Chicken Little Growth Gets Cooked

Funds that stink are rarely worth a mention. But when a fund fails on every level -- lousy strategy, unproven management, high expenses, a spotty track record, poor board oversight and a cheesy name -- it certainly merits attention.

That's especially so when a state securities regulator claims that the fund's manager is guilty of more than bad judgment.

The fund in question, Chicken Little Growth, rocketed out of the starting gate with a 41% return in its first 12 months of existence. That performance earned it the top spot in our one-year ranking of large-company funds published in the October 2006 issue of Kiplinger's Personal Finance. (We initially contacted the fund's manager, Stephen Coleman, to make sure name of the fund wasn't a joke.)

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The reasoning behind the fund's ridiculous name was the first warning sign to investors. Coleman said he chose the name because he thinks most investors are chicken, and he wanted to create a fund for "people who were afraid of the market."

Get past the fund's confusing mandate and you find an incoherent and risky investment strategy. Coleman made concentrated bets. Chicken Little Growth typically held 20 to 25 stocks, and even that understates the degree of concentration.

Three stocks -- Apple (symbol APPL), Caterpillar (CAT) and Advanced Micro Devices (AMD) -- accounted for 56% of the fund's assets, which then stood at $600,000. Apple alone accounted for 35% of its assets.

Coleman only updated his picks once a year. But thanks to outsized bets that worked out, Chicken Little Growth sizzled upon venturing out of the coop. It returned 31% in September 2005, its first full month of operations. That astonishing gain more than compensated for the fund's whopping 3% expense ratio.

But after posting stellar one-year returns, which Coleman touted in press releases, the sky fell on Chicken Little Growth. On December 1, 2006, the fund filed documents with the Securities and Exchange Commission to say that its adviser -- Coleman's St. Louis-based Chicken Little Fund Group -- couldn't afford to pay all the expenses the fund had generated.

As a result, the fund's board of directors approved a one-time reduction of net asset value by 32 cents a share, or 2%, to cover the costs. On December 4, 2006, the adviser reimbursed the fund for all costs the firm was supposed to have covered in the first place and investors were made whole.

But soon thereafter Coleman's company warned once again that the fund might not be able to meet all of its expenses and, last January, after just 16 months of existence, Chicken Little's directors liquidated the fund.

But there's more to the story than just disastrous fund management. Missouri Commissioner of Securities Matt Kitzi claims that Coleman has made untrue statements, omitted material information and schemed to defraud investors in Chicken Little Growth.

Kitzi filed two enforcement orders against Coleman and his companies November 1. The first order accuses Coleman of fraud, and the second seeks to revoke his investment-adviser license as well as the licenses of his two companies, Daedalus Capital and Chicken Little Fund Group. Regulators also want Coleman to pay $200,000 in civil penalties and costs.

The majority of the money invested in Chicken Little Growth went to pay for Coleman's salary, a financial plan for him and his wife and a $100,000 personal tax lien, regulators say. According to the order, Coleman never told his clients that their money would be used for his personal expenses and failed to disclose to investors that two lawsuits had been filed against him for breach of contract.

Coleman has until December 1 to request a hearing to dispute the fraud charges and civil penalties. "We feel very good about our situation," Coleman says. He directed all questions about Chicken Little Growth to his lawyer and brother, Larry Coleman, who declined to comment further.

Regardless of Coleman's fate, Chicken Little Growth fund stands as sterling example of the type of fund all investors should avoid. Instead look for funds with reasonable costs and veteran managers who consistently generate benchmark-beating returns and employ a strategy you can understand. The Kiplinger 25 is a great place to start your search.