Fool Portfolio Report
Thursday, November 14, 1996


by Tom Gardner (TomG@fool.com)

ALEXANDRIA, VA, November 14, 1996 -- The Motley Fool scampered past the competing indices today, rising 1.18% to bring year-to-date 1996 returns to 51.75%. Our nation is one where less than 5% of the citizenry is taught important "why nots" -- why not to let your local government pilfer you with its lottery and why not to let credit-card payments linger and why not to rely on brokerage firms to protect your best interests. In this sort of environment, the reality of 51.75% growth since January 1st means nothing to most.

The evidence is everywhere around us. Mutual funds are pounding advertising dollars into financial newspapers and magazines and television programs to get consumer "eyeballs" going into the Christmas season after an extraordinary two-year run for the stock market. They are also promoting themselves by actively compensating investment advisors (a.k.a. financial consultants, a.k.a. brokers) to push their products on ordinary people, like you and me. The higher that commission for the sale of The Deandelity Wiseman Fund, the harder the selling over telephones and in elegant offices.

What gets lost in fund-first or firm-first selling, rather than in customer-first business, is the accountability. Of what use are these products? Of what value? There are thousands upon thousands of mutual funds today, as many as there are stocks. As always, the managers of mutual funds are paid for attracting more money into their fund. By way of illustration, let me posit a scenario that I offered up a few months back.

Lord Charles Wentergrass is the fund manager of the Royal Honor Fund, based out of Boston, Massachusetts. Lord Wentergrass is managing $1 billion worth of funds, all of which he has invested in U.S. stocks. The Royal Honor Fund claims a 5% annual management fee, quite above the average, but Wentergrass is, after all, a Lord. It says so in the business magazines.

Decked in silk suit, ascot, and burnished shoes, set in a burgundy office, with all the sticks of great wealth surrounding him -- rosewood paneling, Belizean teakwood carvings, Louis XIV desk and credenza -- there stands Lord Wentergrass, glowing on the page. The Royal Honor Fund, the advertisement flaunts, has returned its shareholders:

1-year returns: 18.2%

3-year returns: 44.7%

5-year returns: 74.7%

What too many investors don't realize is that, making the thousands of Wentergrassian funds look dismal, the S&P 500 Index Fund, a no-brainer, has generated:

1-year returns: 24.1%

3-year returns: 63.1%

5-year returns: 105.6%

Ouch.

But with $1 billion under management, a 5% management fee, and Americans who don't entirely grasp investment performance figures, Wentergrass will generate fees of $50 million in 1996. He will be featured at the year-end round table of savvy investors. He has spoken at Harvard's Business School three out of the last four years. He was just positively profiled in the most prominent business newspaper in the world. They love the guy on financial television. He is distinguished and elegant. He chortles at the thought of individual Americans trying to manage their own money, and mocks the Internet as nothing more than a fad.

The majority of Royal Honor Fund shareholders have no idea that Wentergrass has markedly underperformed mere mediocrity in each of the last five years. Nor do these shareholders realize that Wentergrass and his one-man research team do not give two hoots about the S&P 500, or trying to beat it. Why not? They have a simple model in place on the Excel spreadsheet constructed last year by a whippersnapper in Royal Honor's marketing department. This is what it showed in layfolk terms:

Advertising outdoes performance.

When his mutual fund rises 10%, driving assets up from $1 billion to $1.1 billion, Lord Wentergrass earns an extra $5 million. He grew assets by $100 million, and his 5% fee generated an additional $5 million in profit, bringing the total up to $55 million. Let's suppose the market rose 15% in that year. Wentergrass would have driven assets up by $150 million and, from fees, taken home an extra $7.5 million, or $57.5 million total.

Those numbers aren't bad. Would you be unhappy with a $55-million check for underperforming the market by 33% in the year ahead? I imagine not and, had you actually just matched market growth in that year, by putting all of your assets into the S&P Index Fund, you'd have earned $57.5 million. Good Lord Wentergrass, not bad for being just average.

But let's assume that you're as ambitious as our Wentergrass, less honorable than the name of your fund, and that you think average performance deserves more than $57.5 million in annual payments. Market, market, market! Your whippersnapper's marketing model proves that if you aggressively buy up advertising space to promote your name, your image, and your elegance to the public, you can drive assets up from $1 billion to $2 billion over the next year. It's been a smashing year for stocks. People hunger to get their money into play. You will catch them everywhere with your glorious advertisements -- during the evening news, at halftime of the 49ers game, in Big Money magazine, everywhere, everywhere, everywhere.

At year's end, The Royal Honor Fund either has $1.15 billion under managment for toiling to tie the market's performance or it has $2 billion under management for spinning the nation toward its fund. With 5% management fees, here's the pay back to the honorable Lord Wentergrass:

Scenario 1: 15% investment returns, $1.15 billion assets, 5% fees, earnings of $57.5 million.

