Three new funds with unique investment approaches recently debuted, two of them last week. The Blue Large Cap Fund and the Blue Small Cap Fund, managed by Blue Investment Management of New York, screen for socially responsible characteristics as well as political leaning that aligns with the Democratic Party. (The blue name derives from the Democratic focus, versus the opposing red, representing Republican.)
Well-known KLD Research & Analytics of Boston will do the social screening for the funds, while the advisor will do the political screening, looking for companies that engage in business practices that are consistent with progressive values, such as respecting human rights and treating employees fairly, and that make corporate donations to Democratic candidates and political action committees whose policies are in line with the Democratic Party. In addition, the personal political contributions of each company's top three executives will be scrutinized to be sure their contributions are also true blue.
The funds themselves will be run as managed index funds, each tracking to a blue index the advisor created. The large-cap fund will track to a modified "blue" version of the S&P 500, with any "red chip" stocks that don't meet the social and political agenda excluded. The small-cap fund will track to a modified blue version of the Russell 2000.
Surprisingly, stock performance or other financial considerations won't ever be considered in evaluating whether or not to invest in a company.
The Blue funds are the brainchild of Daniel Adamson, founder and CEO of the advisor, and Joe Andrew, a former chairman of the Democratic National Committee who serves as the chairman of the funds' board of trustees. The two realized that although a myriad of socially responsible funds existed, there weren't any that evaluated companies' commitment to progressive values through their political contributions.
The funds also allow Adamson to challenge the conventional wisdom that big business thrives on Republican values. "There is a myth that Republicans are better at business and better for business," Adamson said. His firm's research shows that over the past five years ended June 2006, blue companies within the S&P 500 outperformed so-called "red chips" as well as the overall index.
All-Or-Nothing Fees
Some funds use a performance enhancer that increases or decreases a fund's management fee level depending on whether a fund's performance beats its benchmark.
The seven-month-old TFS Small Cap Fund, managed by TFS Capital of West Chester, Pa., and Richmond, Va., will be up against a self-imposed all-or-nothing management fee that goes into effect at the end of March 2007. At that time, the fund's manager will, literally, bet that it can beat the performance of its Russell 2000 benchmark, and if it doesn't, its management fee will be zero.
Of course, there's a juicy carrot being dangled if the fund's advisor is successful in besting the Russell 2000's returns. Built into this innovative "fulcrum" fee is the agreement that the advisor will pocket 50% of the over-performance. But that fee will be capped at 2.5% per annum.
Adding to the challenge is that, as with all mutual funds that track to an index, day-to-day, ordinary fund expenses will handicap the fund's over-performance efforts from the get-go. Moreover, if the fund does really well and caps out its management fee at 2.5%, that higher fee will add to the fund's overall expense ratio, making the performance hurdle that much higher to exceed.
Of course, it's pretty obvious that a fund that earns no advisory fee won't be a viable fund for very long. And that is exactly the way it should be, TFS Capital executives said.
"We believe in adding value, and we don't want to be in the business if we are not adding value," said Larry Eiben, one of the fund's portfolio managers.
The novel advisory fee concept was borne out of the hedge fund world where fee structures provide handsome rewards for great performance, Eiben added. The firm actually wanted to structure such a fulcrum fee for its flagship mutual fund, the TFS Market Neutral Fund, which focuses on the small-cap sector and debuted in September 2004. But for that fund, there was no perfectly matched benchmark for which to calculate the over- or under-performance, he said. So the executives tabled the concept.
For its first year, the TFS Small Cap Fund is charging an annual management fee of 1.25%. But come the end of March, the advisory fee clock will start ticking, and the fund's administrator will begin monthly comparisons of the fund's performance against its benchmark, Eiben added. The fee could adjust for the first time in the fund's 13th month of operation. If the fund fails to beat the benchmark, the advisor would then begin reimbursing the fund for the management fee accrued.
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