From: SCOTT COOLEY [scott.cooley@morningstar.com] Sent: Tuesday, February 11, 2003 10:01 AM To: rule-comments@sec.gov Subject: File No. S7-51-02 I submit the following on behalf of Morningstar, Inc. The SEC has proposed requiring mutual funds to reveal their holdings once per quarter instead of semiannually as they currently do. We applaud the SEC for this shareholder-friendly initiative. We believe there are a few reasons timely portfolio disclosure strongly benefits fund shareholders. Sometimes updated portfolio information can be critical to investors' ability to understand their funds. Woe to the shareholder who, in early 2000, did not realize that after value manager George Vanderheiden retired, his successor made Fidelity Advisor Growth Opportunities into a growth-biased fund with a technology stake of 40%. Although Vanderheiden retired in January 2000, Fidelity didn't again release complete portfolio holdings for the fund until July of that year--well after the Nasdaq Composite (and the fund) had begun tumbling from its March 2000 highs. Similarly, early on in the bear market for growth stocks, some Janus managers were already getting more defensive, and investors, because they didn't have fresh portfolios to go on, were flying blind. Moreover, over the past few years investors who lacked the necessary information to closely monitor--and carefully rebalance--their portfolios may have been overexposed to growth issues in early 2000, when they peaked, and may currently have a higher allocation to value stocks than they had intended. It's also worth noting that some of the best evaluators of fund-management talent require timely portfolio disclosure. For example, Jeff Molitor, who heads up Vanguard's portfolio-review group, continuously monitors the holdings of the outside managers the firm hires as subadvisors. By examining individual holdings, as well as aggregate portfolio statistics, Molitor ensures that managers aren't straying from their stated investment objectives. Molitor's team does a fine job of monitoring funds' investment approaches and characteristics. Shouldn't the actual owners of the funds and their financial advisors have the right to obtain enough information to make intelligent investment decisions? (For the record, Vanguard supported the SEC's most recent portfolio disclosure proposal.) The Opponents' Position Of course, not everyone was as impressed with the SEC's decision as we were. The Investment Company Institute and other industry participants have in the past decried similar measures. It is worth recapping the ICI's previous arguments against more frequent portfolio disclosure, if only to explain why it is erroneous. The ICI contended that with timelier portfolio disclosure, investors could see trends in portfolio changes and then trade on that information. For example, if investors saw that Legg Mason Value's Bill Miller had added shares of JP Morgan Chase & Co. in the previous quarter, they might reasonably assume that he was still buying. Miller's purchases alone might drive up the price of the stock, and if investors also buy in--hoping to make a quick buck--they'd further drive up the price Miller would have to pay for additional shares. There are a number of problems with the ICI's logic. First off, fund firms and other investment managers have long had to file a form called 13-F that provides a comprehensive list of their firmwide holdings. Therefore, the ICI's implausible position is that it has prospered in the past while it revealed all of its holdings, but it would simply crumble if it provided quarterly disclosure of some of its holdings, that is, the stocks in any given mutual fund. Second, a number of successful firms already provide quarterly disclosure to their shareholders. For example, Oakmark and American Century, two terrific fund families, produce outstanding quarterly reports that include complete lists of portfolio holdings, as well as a discussion of recent changes to their funds. To undercut the ICI's argument about the harm that would come from quarterly portfolio disclosure, there's nothing quite as compelling as successful shops that are already (voluntarily) providing such information--and thriving. Third, portfolio managers collectively accounting for well more than 80% of domestic-equity assets already provide quarterly or monthly portfolios to Morningstar, which we make available to the public. These include large shops such as American Funds, Vanguard, American Century, and T. Rowe Price. Are they really engaging in behavior that's detrimental to their business? That seems unlikely. At Morningstar, we deeply appreciate the willingness of fund families to help us get timely information to our customers, but we believe shareholders should also be able to obtain that information directly from their funds. Fourth, portfolio disclosure is not instantaneous. The SEC would require only that funds disclose their portfolios with a two-month lag. (Many fund firms already provide disclosure to Morningstar with a lag of one month or less.) A two-month delay should give a manager plenty of time to build or exit a position. If a manager cannot establish or unwind a position in two months, one must question whether that stock is a suitable holding for the fund. We're glad that the SEC, which has so many issues to address, has focused on the important matter of portfolio disclosure. By making investing in funds more transparent, the SEC has improved the appeal and viability of mutual funds.