Just because a mutual fund company has been implicated in the rapidly expanding trading probe doesn’t mean its funds are laggards.
The performance of scandal-tainted mutual funds last year was all across the board. Even within many of the fund families accused of wrongdoing, performance often varied considerably. In the few cases where fund companies accused of trading irregularities managed a group of underperformers, investors tended to act decisively, taking their money elsewhere.
Eight of the scandal-tainted fund firms — Putnam, Strong, Bank One, Bank of America, Janus, Alger, Alliance and PBHG — saw a net $78.5 billion in assets withdrawn through Nov. 30, according to Lipper. Janus and Putnam bore the brunt of the outflows.
”Janus and Putnam had the worst bear market performance and for those firms, the mutual fund investigation was the last straw,” says Russ Kinnel, chief analyst at fund researcher Morningstar.
Putnam’s popular Growth & Income fund ended the year ranked 218 out of 385 funds in its peer group, according to fund tracker Lipper. And the widely held Janus Worldwide fund ended the year ranked 301 out of 328 funds.
The mutual fund scandal ignited in early September when New York Attorney General Eliot Spitzer settled charges with hedge fund Canary Capital Partners that it engaged in illegal trading practices with Janus Capital, Strong Financial, Bank of America’s Nations funds and Bank One’s One Group funds.
Since then, the probe has expanded to include Putnam, Invesco, PBHG, Strong, Alliance, MFS, Alger, Franklin Templeton, Federated and Heartland. It centers on market timing and late-trading irregularities.
Market timing involves frequent trading, often in international funds, to exploit ”stale” prices due to time differences. It is legal but might violate fund rules. It can give market timers a profit at the expense of long-term shareholders. Late trading is the illegal practice of buying and selling funds after the 4 p.m. ET market close but getting the 4 p.m. price.
When a highflying fund is managed by a firm implicated in trading irregularities, investors are faced with a dilemma. ”If you’ve owned a fund for many years that’s accused of wrongdoing, you may not be very comfortable with it any longer,” says Don Cassidy, senior research analyst at Lipper. ”But how much are you willing to pay in taxes to move to another fund?”
You don’t have that concern if a fund is held in a tax-deferred retirement account. But investors generally have a tremendous amount of inertia when it comes to selling, Cassidy says. ”That has helped to stabilize the fund flows for companies on the bad list.”
There’s a danger to hanging on to a fund when others start to flee: The defections can lead to higher fees and commissions, force the fund to sell holdings to meet redemptions and drive up tax liabilities.
Morningstar has advised investors to consider selling holdings in funds from Alger, Alliance, Invesco, Janus, One Group, PBHG, Strong, and Nations Funds, though it still endorses its sister funds run by Marsico Capital Management. It also suggests holding off on new investments in Putnam and Federated funds.
Market timing may not seem like a big deal, but it can say a lot about a firm, Kinnel says. ”The ethical firms have a willingness to do the right thing for investors, and that tends to lead to better results.”
