The recent sharper-than-average downturn in U.S. Global Investors’ gold shares fund highlights the volatile—and often undisclosed—strategy behind warrants, according to The Wall Street Journal. Because the fund has been the leader in its class for the past five years, many investors were surprised to see the fund affected more dramatically by its peers after the recent drop in commodities prices. What investors didn’t realize is that the reason for the bigger drop is because the fund held as much of 30% of its assets in warrants. Uncommon among mutual funds, warrants are a type of option that allows the holder to buy shares at a set price in the future. They work well if the price of the security rises quickly, but are a bad bet if the price goes the other direction. The volume of warrants traded regularly is relatively low. In the case of U.S. Global Investors, the warrants, although a significant part of the portfolio’s strategy, were not listed in the fund’s prospectus or described in shareholder reports. U.S. Global Investors representatives said the fund “has never attempted to obscure these holdings and believes it has been fully transparent of its holdings as required under the relevant disclosure laws.” The San Antonio-based company said it includes warrants in the catchall “equity securities” category, which, according to the prospectus, comprise about 80% of assets. While this disclosure may adhere to the letter of the law, some suggest it violated the spirit, giving investors an inaccurate depiction of the risk the find undertakes. “The general rule the SEC follows is that anything that’s going to involve 5% or more of fund assets is considered material,” said Julie Allecta, an attorney who focuses on mutual funds for Paul, Hastings, Janofsky & Walker in San Francisco. When returns are either positive or negative, regulators often ask funds to explain the performance drivers in shareholder reports. U.S. Global Investors maintains that the annual reports “discussed the factors that materially affected the Fund’s performance.” Warrants’ low trading volume can be tricky for portfolio managers. If faced with a big withdrawal, and sudden demand for cash, managers might be forced to sell assets they might not otherwise. U.S. Global Investors Chief Investment Officer and Chief Executive Frank Holmes bristled that the warrants exposed investors to greater risk, and said, instead, they help manage risk associated in investing in mining companies. “We’re very sophisticated investors,” he said. Since Aug. 03, the U.S. Global Investors Gold Shares Fund has lost 12.3%. The average gold fund dropped 9%, according to Morningstar data. Despite the SEC’s requirement that the “investment strategies and risks” section of a fund’s prospectus delineate “principal investment strategies,” that section of the Gold Shares prospectus includes no mention of warrants. That is left to a separate filing: the statement of additional information, in a section called “other rights to acquire securities.” In the annual report, the funds’ warrants in Goldcorp, a Canadian mining company, is a footnote to management’s discussion. “This security comprised 23.56% of the total net assets of the Gold Shares Fund as of June 30, 2006,” it said. The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.

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