The Mutual Fund Goat Rope?

Any mutual fund executive who made a deal to allow institutional investors to trade forward (also called late trading) mutual fund shares should be taken out and flogged. Oops. Did I say flogged? I meant that he should be prosecuted to the full extent of the law. Late trading is illegal. Period. And, indeed, heads have been rolling for that crime. For example, last month, a Fred Alger Management executive

Any mutual fund executive who made a deal to allow institutional investors to trade forward (also called late trading) mutual fund shares should be taken out and flogged. Oops. Did I say flogged? I meant that he should be prosecuted to the full extent of the law. Late trading is illegal. Period. And, indeed, heads have been rolling for that crime. For example, last month, a Fred Alger Management executive was fined and barred from the industry by the SEC for his role in market timing, or, more specifically in this case, for trying to obstruct an investigation into fund trading practices.

The SEC described Alger's ousted executive with putting “his own firm's bottom line ahead of the interest of the fund shareholders he was entrusted to protect.” That said, market timing is not illegal, per se. Indeed, one could argue that it's a form of arbitrage that any investor with talent would want to pursue. Alas, “It can cause disruption to the portfolio manager, especially if it's a smaller fund,” says one fund executive. Many fund families therefore actively pursue market timers, so as not to raise costs and dampen returns of long-term shareholders. As the executive puts it, “You simply can't allow traders to be screwing your shareholders.”

Amen to that. But one wonders how much has market timing actually hurt retail shareholders in returns? Another fund family executive likens the scandal to a “goat rope,” slang for an insignificant event (i.e. a goat is pretty easy to rope). That's letting the fund industry off too easily. However, except for emerging market funds, the damage seems, by most estimates, to be negligible to non-existent — non existent in the case of large-cap domestic funds, anyway (Stan Luxenberg, a veteran mutual fund reporter, explores the issue in an article on page 69.)

More harmful, says Sheldon Jacobs, editor of the newsletter The No-Load Fund Advisor, are such practices as: Brokers not giving load-fund clients proper price breaks for volume; brokerage houses flogging their own proprietary funds over better or more suitable third-party funds; high expense ratios; closed funds continuing to charge 12b-1 marketing fees (there were 197 of these at last count, Jacobs says); and excessive trading to generate soft dollars. In all, Jacobs cites in his October newsletter about a dozen industry practices that hurt retail shareholders far more than the market timing.

Please note that you, the financial advisor, have an actual responsibility to avoid the first two complaints. And you should be actively steering clients away from funds that are guilty of Jacobs' other complaints.

We thank you for your support. Drop us a line with your comments at: 249 W. 17th St., New York, N.Y. 10011-5300. Or email us at [email protected]. Publisher Rich Santos can be reached at [email protected].

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