Nov. 7–When your own money is being misused, you feel like you should do something about it.
That’s why, after building up a strong sense of outrage about financial misdeeds at Enron and WorldCom, investors are even more concerned about the recent mutual fund trading scandal. The people involved in the violations uncovered by New York Attorney General Eliot Spitzer aren’t just profiting at the expense of some giant corporate entity. They’re taking money, albeit small sums, out of other shareholders’ pockets.
Having grasped that fact, many investors are responding to the scandal with a single question: Should I sell?
Financial experts are divided on this issue. Morningstar, the leading mutual fund information service, says investors should “consider selling” funds from Bank One, Janus, Strong, Alger and Bank of America’s Nations Funds. It also says to hold off on new investments in Putnam or AllianceBernstein funds.
“At a minimum, you need to take a hard look at your investments with these companies,” said Kunal Kapoor, Morningstar’s associate director of fund analysis.
In making its recommendations, Morningstar says the funds have committed “an egregious breach of their fiduciary responsibilities.”
It says they need to fire anyone involved in questionable trading, offer restitution and improve protections for investors. The firm views Putnam and AllianceBernstein more favorably than the others, Kapoor said, because “they have cleaned house pretty quickly.” Putnam’s chief executive, Lawrence Lasser, became the highest-ranking casualty of the scandal when he was ousted this week.
Many clients of St. Louis-based Edward Jones have investments with Putnam, which is on the brokerage firm’s list of preferred fund providers. The firm took out newspaper ads Thursday in which John W. Bachmann, Edward Jones’ managing partner, outlined his views on how the Securities and Exchange Commission should clean up the mutual fund industry.
Alan Skrainka, Edward Jones’ chief market strategist, is advising people that it’s too early to bail out. Dozens of fund families have been subpoenaed by investigators, he noted.
“If you own Fund A that’s already in the newspapers, and you sell it and buy Fund B, that fund could be in the newspapers next week,” Skrainka said. “My advice is to go slow, wait a few weeks and see how it plays out.”
Mark Keller, chairman of the investment strategy committee at A.G. Edwards & Sons Inc., says investors could make a mistake if they act in anger. “There’s plenty to get angry about, but don’t make an investment decision when you’re in that state,” he advises.
Investors need to make sure they aren’t making moves that go against their long-term strategy, and they need to consider taxes and expenses. For example, you probably should continue participating in your employer’s 401(k) plan even if all the investment options are Janus or Nations funds.
You also might want to sit tight if selling would force you to pay an exit fee or a large capital gains tax.
If it’s any consolation, the people who engaged in improper trading probably only took a tiny amount of your money.
A variety of people, including mutual fund executives, brokers, hedge funds and even some retirement plan participants, have been accused of using rapid trading strategies that, in most cases, violated the funds’ internal rules.
For instance, a trader could buy an international stock fund on a day when the U.S. market had risen sharply, assuming that the fund’s overseas holdings would rise the next day. When that happened, the trader could sell and make a quick profit.
But the fund probably couldn’t invest the hot money in stocks immediately. The gains really belonged to the fund’s long-term investors, but they were hijacked by a short-term trader. Besides, the fund incurred costs in handling the trader’s buy and sell orders.
No one has yet come up with a definitive calculation of the amount that has been skimmed off in this way. The gains by individual traders are large: Richard Strong, chairman of Strong Capital Management, allegedly made $600,000 through short-term trading strategies.
But people like Strong were operating in an industry that manages $7 trillion of other people’s money. By some estimates, the scandal’s costs amount to just pennies per share for the ordinary investor.
This isn’t a case like Enron, Keller notes, where a scandal-ridden company’s value is headed toward zero. “There really isn’t any evidence that the viability or solvency of any of these investment vehicles has been questioned,” he said.
Still, Carl Enloe, a private money manager who is president of J.A.G. Advisors in Ladue, said that if he were advising a friend who had money in a fund affected by the scandal, “I would be likely to recommend that they move out of them. If there’s any smoke there, I would start to look around and see if I had better options.”
Columnist David Nicklaus: E-mail: [email protected]; Phone: 314-340-8213
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