The mutual fund industry has staked its claim to the confidence of investors by establishing a tradition of plain dealing, honest accounting and overall trustworthiness. If there were sharks on Wall Street, they didn’t swim in the mutual fund sea.
That image changed early September, 2003 when the attorney general of New York State announced a $40 million settlement on insider trading charges involving a hedge fund and several mutual funds. Further revelations brought the impact of Wall Street’s recent reforms into question and cast the fund industry in a distinctly negative light.
The initial charges centered around the hedge fund Canary Capital Partners and Bank of America’s Nation Funds and Bank One’s Banc One Funds. Among the alleged improper activities is the charge of “back-dating” the Net Asset Value, or NAV, of shares for select customers at the expense of others.
The pricing of NAV is supposed to take place at the close of every session. An investor who can back-date his shares can take advantage of a news event after the close that will impact the NAV the next day. Buying a technology mutual fund after a big announcement by Intel or Microsoft at 4:15 p.m. means that the customer will benefit from the likely upward move the next morning.
There were other shenanigans, all of which is letting air out of the balloon of trust in the fund companies. Right now the New York AG is still investigating Bank of America and Bank One along with Strong Capital Management and Janus Capital Group, the Vanguard Group and Invesco funds. Illinois regulators are looking into the practices of Samaritan Asset Management Services. The financial regulator in Massachusetts is probing Prudential Securities and associated fund companies. The SEC has sent out letters requesting information to Merrill Lynch, Goldman Sachs and Fidelity Investments.
That covers a big chunk of the mutual fund industry. If you have money in a fund from one of those companies, this is not necessarily the time to bail out. But you should invest with your eyes open.
For ages we’ve questioned the priorities of mutual fund managers, and the whole brokerage business for that matter. Our question: Are they in it for you, the investor, or for themselves and the string-pullers in the boardroom?
Last year we ran a piece on a fund manager who was eased out of his position because he failed to put all of his cash to work in stocks and warned of the pitfalls of the industry’s standard “buy and hold” strategy during a bear market.
We drew three lessons from the story:
First, with a few exceptions mutual funds and the entire brokerage industry are devoted first and foremost to making money for the company. If the customer makes money, too, that’s fine. The buy and hold strategy is the prime reason why millions of investors have lost much of their retirement savings from 2000-2002.
Next, if you invest in mutual funds, you’re usually better off using index-tracking funds that simply follow the S&P 500, NASDAQ or DOW and are less likely to be manipulated by management.
Finally, take control of your financial destiny by setting up a model portfolio. Closely monitor it, and jump in and out of the market as the trends come and go.