts and the terminology. Once you have a handle on those basics, use them to review the prospectus and financial report on your favorite mutual fund. I will use the March 1, 2003 Prospectus and the June 30, 2003 Semi-Annual Report for the Muhlenkamp Fund, available on our web site. On page 5 of the Prospectus I learn that the Muhlenkamp Fund has no SHAREHOLDER FEES (sales charges or loads) that are deducted from my account, except an account maintenance fee if my account doesn’t meet established minimums. (I have to go to the IRA Disclosure Document to learn that there is also an IRA Account Maintenance fee deducted from my IRA account). The ANNUAL FUND OPERATING EXPENSES, which are deducted from Fund assets total 1.18% (the fact that these fees are deducted from Fund assets is important, and we will come back to that later.) Of that 1.18%, 1% pays management fees, and the remaining 0.18% pays for “custodian, transfer agency, and other customary fund expenses.” More detail on the Management Fee is given on page 6, where we learn that “The investment adviser for the Fund is Muhlenkamp & Co., Inc. The adviser receives a fee from the Fund equal to 1% per annum of the average daily market value of its net assets.” So the management fees are paid by the Fund to the investment adviser for portfolio management services. What about the remaining 0.18%, what exactly are “custodian, transfer agency, and other customary fund expenses”? For that, we have to go to the Statement of Operations on page 5 of the June 30, 2003 Semi-Annual Report. Under expenses is the whole list of what the Fund pays for, including the Investment advisory fees. These are typically what it takes to offer a mutual fund to the public. The regulators require a mutual fund have a transfer agent to keep track of each shareholder’s account, a custodian bank to hold the money, a fund accountant to keep track of the fund’s portfolio, lawyers to review the fund documents, printing and mailing prospectuses and statements, state registration fees, etc. There are costs to a mutual fund that are not covered in the expense ratio and not listed in the financial reports; costs of trading the stocks in the portfolio, costs of taxes from selling stocks at gains; opportunity costs of holding cash, etc. I call these costs “real–world costs” and they are not easy for the shareholder to find or track. A good portfolio manager can control them, can reduce them, but he probably cannot eliminate them. Imagine you are tracking a stock and decide you want to buy it. In the real world, you have to go through a broker and pay a commission to make the purchase. If a day later you decide to sell the stock, you have to pay a commission to the broker again. Plus, if you sell the stock at a gain, you won’t get to keep the whole gain, you will have a tax cost to pay. Then imagine you hold the proceeds in cash and watch the stock go even higher before you buy it for the second time. There is an opportunity cost in holding cash while the stock goes higher. We think that a good money manager can reduce the brokerage costs and commissions by limiting his trading, can eliminate the opportunity costs by staying invested, and can reduce the tax costs by increasing his holding period and paying long-term capital gains rates. (A good money manager cannot eliminate the tax costs; he can only reduce and postpone them.) So a mutual fund’s expenses consist of paying the portfolio manager, paying for services, and the real–world costs associated with the securities markets. All these expenses are paid from, or already built into, fund assets. So the returns to the shareholder are already net of all fees and expenses. Lowering these costs should improve returns and increase fund assets for the shareholders. But how to lower costs? We do try to reduce the 0.18% we pay for other expenses. But to lower the costs would require losing some services, and the costs for those services are a small part of the total, and the services are pretty useful (if not simply required by law) so any incremental benefits to cutting those costs would be marginal. In fact, shareholders often demand services like listing the share price in the newspapers, or having an 800 number to call. Currently, we are getting some requests to make account information available online. That would probably cost $50,000 to set up, and at least $36,000 a year to maintain, and the costs would be paid by the Fund and be added right to the expense ratio. So some shareholders want to spend more money and increase services, not reduce existing services. (By the way, regulations and disclosure add costs as well. So far, one of the effects of Sarbannes-Oxley on our Fund has been to increase expenses.) We could cut the 1% management fee, but do you really want a portfolio manager that works cheap? I have had some potential clients ask us to manage large private accounts for them, but wanted us to cut our management fee in half. We agreed to do that, as long as we only had to work half as hard, half as long, and earn half the investment returns. Somehow they weren’t interested in that. And think of what the management fee pays for in terms of investment performance, service and education. Our investment performance after-tax has outpaced the S&P 500 returns pre-tax.(3) We actively work to reduce the “real–world costs” of managing a portfolio (as evidenced by staying invested, with low turnover and small taxable distributions). We attend trade shows and seminars where we can meet our shareholders, answer their questions and share our expertise. And we employ a team of shareholder services people, in addition to the ones provided by the transfer agent call center, to provide a level of service beyond what you can get from someone that is servicing dozens of funds with dozens of managers. As one shareholder told me, he doesn’t care what the management fees are, since the Fund returns are net of all fees anyway (this is why the fees being paid from Fund assets is important). As long as our performance, service, and education efforts meet his needs, he isn’t worried about our fees. And frankly, if we didn’t meet his needs he wouldn’t worry about our fees either — because he would be gone. If our performance, service, and education were not satisfactory, we wouldn’t have him as a shareholder very long. So we could lower our costs by reducing our services, but shareholders seem to want most of what we provide. We could lower our costs by reducing the management fee, but most shareholders seem to think they are getting value from the manager in terms of performance, service and education. So given what we provide to our shareholders, we think our expenses are reasonable. — Anthony Muhlenkamp Reading List 2. “What Can Active Managers Learn from Index Funds?” by John Bogle, The Vanguard Group, www.vanguard.com/bogle_site/december042000.html. 3. “What You Need to Know About Mutual Funds,” by Kenneth Lefkowitz, Economic Education Bulletin published by American Institute for Economic Research, www.aier.org, $6.00. (Footnotes) 2 Heuslin, William, “The Honor Roll,” Forbes, September 15, 2003, page 162. 3 Click here to see the performance table and accompanying disclosure on the Fund's Home page.
