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Friday, July 09, 2004

What is Primecap Thinking?

Reported by Theresa Sim

Pasadena-based Primecap Management is taking a bold step. The institutional money manager and subadvisor to two Vanguard funds is trying its hand at the Forty Act game and readying a launch of three new funds branded under the Odyssey label.

The new funds will be called the Odyssey Growth Fund, the Odyssey Aggressive Growth Fund and the Odyssey Stock Fund, the firm disclosed in a July 1 SEC filing.

The filing, however, was noticeably devoid of information. Primecap, according to the filing, has not named a transfer agent, an independent auditor, or even a distributor.

Calls to senior Primecap executives went unreturned, although one Primecap employee said the company is not at liberty to discuss the new funds during the registration period, which she estimated could take up to 90 days.

Just how the institutional money manager plans on distributing the new funds remains a mystery.

According to the 2004 Directory of Registered Investment Advisors, the high-flying money manager has only 14 professional employees, including Chairman Howard Schow, President Theo Kolokotrones and Vice Chairman Mitchell Milias. The directory listing does not name a single sales or marketing contact within the firm. Milias is the executive who signed the filing.

A search of the filing does not reveal much, either. Officials do state that there will be no sales charges on purchases, but that investors "may purchase shares of a Fund through a securities dealer which has an agreement with the Fundsí distributor." There is no distributor identified in the filing. Investors can also purchase shares directly from the unnamed transfer agent, using a form available on the company's unnamed website.

A zero sales charge and no 12(b)-1 fees probably means that the funds will be distributed through supermarkets, hypothesizes Dan Wiener, editor of The Independent Adviser for Vanguard Investors newsletter. Direct distribution raises another problem -- the moms and pops of the world have not heard of Primecap.

What Primecap Stands to Gain
Vanguard's Primecap Fund
Net Assets $23,643,485
Subadvisory fees paid to Primecap $18,940
Percent Earned by Primecap 0.08%
Vanguard's Capital Opportunity Fund
Net Assets $7,308,906
Subadvisory fees paid to Primecap $7,763
Percent Earned by Primecap 0.11%
Primecap Proprietary Funds
Management Fee 0.60%
Multiple of Vanguard Primecap Fee 7.5
Multiple of Vanguard Cap. Opp. Fee 5.6
Source: Vanguard SEC filings, Primecap filing
Source: For the six months ended February 29, 2004
Although Primecap's managers and the company are well-known as institutional money managers, can the brand stand up to vaunted Vanguard in the mass market? And is that even the fledging fund firm's goal? If so, a first step might be creating a website. (The domain http://www.primecap-mgmt.com is registered to a Joan Yoshioka of Primecap, but the site is blank).

Wiener thinks Primecap's performance record will make branding easier for the firm. Wiener forecasts branding driven by their "tremendous track record" and predicted that the media would heavily cover the funds in the future.

Even if Primecap is able to build a retail brand recognized by direct investors, it may face a cultural challenge. Today, the investment advice operates as an institutional boutique that requires clients to bring $100 million just to get through the door (Vanguard is its largest client, but covers just two mandates).

While it may be able to outsource the nuts and bolts of shareholder services, learning to understand that market often requires a cultural shift that institutional boutiques often find difficult to make.

In this case "smaller" clients might well be an understatement -- the filing states that the minimum investment for the funds is $2,000.

Though no one is talking, Primecap may have a "third way" to solve the direct versus intermediary puzzle. It may be planning to offer the funds directly to its existing institutional clients for use in their defined contribution and 401(k) programs. Such a strategy would enable it to avoid having to learn the ropes of retail distribution while also reaching hundreds of thousands of individual investors. To enter that "instividual" market may only require Primecap to woo consultants such as Callan, Wilshire and Mercer -- a group it already knows well.

Primecap's decision to launch in-house funds certainly makes sense from a fee standpoint. Primecap earned roughly 8 basis points from managing Vanguard's Primecap Fund and 11 basis points for Vanguard's Capital Opportunity Fund for the six months ending in February. With its own funds it stands to make five to seven times that. Whether that will amount to more in total fees depends, of course, on Primecap's ability to gather assets.

For its part, Vanguard seems nonplussed by the filing. Expect the two firms to continue their relationship for the foreseeable future, Brian Mattes, a Vanguard spokesman told the MFWire. Primecap has managed the Primecap fund since 1984 and the Capital Opportunity Fund since 1989.

Vanguard was informed about Primecap's plans, said Mattes, although he would not comment on when the two firms discussed the matter.

The situation is not problematic for Vanguard for many reasons, said Mattes, citing Vanguard's relationships with other subadvisors with their own funds, such as Wellington Management and Turner Investment Partners.

Mattes also stated that Vanguard believes that another key difference is that Primecap's funds will be intermediary sold, a fact that seems to conflict with the information in the filing.

One certain difference between Vanguard's Primecap funds and Primecap's proprietary funds will be size. The Vanguard funds are already huge ($24.7 billion in assets for the Primecap Fund and $7.8 billion in assets in the Capital Opportunity Fund), while the Primecap funds will be start-ups, possibly leading to different investment choices, said Mattes.

The new Primecap funds' investment strategies are similar to the two Vanguard funds that Primecap subadvises, which were closed on March 4. While the Vanguard Primecap fund invests in domestic, large-cap growth stocks, the Capital Opportunity invests in domestic, mid-cap growth stocks.

Primecap's managers will invest in domestic small- and mid-cap growth stocks through its Odyssey Aggressive Growth Fund, domestic mid- and large-cap growth stocks through its Odyssey Growth Fund, and domestic growth stocks through its Odyssey Stock Fund.

Besides the most recent closure, Vanguard has closed the high-performance funds in the past -- turning off the tap on the Primecap Fund in 1995 and 1998 and the Capital Opportunity Fund in 2000. At that time, Vanguard simply stated that it "decided to close the two funds after consulting with the funds' investment advisor."

Vanguard closes funds on a fund-by-fund level, said Mattes, for reasons including unsustainable asset or cash flow levels, "investment gridlock," or a disproportionate amount of "wrong money" -- investors who are not in the fund for the long-term.

In the case of Vanguard's Primecap-managed funds, Mattes said that both firms agreed it was in the best interest of shareholders. That Primecap, within a few months, made the decision to launch its own funds investing in generally the same markets indicates that the subadvisor thought otherwise.

Stand by to see whether a top institutional manager can turn into a top mutual fund. 

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