MARKETS
Time to bail on targeted mutual fund firms?
Morningstar recommends selling Strong, others, but some disagree
By KATHLEEN GALLAGHER [email protected], Journal Sentinel
Sunday, September 21, 2003
Some mutual fund investors aren’t waiting for any more news — they’ve decided to get out of the fund companies New York Attorney General Eliot Spitzer fingered.
Take William Randall of Sturgeon Bay.
Randall about a month ago signed on to Wisconsin’s Edvest program — whose assets are managed by Strong Capital Management Inc. — to save money for his son’s college education.
Shortly after that, Spitzer accused Strong and three other fund companies of allowing a New Jersey hedge fund, Canary Capital Partners LLC, to make short-term trades in exchange for fees and deposits in longer-term accounts.
The three other fund managers are: Bank of America Corp.’s Nations Funds, Banc One Corp. and Janus Capital Group.
Strong said Thursday it has hired outside professionals to conduct an internal review. It is the only one of the four fund managers, however, that hasn’t promised to repay shareholders if the review shows they lost money as a result of the hedge fund’s trades.
“Strong is spending too much money on internal reviews and lawyers, therefore returning less value to me as an investor,” Randall said. “I probably will never invest in Strong funds again.”
Randall isn’t the only one with a hard-line reaction.
A little more than a week ago, Morningstar Inc. made a significant and unprecedented recommendation: Sell all the funds that all four companies manage.
Sure, the Chicago-based mutual fund and stock analysis firm cautioned shareholders to consider things such as taxes and transaction costs before dumping the funds.
But not only did Morningstar unequivocally offer up an overall argument for selling, it provided a cogent discussion of each of the four companies written by an analyst who covers that fund complex.
Morningstar — hands down the leading voice for mutual fund analysis — has never before made a blanket sell recommendation on every fund that a fund family offers. In essence, Morningstar is saying these management companies are so untrustworthy, none of their funds can be trusted.
“We sifted through what was there in Spitzer, thought about what that said about the firms, thought about what else we knew about the firms and how they had acted for investors,” said Russel J. Kinnel, Morningstar’s head of equity research.
“And I think it’s hard to get past why you should invest with someone who put profits ahead of fund holders to the point where they appeared to have violated the prospectus.”
If the four fund companies allowed Canary to engage in late trading or market timing — Spitzer implicated Strong only in allowing market timing — they breached their prospectus to give someone else an advantage. So why would you trust them to make your interests a priority going forward, Kinnel asked.
“There are a lot of legal ways to nickel and dime shareholders,” he said.
If history is any guide, Morningstar’s sweeping sell recommendation may not cause huge outflows at the four fund complexes, said Carl Wittnebert, research director at TrimTabs.com Investment Research Inc. in Santa Rosa, Calif.
“Even in times of extreme volatility, the money tends to be sticky,” Wittnebert said.
And not all professional advisers are following Morningstar’s advice.
Roy L. Hauswirth, for example, is recommending clients stay in certain Strong short-term bond funds because they’re not related to the equity funds Spitzer questioned.
“I don’t think it is necessary to make a knee-jerk response,” said Hauswirth, chief executive officer of Innovative Investment Advisory Inc. in Brookfield.
Robert J. Bukowski says he thinks it’s important to determine whether the alleged activities are pervasive throughout the firm.
“If I like (Strong Opportunity Fund portfolio manager) Dick Weiss, and he’s beating his benchmarks, and he happens to work for the Strong organization, do I punish Dick Weiss?” asked Bukowski, senior consultant at Alpha Investment Consulting Group in Milwaukee.
“Should the portfolio manager who had nothing to do with it be punished? Should the employees who had nothing to do with it be punished and laid off because of something that happened in the mutual fund area?”
That may be the price they pay, says Roy Weitz, publisher of FundAlarm.com, an online newsletter that warns which mutual funds to sell.
Shareholders in the four companies’ funds shouldn’t worry that the companies will abscond with the money or go out of business, Weitz said. But they should worry about whether they’ve gotten “optimum performance and undivided attention” — and barring huge tax implications, he says he agrees with Morningstar in that fund shareholders should at least consider selling.
“Investors can’t bring criminal actions,” Weitz said. “All they can do is hurt these people in the way they know — and that’s their bottom line.”
Kathleen Gallagher covers the financial markets for the Journal Sentinel. She can be reached at (414) 223-5460 or [email protected].
WHAT SHOULD YOU DO?
Some of the reasons investors at the four fund companies New York Attorney General Eliot Spitzer targeted might want to consider selling shares or staying put.
REASONS TO SELL
You can probably find a fund that’s as good or better in the same category.
The companies at least breached the terms of what they promised in the prospectus — how can you trust them again?
If a lot of investors leave, the managers could be forced to sell, perhaps at unattractive prices, which hurts the shareholders who stay.
If a lot of investors leave, remaining shareholders will pay a higher expense ratio because the costs of running the fund will be spread over fewer shareholders.
Shareholders could bear the brunt of the costs of lawsuits that have been filed.
REASONS TO STAY
The damage is likely done and the companies will probably be on their best behavior going forward.
If you like particular managers at one of the firms, why blame them for what their company likely did without their knowledge?
Selling could create a tax situation you don’t want to have.
Spitzer says he’s got the goods on 26 more fund companies. If you move to another fund, it might be one of them.
Even in times of extreme market volatility, people tend to stick with mutual funds, so there may not be any of the fallout that could accompany a mass exodus.
Source: Alpha Investment Consulting Group; FundAlarm.com; Innovative Investment Advisory LLC; Morningstar Inc.; TrimTabs.com Investment Research Inc.
