In a 1995 mid-year report to shareholders, management at Coca-Cola Co. compared the company to a global mutual fund.
“The more uncertain the times, the more you hear the old saying, `Don’t put all your eggs in one basket,’ ” began the message from the late Coke chairman Roberto C. Goizueta. “Your company not only has an abundance of `eggs,’ but an abundance of `baskets.’ “
The point was that the company was a participant in more than 200 markets around the world, a geographic diversification that was designed to weather downturns in any individual region.
Underlying the message was something that was not said: Mutual funds were diversified, less risky than stocks, and so widely accepted that companies wanted to cloak themselves in the fund banner to appease nervous investors.
Now fast-forward to 2000.
In some investment circles, the mutual fund has become passe, derided as unable to beat market indices and for being frustrating from a tax standpoint by a growing number of investors who instead want to turn back to the individual stocks that the general public moved away from in the booming stock market of the late 1980s and early ’90s.
Among the most popular of those stocks today is Yahoo! Inc., and there is more than a little bit of irony that this popular stock, in the eyes of the Securities and Exchange Commission, might actually be a mutual fund.
You read that right.
It’s not a status Yahoo! wants, nor a comparison that any New Economy company would ever make in its shareholder communications, but the devil is in the details for Yahoo! and an untold number of New Economy stocks that act to some degree like funds.
What’s more, it provides a timely reminder of the differences between stocks and funds, a refresher that’s particularly worth looking at with the market having more ups and downs than a Slinky toy.
Here’s how the situation breaks down:
At first blush, Yahoo! has very little in common with a fund management firm such as Fidelity or Vanguard.
But the company has investments in other Internet companies that, in spite of the recent techno-market downturn, have grown to such a level that they represent at least three-quarters of Yahoo’s total assets. (The company’s $60 million investment in Yahoo! Japan, for example, is now worth about $10 billion.)
The Securities and Exchange Commission’s Investment Company Act of 1940, the defining legislation for the mutual fund business, specifies that an “investment company” (read “mutual fund” for non-lawyer types) is any firm with more than 40 percent of its assets tied up in non-controlling stakes of other companies.
In fact, Yahoo! has been living in the murky realm of these rules almost from the start. Since July 1998, the company has invested its cash positions in government securities rather than in for-profit stocks in an attempt to comply with the rules. (Fancy that, a high-flying Internet company investing its cash in staid government bonds. How Old Economy.)
None of the Internet stocks is shouting “Yahoo!” over this situation. It not only affects Yahoo!, but it has the potential to hit CMGI, Intel, Oracle and any number of other Web stocks that have spent time investing in other firms without buying control, or that have a significant amount of their worth tied up in intangible assets (like goodwill or intellectual property rights) that typically don’t show up on a balance sheet.
If regulated as a mutual fund rather than a stock, these companies face a whole new level of regulation. Say goodbye to stock options as compensation; say hello to greater shareholder say in who serves on the board of directors.
What’s more, mutual funds must pass along virtually all of the capital gains and dividends they earn in a year (which is why critics say they are tax-inefficient). The investing public would be amazed to see a dividend passed along by the high-flying tech stocks, but they’d get a doozy of a payout if any of these stocks were regulated as a fund.
Now that we have imagined the possibilities, forget about them.
It’s not going to happen.
Yahoo! raises some good points in asking for an exemption from the rules. Those include the fact that the SEC’s rule applies to assets listed on a balance sheet, which excludes the intangible assets that many Internet companies have. (Yahoo! also is a hands-on investor in Yahoo! Japan even if it does not own control.)
The bottom line is that situations like this have come up periodically over the years and always have been settled quietly with an exemption or some legal and accounting maneuvers.
The one thing folks at the SEC can agree on in this case is that they are surprised anyone has noticed, if only because plenty of companies have gotten around these rules in the past. What’s more, no one there seems to think Yahoo! (or any of the other suspects on this issue) will get snagged here, though they acknowledge that the scrutiny this case is getting could make for some rethinking of the rules going forward.
For investors, however, the bigger issue comes down to one of labeling, buying and strategizing.
Five years ago a major corporation felt the need to cloak itself in the mantle of a fund. Then the tables turned, and stock investing returned to vogue and no one wanted to buy a fund.
The truth, as with most things in investing, is that there is no right answer. People buying diversified stocks such as Coke, Yahoo!, Warren Buffett’s Berkshire Hathaway or almost any other conglomerate/investment firm certainly don’t think of their investment as if it were a mutual fund.
Conversely, the many people buying popular concentrated mutual funds that focus their holdings on 20 or fewer stocks aren’t thinking they are buying something that may resemble a conglomerate’s stock more than it does the typical diversified mutual fund.
People who believe you can invest only one way are almost certain to be wrong a great deal of the time. Most investors have room for, and can benefit from, both types of investments. The big key is that they understand what they are buying — and whether it delivers the ownership benefits associated with being either a stock or a mutual fund — rather than following popular thinking.
Says John Markese, president of the Chicago-based American Association of Individual Investors: “What this (Yahoo!) kind of situation shows is that people need to worry more about what they are buying and less about what they call it. What matters is that you have a plan in place to reach your goals, not whether someone else thinks you are doing this the `right way.’ “