Scenario 2: 0% investment returns, heavy brand promotion, $2 billion assets, 5% fees, earnings of $100 million.

To my eye, Fools, 80% of all mutual funds lose to the S&P 500 each year because they don't much care about the S&P 500. Within their hallowed halls, performance is measured first in asset growth (read: good advertising) and second in investment returns. Lose to the market and market yourself well as a mutual fund, and you'll be in Montserrat before the next millenium. It is a brilliant short-term business plan.

Contrast all of that fluff with The Foolish Four Dow stocks. The group of four giants are up 29.76% this year. Take that number to the mutual fund pages in your newspaper. You will find that once again this year, as with so many of the past thirty, The Foolish Four Dow stocks have trounced those many-thousand well-marketed and growing mutual funds.

Upon the rock of truth and simple mathematics, we build our investment portfolio. Our aim has always been to outperform the Foolish Four Dow stocks. Performance in the slice of the business world that concentrates on long-term customer betterment, glee, and loyalty is defined in one word: service. I hope and trust that we will continue to serve you well here in the Hall of Portfolios. Investing is not the challenge that even we sometimes mistakenly present it to be. I hope the members of the press that consume information in this forum regularly will make it their mission toward the end of this year and in 1997 to use their platforms to educate people.

Daniel Boorstin, our former librarian of Congress, pleaded with the media three decades back to give up on celebrating controversy and corporation and short-term subscriber growth and to hone in on education, level debate, and long-term service. With this in mind, we hope that you will begin shedding light on Manhattan for the nation to see, that you will stick close to common-sense business principles, that education, merit, and simple mathematics will flow through all of your work. Tens of thousands of participants in this forum have been preaching these lessons to family members, colleagues and investment clubs. The mathematical truth is a perfect starting point.

Here is a comparison of the performance numbers for the S&P 500, the Foolish Four, and The Motley Fool Portfolio:

1996 S&P 500 + 19.47% Foolish Four + 29.76% Fool Portfolio + 51.75% 1995 S&P 500 + 34.11% Foolish Four + 37.80% Fool Portfolio + 68.17%

The numbers tell the story about our dismal state lottery systems, about the attack of credit-card companies on their customers, about the submediocre vehicle that is today's mutual fund, about the widespread underperformance provided by full-service brokerage firms, and about the S&P 500, the Foolish Four, and The Motley Fool Portfolio.

Let's start teaching what is.

CLOSING NOTES: America Online and ATC Communications signed a deal whereby ATCT will begin servicing the online company's incoming calls. ATC rose $1, to $17 3/4.

Tom Gardner, Fool

TODAY'S NUMBERS


Stock Change Bid ------------------- AOL +1 3/8 27.13 T - 1/4 37.63 ATCT +1 17.75 CHV + 3/4 66.00 GM + 1/2 55.63 IOM - 1/4 23.00 KLAC +1 1/4 30.63 LU +1 1/8 49.13 MMM +1 1/8 81.75 QDEK + 1/8 4.69 COMS + 5/8 71.88
Day Month Year History FOOL +1.18% 4.58% 51.75% 183.35% S&P 500 +0.65% 4.34% 19.47% 60.53% NASDAQ +0.77% 4.00% 20.74% 76.40% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 23.00 813.07% 8/5/94 680 AmOnline 7.27 27.13 272.96% 8/13/96 250 3Com Corp. 46.86 71.88 53.38% 9/27/96 -890 Quarterdec 7.08 4.69 33.83% 8/11/95 125 Chevron 50.28 66.00 31.25% 8/12/96 110 Minn M&M 65.68 81.75 24.47% 8/12/96 280 Gen'l Moto 51.97 55.63 7.03% 10/1/96 42 LucentTech 47.62 49.13 3.17% 8/12/96 130 AT&T 39.58 37.63 -4.93% 10/22/96 600 ATC Comm. 22.94 17.75 -22.61% 8/24/95 130 KLA Instrm 44.71 30.63 -31.51% Rec'd # Security In At Value Change 5/17/95 2010 Iomega Cor 5063.13 46230.00 $41166.87 8/5/94 680 AmOnline 4945.56 18445.00 $13499.44 8/13/96 250 3Com Corp. 11714.99 17968.75 $6253.76 9/27/96 -890 Quarterdec -6304.75 -4171.88 $2132.88 8/11/95 125 Chevron 6285.61 8250.00 $1964.39 8/12/96 110 Minn M&M 7224.44 8992.50 $1768.06 8/12/96 280 Gen'l Moto 14552.49 15575.00 $1022.51 10/1/96 42 LucentTech 1999.88 2063.25 $63.37 8/12/96 130 AT&T 5145.11 4891.25 -$253.86 8/24/95 130 KLA Instrm 5812.49 3981.25 -$1831.24 10/22/96 600 ATC Comm. 13761.50 10650.00 -$3111.50 CASH $8801.62 TOTAL $141676.75