A Fund with a Four-Corner Strategy


By Amey Stone In his 19-plus years in the mutual-fund business, Matt Sadler has seen companies try everything -- from launching very narrow sector funds to using several independent portfolio managers to run a single fund. "Some things fund companies did seemed brilliant, and others made me scratch my head," says Sadler.

He had plenty of opportunity to evaluate such moves: For about six years, his job was helping independent fund companies distribute their wares through the networks set up by Fidelity (where he worked from 1997 through 2000) and Charles Schwab (where he spent the 14 years before that, the last three running outside fund relations). He decided if he ever started his own fund company, he would rely on four key concepts: Stick to a single asset class, use multiple managers (a fund-of-funds approach), limit the number of stocks each manager can select, and build performance-based incentive compensation into the management fee.

Now, Sadler is putting that combination of approaches to work. He created a new no-load fund family, Quintara Funds, which debuted with a small-cap value fund on Mar. 1. The Quintara Small Cap Value Fund (no ticker) is made up of about 45 stocks -- 15 each from three top-performing portfolio managers who run small-cap value funds of their own.

STARTING LINEUP. The managers are: Warren Isabelle, whose ICM/Isabelle Small Cap Value Fund (IZZYX) has gained an average of 21% in the past three years but was up only 1% in the past 12 months. Curtis Jensen of Third Avenue Value (TASCX), which was up 11% in the past year and has been higher by an average of 15% in the last three years. And the relatively new team of James Benson and Clyde McGregor. They've been managing Oakmark Small Cap (OAKSX) together since mid-2000. They have a 20% gain in the past year, but the fund has only a 12% three-year annualized return.

The first Quintara fund will be followed with a Small-Cap Growth Fund. Then Sadler will introduce growth- and value-oriented mid-cap funds later in the year, to be followed by large-cap funds sometime in 2003. In each case, he'll monitor performance, shifting subadvisers only if a fund closes or a manager's portion of the fund underperforms the index for several years.

While none of the four defining concepts of the Quintara Funds are completely original, the one that stands to set it apart is the performance-based management fee. For now, the funds will start out with what's known as a "fulcrum" fee -- managers get paid extra for beating their benchmark. (Putnam and Fidelity already use this structure in several funds.) Quintara Small Cap Value's benchmark is the Russell 2000 Value index (up 13% in the past year and an average of 12% a year in the last three years). The management fee will vary between 1.4% and 1.75%.

BATTLING MANAGERS. If Sadler gets approval from the Securities & Exchange Commission, however, he plans to take the incentive-based plan one step further and have the mutual-fund managers compete against each other. In that format -- which would be a first for the industry -- part of the management fee would go to create a compensation pool. If the fund beats the index, the top-performing manager in the fund would take home 60%, the next would get 30%, and the last would get 10%.

If the fund doesn't beat the index, none of the managers would get a cut, and the pool would be held over until the following year. "Fund managers tend to be very competitive," says Sadler, who thinks this would give them even more incentive to outperform. He expects to hear from the SEC by this fall.

Morningstar's director of fund analysis, Russel Kinnel, says he likes the concept of the Quintara Funds, particularly using multiple managers to run concentrated portfolios. He says Ken Gregory, president of Litman/Gregory Asset Management, pioneered the idea with the Masters' Select Funds, which have been successful in the large-cap arena. Their main benefit is that investors get to spread their money across different management styles, without buying several funds and ending up with hundreds of underlying holdings.

END RUN? Kinnel thinks Sadler's biggest hurdle will be overcoming his high initial expense charges. Sadler capped the total expense ratio (which includes the management fee, administrative costs, and a marketing charge) at 2.25%, but each manager he selected already manages a no-load fund that's available for a lower fee. Investors could theoretically put $5,000 in each of the three separate funds and pay less than if they put $15,000 into the Quintara Fund, says Kinnel. "With that kind of handicap it will be tough for these funds to outperform an equivalent combination of three funds run by those managers," he says.

Ultimately, the fund's performance will dictate the interest of investors. Sadler is betting that starting off in the small-cap value category will help the fund stand out. "I think the small-cap arena has more room for great stock-picking talent and was the best chance to start the company with funds that crush the index," he says.

Choosing three top managers, limiting them to their best picks, and giving them extra incentive to outperform their benchmark also sounds like a pretty good formula for beating the odds. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column


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