March 1, 2004
Be careful, and dont take mutual fund reform to an irrational extreme.
....Apostrophes and other punctuation removed for some silly reason from text by web-page processor....
1 Mutual fund fees
Disclosure of fees is fine. Im certainly not against making the investment process more transparent. However, dont forget that without those fees, funds themselves wouldnt exist. Im concerned that Wall Streets latest witch hunt will lead investors to believe that they should choose funds on the basis of their expense ratios. While some fees may be excessive, recall that most fund investors arent shopping for gross returns - they are buying net returns. This is the penalty investors are bearing for a decade of reading Money Magazine, etc., and purchasing funds based on performance. I never concern myself with a funds fees. I dont buy fees. I buy net returns, lower volatility, relative performance, family fund choice, and perhaps reporting/service. If youre really trying to protect the public, then why dont you also mandate disclosure of alpha, beta, standard deviation, and bull/bear market performance? Arent these the qualitative measures that, when combined with net returns, are far more valuable when choosing a mutual fund? I dont expect such dramatic changes to occur, but I ask that you not attempt to commoditize an industry by making fees a primary factor in investors eyes. By the way, I do a fee-based business, and have no conflict of interest when purchasing funds for clients.
2 Late trading - This is obviously a loop-hole to close. No one should be able to trade after hours, unless everyone can.
3 Redemption fees to discourage market timing -- Morningstar did a study that showed that many of the funds that were embracing timers actually had net performance slightly better than the funds who didnt. In aggregate, it would appear that timing is not a problem. However, Im aware of the individual cases where timing clearly caused performance hits. Thus, I can understand the SECs desire for reform. My suggestion is to let funds decide their fate. Some funds obviously can manage their cash flows adequately. Others, must decide if redemption fees are their solution. Why? Morningstar recently reported in a study of the families that allowed timing, performance was not impaired generally, and in fact, was superior to many other funds. While Im sure there were cases where timing had a material impact on returns, can the SEC prove that timing even usually impairs returns? How is it that some funds returns were better than non-timed funds? I wont speculate, but I would ask that the SEC take the approach of forcing funds to clarify their positions on market time - so that buyers can decide if they want to buy the fund - and then the SEC can simply enforce whether funds have followed through on their investor promises. This approach has the benefit of letting the public decide the punishment a fund gets. Re-stated, if funds really are long-term impaired by timing, wont the negative effects appear in their net returns, and wont rational investors migrate to better performing funds? Alternately or in tandem, funds could simply put a limit on how much trading an investor could do. This could be stipulated as a round-trip maximum or a dollar-limit.
4 Recognize that driving timers out of mutual funds will cause a net outflow of assets from the fund industry. This will result in the increase of exchange-traded funds and closed-end funds, two competing industries that dont complain about timers. My personal timing systems trade roughly every year. Occaisionally however, they are wrong, and trades must be reversed. Still, these short duration trades are part of my average holding period. As you can tell, I am not an in-and-out trader with a one to two day holding period. I reject the idea that I could be penalized 2 percent of my assets every year or two. It seems that both the investing public and I would benefit from a more rational approach of assessing a penalty if it happens too frequently. Does a fund really deserve 2 percent of my assets due to an annual trading-system mistake?