Investors left with many questions

Knight Ridder News Service

Many of the nation's 95 million mutual fund investors are both confused and outraged to learn that some of the funds were cheating them.

A few fund shareholders have withdrawn their money; others are thinking about it; and still others are waiting to see if their fund companies are implicated in the scandal.

But experts caution investors against condemning the entire industry for the sins of a few.

The more prudent approach is to know how to spot a well-run mutual fund or, conversely, to quickly spot a fund that has gone astray. The following questions and answers should help investors gain more insight into the industry.

Q. Which mutual funds have been implicated in the scandal so far and what were they doing?

A. Bank of America Corp., Bank One Corp., Strong Capital Management Inc., Janus Capital Group Inc., Putnam Investments and Prudential Securities Inc. are some of the most prominent companies. Basically, regulators say they gave large investors a trading advantage over small investors by allowing what's known as late trading and market timing.

Q. If you have money invested in one of the mutual funds named in the current state and federal investigations, should you sell?

A. Let's look at the reasons for selling or holding on.

With Eliot Spitzer, New York's attorney general, William Galvin, Massachusetts' secretary of the commonwealth, the Securities and Exchange Commission, a couple of panels in the Senate and House and others conducting their own investigations into the issues, you might feel that the chances for future harm have decreased.

You might also stay put because of the uncertainty of where you might go. As the scandals unfold, you cannot be certain which mutual funds might be touched.

You might stay put because you haven't really looked at this in context of your own strategy.

Now, the case for selling. Primarily, you might decide that ethical lapses will not be corrected overnight. Your interests may continue to be hurt.

Going forward, those who hold on will be hurt if others exit the fund in large numbers.

That's because a wave of selling or redemptions will cause fund expenses to rise — and all shareholders pay those expenses. When there are fewer shareholders, each one pays a bigger share.

What's more, a fund manager without enough cash to make the redemptions will be forced to sell some of the fund's holdings. That could affect the manager's strategy and expected returns.

It could also hurt investors at tax time. If the fund sells stocks that have gained, those capital gains must be passed on to all shareholders. Every investor's tax bill would rise if the fund experienced a massive wave of redemptions.

Q. How can I tell if I've lost any money in the latest mutual fund scandals? If so, how much?

A. At this point it's hard to tell how individual long-term investors have been affected. In the case of the Putnam fund market timers, several analyses would need to take place. First, we'd need to know share prices of the funds if the market timers had never purchased the fund. Then we'd need to know the expected share price if the market timers had not sold the fund in a rapid-fire fashion.

Q. My 401(k) portfolio contains one of the funds. What should I do?

A. You don't have any tax consequences from selling or staying. But other issues — ethical concerns, alternatives — are the same.