Posted on: Sunday, September 21, 2003
Scandals hurt mutual funds' image
By Brooke A. Masters
Washington Post
The mutual fund industry has long held itself out as the one part of Wall Street that looks out for the little guy.
Buying individual stocks and bonds requires specialized knowledge and can be highly risky. Many brokers don't want to deal with small investors. But the mutual fund companies promised that their method of pooling small investors would help mom and pop put their toes in the market without risking their shirts.
And small investors believed them. Since 1980, the number of households with mutual fund shares has jumped from less than 5 million to more than 54 million.
But a series of revelations this summer has tarnished the image of the industry.
Most seriously, New York Attorney General Eliot Spitzer alleged earlier this month that at least four big mutual fund companies had cut deals that allowed some wealthy investors to profit improperly from quick trades at the expense of ordinary buy-and-hold investors. He and the Securities and Exchange Commission have asked for information from at least 80 other companies.
While holders of individual stocks can see clearly which parts of their portfolio are lagging, mutual fund investors have little or no opportunity to spot many of the problems that are sapping their returns.
So what's a small investor to do? Hedge funds and investment banks cater to people with big bucks. Banks and certificates of deposit aren't giving much in the way of interest. And the market's recent history would give pause to anyone trying to pick the next big stock.
The answer, say most finance experts, regulators and even industry critics, is to stick with mutual funds. That's because they have a record of cleaning up problems pretty quickly and remain almost the only way for someone without a lot of cash to diversify their holdings.
"Mutual funds are still far and away the best option," said Mercer Bullard, who quit the SEC to found Fund Democracy, a shareholder advocacy group. "Have they made some mistakes? Yes. But they are still head and shoulders over other financial products. And I'm one of their biggest critics."
So far investors are taking this long view, as well as focusing on the fact that the stock market has been heading up sharply this year. TrimTabs Investment Research, which tracks the flow of money into and out of mutual funds, estimates that $25 billion to $30 billion will move into equity funds this month, the highest monthly total in more than a year, said chief executive Charles Biderman.
But industry leaders and government investigators are also well aware that the markets can ill afford to alienate the small investors who are the funds' bread and butter.
"We are based on investor confidence. We aren't insured by the government. We are totally dependent on investor trust," said Matthew Fink, president of the Investment Company Institute, the main mutual fund trade group. "You have an industry that wants to stay as clean as possible."
He noted that the industry has been heavily regulated since Congress passed the Investment Company Act of 1940, to address self-dealing in the 1920s, and promised that the current problems are being taken seriously.
Regulators, too, say they plan to take rapid steps to identify and punish funds and brokers who have been selling out their small investors to win favor and fees from hedge funds and large investors.
"It's a hornet's nest, and it will be cleaned out," Spitzer said in an interview. "What should be troubling to investors is the (mutual fund firms') inability to say, 'No. That's contrary to the interests of the investors, and we shouldn't do it.' That mindset is enormously troubling, and it has got to change."
