Troubled Pilgrim Nearing the End of Its Road
Longtime investors might remember a group of income-oriented mutual funds that enjoyed a flash of popularity during the early 1980s before a tax law change and market conditions went against them.
These were the old “adjustable-rate preferred” funds, which held special preferred stocks that readjusted dividends quarterly in response to changing interest rates.
Later this month, a chapter will close on the history of this troubled fund category when the remaining shareholders in what was once the largest such portfolio, the old Pilgrim Adjustable Rate Fund, vote on a proposal to merge it into the Leper-Istel Fund of New York.
But rather than fade away quietly, the Pilgrim fund--which has changed names, portfolio managers and investment objectives--has been dogged by controversy.
Recently, its former president raised allegations that shareholder assets were inappropriately used several years ago to pay consultant’s fees that were the obligation of Pilgrim’s management.
Earlier this year, that charge gained some credence when the Los Angeles-based Pilgrim Group, at the urging of the fund’s board of directors, agreed to reimburse $205,000 to the fund, including $105,000 in consultant fees. Pilgrim’s distribution arm made the payment in May.
The story began in March, 1983, when Pilgrim launched the Adjustable Rate Fund. It was and remains targeted to corporate investors, who in the mid-1980s could exclude from taxes up to 85% of the dividend income they received from other corporations.
On the heels of three years of respectable performance, the fund had ballooned to nearly $1 billion in assets by the spring of 1986.
But Congress subsequently reduced the dividend exclusion tax break to 70%, which lessened the appeal of dividend income for corporations. In addition, many of the companies that issued preferred stock got into financial trouble, a problem exacerbated by the decline of Drexel Burnham Lambert as a market maker for their shares.
Pilgrim certainly wasn’t alone in this regard. Several other fund families also had adjustable-rate preferred funds that foundered.
The Pilgrim fund started losing investors and money. It slumped 21% in value over the four years from 1987 through 1990. In 1988, Pilgrim Adjustable Rate switched its name to Pilgrim Corporate Investors. Its focus shifted to a diverse mix of preferred stocks.
In 1991, the fund again changed its name and niche--this time to Pilgrim Corporate Utilities, with an emphasis on utility shares. The fund had modest up years in 1991 and 1992, but the write-down of a lingering preferred-stock investment in Westfed Holdings resulted in a 17.7% loss in 1993.
This year hasn’t been much better, with the fund off 5% through April. Its assets have since dwindled to about $6 million.
Even while it was shrinking fast in the late 1980s, the fund continued to make payments to Alan Snyder, a marketing consultant. From 1985 through 1989, the fund paid a total of about $800,000 to Snyder using money generated from shareholders by its marketing fee, says Robert A. Grunburg, president of the fund from December, 1986, to July, 1993.
Pilgrim officials credit Snyder with devising a campaign that boosted the fund’s assets so much in the first place, but Grunburg says all of the consulting fees were the Pilgrim Group’s obligation, not that of the fund or its shareholders.
Snyder, now chief executive of Aurora National Life Assurance Co. in Los Angeles, did not return phone calls.
According to Theodore J. Cohen, Pilgrim’s senior vice president and general counsel, the fund’s board of directors has concluded that “there had been no misconduct or impropriety by any party” in connection with the consulting agreement.
In addition, the board “affirmed that the fund derived substantial benefit from the consulting agreement and that the compensation paid pursuant thereto was fair and reasonable,” Cohen added.
A Pilgrim spokesman labels Grunburg as a disgruntled former employee who is in litigation with the company.
Nevertheless, “it was our determination that there were some inappropriate charges,” said Eliot Karasick, a former independent director of the fund.
Why was only $105,000 in consulting fees reimbursed?
“The fund got the best deal we felt we could get,” said Karasick, who with another independent director resigned in March. Negotiations between Pilgrim’s board and management on the issue took more than six months, he said.
The remaining $100,000 of the $205,000 reimbursement payment consisted of $30,000 to correct an accounting error that “shouldn’t have been charged (to shareholders) in the first place,” said Karasick, along with $70,000 that had been allocated to the fund to investigate the matter. Another $70,000 in investigation costs were not reimbursed to the fund.
Of note, officials in the Securities and Exchange Commission’s Los Angeles office questioned the consulting payments as early as 1989, more than four years before the fund’s directors and Pilgrim’s management deemed that a reimbursement was justified, but regulators took no action.
In addition to the question of inappropriate consulting charges, there was no contract documenting Snyder’s payments and duties, says Grunburg. That would appear to be an oversight in the tightly regulated mutual fund business.
“Normally, if you don’t have records, the SEC holds that against you,” Grunburg said.
In recent weeks, the agency has apparently taken renewed interest in the case by questioning the fund’s directors. But in line with SEC policy, officials at the agency declined to comment on whether an investigation is in progress.
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New real estate mutual funds continue to arrive on the scene. One new entrant that might be worth a look is CGM Realty ((800) 345-4048; no-load; $2,500 minimum), which started selling shares in mid-May.
It’s managed by Kenneth Heebner, whose CGM Capital Development Fund had the second-best performance record of the past 10 and 15 years through March 31, 1994, and was No. 1 for five years, according to Lipper Analytical Services of Summit, N.J.
A Vanishing Fund Group
Back in 1986, about 16 mutual funds invested in adjustable-rate preferred stocks--securities that periodically changed their dividends to reflect market interest rates. All told, they once counted nearly $4 billion in assets. But hurt by a tax-law change and market conditions, the funds have virtually disappeared. Here’s what happened to some:
* Pilgrim Adjustable Rate changed its name and investment objective twice, most recently to Pilgrim Corporate Utilities, with an emphasis on utility stocks. Subject to shareholder approval, it will merge into the New York-based Leper-Istel Fund. Pilgrim Adjustable Rate had more than $900 million in assets at its peak.
* Putnam Corporate Cash ARP merged with another portfolio into Putnam Corporate Asset Trust, an income fund that now counts about $135 million. In 1986, Putnam Corporate Cash had about $600 million.
* Prudential-Bache Adjustable Preferred once had about $300 million in assets, but following a name change in 1988 it liquidated in 1989.
* Colonial Corporate Cash II had about $300 million in 1986. It was merged in 1990 into a fund that became the Colonial Utilities Fund, which today counts $1.3 billion in assets.
* Vanguard Qualified Dividend Portfolio III changed its name to Vanguard Adjustable Rate Preferred Stock Fund in 1987 but liquidated in 1991. In 1986, it had about $170 million in assets.
