By Greg Carlson For years, mutual-fund companies have been selling portfolios specifically for parents who want to build nest eggs for their children. These funds are designed so kids can later finance everything from education to retirement, as well as let them learn as they earn.
Though it's a novel idea, the recent performance of many of the funds geared toward children does not justify the extra costs or restrictive structures, according to a recent review by Standard & Poor's Fund Advisor. Indeed, Standard & Poor's found other ways for parents to accomplish the same financial goals.
Funds for children can be divided into two types: Those set up as irrevocable trusts for parents and others looking to give gifts, and funds that provide educational newsletters and other bells and whistles aimed at teaching youngsters about saving and investing.
The two available trust-structured funds, American Century Giftrust (TWGTX) and Royce Fund Trust & Giftshares (RGFAX), both require long lock-up periods. American Century's fund must be held for at least 18 years, while Royce mandates a minimum holding period of at least 10 years, or until the beneficiary reaches 18 or 21 (the age of majority depends on the state), whichever is longer. Many donors decide to establish trusts for far longer stretches. Says American Century spokesman Chris Doyle: "They're often set up with a 20-year to 40-year time frame. Some are even [designated for the child's] retirement."
A FOR ACHIEVEMENT. That kind of commitment requires a lot of faith, not just in the fund's current portfolio manager, but also the fund company. The typical fund manager is lucky to stay on the job for five years. Unfortunately, American Century Giftrust, which opened in 1983, hasn't justified that faith in recent years. The fund was fast out of the gate, gaining more than 20% per year in its first decade of operation, according to data from Standard & Poor's. Then money started pouring in. As its assets swelled to nearly $2 billion by 2000, performance suffered. Giftrust trailed more than three-quarters of its midcap growth peers in five out of the six years between 1996 and 2001. And for the 10-year period ended Jan. 31, the portfolio had an average annualized total return of 3.5%, vs. a total return of 9% for the S&P 500 index.
In fact, several investors successfully sued to break their trusts and get out of Giftrust early. In mid-2001, American Century brought in a less-aggressive management team and performance improved -- at least on a relative basis. Still, Giftrust has a long way to go to prove itself again.
The story is more encouraging for Royce's fund. Trust & Giftshares -- run by small-cap value veteran Charles Royce (who started his firm 30 years ago) -- beat its small-cap value peers in three of the past five years. For the five-year period ended Jan. 31, the portfolio had an average annualized total return of 12.3%, vs. 2.5% for all small-cap value funds and a 1.3% decline in the S&P 500.
Unlike American Century's fund, donors in the Royce fund can select one trust option that allows beneficiaries to withdraw funds for educational expenses. And size isn't a problem, since the fund has just $29 million in assets.
EXPENSIVE LESSONS. "It's really a niche product," says Cheryl Leban, Royce Funds' Giftshares specialist. Leban says she gives personalized service such as writing quarterly letters to donors and answering questions by phone and e-mail. Such service was a big help to shareholders in 2001, when Royce sold the company to Legg Mason. Leban quickly assured donors that there would be no changes in the fund, and that Royce and the firm's other portfolio managers had signed five-year contracts. Of course, it's not clear what will happen when 63-year-old Royce retires. Still, this is the more promising of the two trust-fund choices.
Parents more interested in teaching their children about investing than setting up a trust have a broader array of fund choices, though they're not necessarily better. The biggest of the bunch is the $663-million Liberty Young Investor Fund/Z (SRYIX). Shareholders get quarterly newsletters covering basic investing concepts and highlight the fund's holdings, which lean toward companies that kids can understand. In addition, the company has a Web site (younginvestor.com), and sponsors an annual essay contest in which the winners get shares of the fund. Stein Roe, which started the Young Investor fund before being acquired by Liberty, rolled out a cheaper version of the portfolio without the child-friendly materials.
Unfortunately, Young Investor's performance hasn't been as distinctive as the perks. The fund got off to a sizzling start in 1994, and investors rushed in. "That was hot money totally unrelated to the basic concept of the fund," says fund-industry consultant Burton Greenwald. Young Investor has struggled of late, failing to beat the S&P 500 in four of the last five years. For the five-year period ended Jan. 31, Liberty Young Investor Fund/Z's average annualized total return declined 4.4%, compared with a drop of 3.4% for all large-cap growth funds.
AND A TOY, TOO! Adding insult to injury, Liberty has raised the fund's expenses from 1.26% to 1.76% on the no-load Z shares (which are closed to new investors). The broker-sold A shares cost 1.67%, while the fund's peers charge an average of 1.55%. Liberty spokesperson Marilyn Morrison says the increase was necessary to defray the cost of servicing the fund's many small accounts, and acknowledges that portfolio managers David Brady and Erik Gustafson have their "work cut out."
Shareholders of USAA First Start Growth Fund (UFSGX), a fund with many of the same features as Young Investor, have had a rough ride, too. The portfolio is down an annualized 7% since the start of 1998, worse than 88% of its large-cap growth rivals.First Start's prospects are brighter, though, now that Tom Marsico -- who rang up a stellar ten-year record at Janus Funds and has since done the same at his own firm -- has taken the helm. The fund's expense ratio is 1.45%.
Given First Start's expenses, investors might want to check out another Marsico-run fund, USAA Mutual Fund: Aggressive Growth Fund (USAUX), as an alternative. Despite its billing as "aggressive growth," the portfolio is nearly identical to First Start's, and expenses are just 0.99%. Children won't get any newsletters or other perks with this fund. However, if Aggressive Growth and First Start each gain 10% per year for 10 years on a $10,000 investment, shareholders of the former will reap an additional $1,000.
Investors who start a custodial (UGMA/UTMA) or Education IRA account for their child with no-load Monetta Funds get a kid-friendly investing kit, as well as a bean-filled toy for every $500 put in. Even nonshareholders can take advantage of Monetta's Miles Program, in which kids earn prizes by playing educational games on its Web site (www.monetta.com).
BOTTOM OF THE CLASS. Unfortunately, it's tough to recommend any of Monetta's funds. All five stock portfolios trail more than three quarters of their rivals over the past five years, and the firm's bond fund has been subpar as well.
Clearly, every one of these funds has its snags in one way or another. But maybe a specialized fund isn't the best way for parents to invest for and educate their children, suggests Neale Godfrey, chairperson and founder of The Children's Financial Network, an advocacy group. Godfrey, who served as a consultant to Stein Roe and wrote some of the Young Investor fund's ancillary materials when it was launched, says she's "a proponent for getting kids involved in investing, not necessarily for the funds."
Industry consultant Greenwald is also cautious on these portfolios. He calls the Liberty and USAA funds "marketing gimmicks of limited value," and says the trust-structured funds are "inflexible." Greenwald suggests parents make "a modest investment in a good, diversified growth fund, then go over the shareholder reports with the child." Parents can also supplement this with one of Godfrey's best-selling books, such as Money Doesn't Grow On Trees. This will help both parents and children learn money skills -- and the ABCs of stocks and funds. Carlson is a freelance writer