Women and Finance BACK As a Shareholder Services Representative, I talk to people every day about their current accounts or the types of accounts they may be interested in opening. I also answer their questions about our investment objective, process, and performance. So often I hear from the lady of the house, “I don’t know anything about that, my husband takes care of all of the investments.” When I hang up I always feel bad about that, because the odds are that someday she will have to learn about money matters under catastrophic circumstances. In fact, that very same thing happened to me. At the age of 22, my mother died. Since she had been sick for a while, it did not come as a surprise. However, she had been in charge of most of the financial affairs of the family, including the administration of several apartment units. My father was grief stricken and not in the state of mind to attend to the family finances. The burden fell to my younger sister and me. Needless to say we got a crash course in how to handle financial affairs. Years later, when my father died, I was the executrix of his estate. As a result, during a period of grief I had to take care of the settlement of his affairs. Although I was familiar with his financial situation, I was not prepared for the requirements and procedures of administering an estate. I went to the library and learned everything I could regarding my responsibilities and what needed to be done. We never know when any life-changing event such as a divorce or the death of a spouse or parent will happen. However, it is less stressful if we are prepared to deal with the financial part of the situation. Women should take an active role in the financial and investment decisions of the family. The first step is to know what you have. Make a list of the locations (investment institutions, banks, safe deposit boxes and filing drawers) of the following items: • Accounts You will also need to know who the professionals are that handle your family’s affairs and decide if you feel comfortable with them. This would include your: • Lawyer Together, with your spouse, review your wills. If it has been awhile since they were drawn up, you may want to make revisions if circumstances in your lives have changed. An example would be if your children are grown up and no longer require a custodian and how you want any dispositions to them handled. In the case of a parent, you might want to have a discussion with them to determine what their wishes are. Who do they want to handle their affairs in the event of their death? Do they have a living will provision in the event of illness or accident? Next, go over any loan accounts including mortgages,
credit cards, etc. Learn what the terms are. What are the balances?
What is the plan for paying them off? Is there a decreasing term
life insurance policy to take care of the mortgage in the event
of the death of you or your husband? Last, learn what kind of accounts that you (yourself, husband, parents) have. Are they retirement accounts? If so what type: IRAs, 401(k)s, or pension? What other taxable accounts do you have? If you have any retirement accounts, make a point of learning about how they work. This can be done at the library or online. There are several past Muhlenkamp newsletters that can be very helpful in showing you how to maximize your retirement dollars. These newsletters are available on our web site. Next, learn what kind of investments are in any taxable accounts. Are they bonds, stocks, mutual funds and why were they chosen? Also, try to determine if any of them were intended for a particular purpose such as for the education of children or grandchildren. After you have done all of this, you may find that you are actually interested in learning more about economics and investing. One of the best places to start would be with Ron Muhlenkamp’s Reading List. In addition, we at Muhlenkamp try to educate our shareholders and prospects through our newsletter and seminars. On a broader scale, community colleges throughout the country offer courses on basic investing. Or perhaps, you would like a more hands–on approach. In that case, join one of the many investment clubs and learn from the other members. Gentlemen, if you love your wives, sisters, and daughters please encourage them to be prepared to handle your affairs in the event of your passing or illness. This would be true for your brothers, sons or anyone else you may appoint to administer your finances in such situations. In fact, I plan to make sure my son reads this. Then I am going to get my own house in order, because, like so many of us, I tend to put off doing such things until later. — Susen Friday
Announcements BACK Web Survey Drawing Winner
We would like to congratulate the winner of our on-line drawing: Milt Greenblatt of Midland Park, NJ Click here for other web site survey results. Welcome Aboard! Tammy joined Muhlenkamp & Company, Inc. in September 2003 as a full-time Equity Analyst. Ms. Neff’s responsibilities are primarily research oriented including: analyzing industry and company research reports; evaluating company financial statements and annual reports; interviewing and visiting company management and making investment recommendations for inclusion in the Muhlenkamp portfolio. Ms. Neff has 14 years of experience in the healthcare industry as a Psychiatric Nurse Clinician and Healthcare Administrator. Most recently, she served as Director of Operations for the University of Pittsburgh Department of Psychiatry Faculty Practice Plan. Tammy S. Neff received dual Bachelor of Science Degrees in Nursing and Psychology from Carlow College in 1989. She earned a Masters Degree in Business Administration from the University of Pittsburgh in 1994 and is pursuing the Chartered Financial Analyst (CFA) designation. 2003 Distributions Reminder: Minimum Balance Maintenance Fee Reminder: Annual IRA Maintenance Fee
Shareholder Requests Obtaining Account History U.S. Bancorp maintains, at all times, two complete years of transaction history readily available for reporting. You may request this information, at no charge, at any time. All historical account information older than
two years (as of date of request) must be gathered from the Research
Department at To request your account transaction history, contact the Research Department at: Muhlenkamp Fund
Appearances BACK San
Francisco Money Show, October 16-18, 2003 NAPFA
Northeast/Mid-Atlantic Conference, October 22-25, 2003 Annual
Winter Investment Seminar, December 4, 2003 Call (800) 860-3863 extension 4 for more information. Published July 2003.
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