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Funds 'incubate' new ideas
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November 17, 1999: 9:53 a.m. ET
Some companies use funds unavailable to public to try out new investing themes
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - Vortex Contrarian Fund may tantalize you with its triple-digit returns this year while other value-oriented investments have been in the dog house.
But don't expect to see the fund company bragging about it, and don't bother trying to invest. It's not quite a mutual fund yet.
The fund, up 104.74 percent year to date through Oct. 31, is an "incubator fund" not available to the public. It's used by companies to try out new ideas and managers. And, if it's successful, the company will introduce it to mainstream investors.
"It's an inexpensive way to start out a fund," said John Reilly, a spokesman for MFS Mutual Funds, the sponsor of three Vortex funds. "It's a place to try new concepts."
MFS, a major name in mutual funds that is one of the oldest companies in the business, starts most of its mutual funds as incubators, Reilly said. The Vortex Contrarian Fund, Vortex All Cap Fund, and Vortex U.S. All Cap Fund are all available to MFS employees and trustees.
The Vortex All Cap Fund is up 95.32 percent year to date as of Oct. 31, while the Vortex U.S. All Cap Fund has earned a more earthly 29.38 percent in the same time. The funds, which debuted in May 1988, are extremely aggressive and can use short-selling as an investing strategy.
Incubator funds are a common way for fund companies to launch new products, said Reuben Brewer, manager of mutual fund research at Value Line Inc.
"You have to start somewhere," Brewer said.
But you'll never see the word "incubator" in any fund literature, and it's hard to get a handle on how many of them are testing the air on Wall Street.
The Investment Companies Institute, a Washington mutual fund trade group, doesn't track incubator funds because they aren't publicly available. But incubator funds periodically come onto the radar screen of the Securities and Exchange Commission over the advertisement of returns.
The SEC's concern is that the ads can raise unrealistic expectations about future returns, without making it clear that a mainstream fund wouldn't likely be able to duplicate an incubator fund's success rate, said Paul Roye, director of investment management at the commission.
Most recently, Van Kampen Investments and a former executive agreed to censures and fines totaling $125,000 stemming from claims about an incubator fund's performance.
The SEC said Van Kampen failed to disclose information about the impact of hot IPOs on its Growth Fund's 1996 results.
Van Kampen accepted the fine and censure without admitting or denying the findings.
"There is no allegation that the fund's performance was in any way manipulated," the company said at the time. Van Kampen declined comment for this story.
Still, the SEC believes fund companies need to be careful about what they put in ads, Roye said.
"When unusual circumstances drive performance, funds need to step back and see if they need to provide more disclosure," Roye said.
Another problem is that fund companies often will launch four or five incubator funds and introduce to the public the one that is the most successful, said Sheldon Jacob, editor of the newsletter No-Load Fund Investor. The losers will get quietly liquidated.
"Nobody ever wants to admit it," Jacob said about fund companies' use of incubators. "Investors should be aware of it."
Scott Cooley, an analyst at fund-tracker Morningstar in Chicago, said there is a possibility of abuse.
"It's certainly an issue we've been concerned about," Cooley said. "It's so easy for the process to be abused. There's nothing from stopping a fund company from launching 12 of these and seeing which one works."
Morningstar's policy is to not include any returns from the time before a fund is available to the public, Cooley said.
Cooley pointed out that market neutral funds debuted after producing strong gains as private funds. But the category has not performed well.
"There was a lot of talk about how these accounts had terrific returns," Cooley said. "But that doesn't mean anything when you move into the mutual fund world."
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