GUEST OPINION
A few bad apples taint mutual fund investing
By JOHN T. McCARTHY
Monday, December 1, 2003
Early in his tenure as chairman of the Securities and Exchange Commission, Arthur Levitt proclaimed that “in the fullness of time, the mutual fund will come to be regarded among the greatest financial innovations of the modern era.”
Now retired, Levitt was quoted recently in The New York Times as saying, “I believe this is the worst scandal we’ve seen in 50 years, and I can’t say I saw it coming.”
The former SEC chairman is right on both counts. Mutual funds by design brought democracy to the investment masses by offering affordability, convenience and liquidity to Main Street investors and retirement plan participants. By making an investment in a mutual fund, ordinary investors could gain access to professional money managers and entrust to them the difficult and perplexing buy- sell-hold decisions.
The greatest benefit of mutual fund investing is that investors achieve instant diversification. Contrast the fundamental investment principle of broad-based diversification inherent in mutual funds to reduce risk with the portfolio devastation of those investors who loaded up on such stocks as Enron, WorldCom and now-defunct dot- coms.
I was disturbed a few days ago to overhear a coffee shop discussion where it was offered and seconded that all mutual funds are run by crooks. This broad-brush approach tarnishes an entire industry that, until September, was considered squeaky clean.
Most troubling is that, if this becomes a pervasive attitude, it is likely to discourage investors from maintaining a disciplined approach to securing financial independence through mutual fund investments.
The now full-blown mutual fund scandal did not come as a surprise to John C. Bogle, retired founder and chairman of Vanguard Group and a vocal critic of his industry.
Bogle observed in a recent Wall Street Journal editorial that the mutual fund industry in its infancy had trustees and managers focused on the profession of investing.
“But today,” he wrote, “the fund industry is a colossus served largely by giant financial conglomerates focused on the business of marketing, and that simple early principle of stewardship has been subverted.”
Mutual fund marketing prowess has spawned Forbes 400-level wealth for a number of fund managers.
Over the years, industry executives were dismissive when Bogle spoke out against blatant conflicts of interest such as fund directors serving the two masters of fund management and fund shareholders, with shareholders getting the short end of the stick.
As I see it, Levitt and Bogle seem to agree that mutual funds, like apples, are healthy and good for you; but the bad apples that exist are spoiling the rest of the bushelbasket.
I suspect that the root cause of the scandal will be shown to be an unhealthy association with hedge funds. That these unregulated, exclusive and aggressive investment vehicles (hedge funds) have spoiled peoples’ investments (mutual funds) is a darn shame and should not be tolerated.
Mutual funds by design were never meant to be actively traded or timed. The end-of-the-day pricing is to facilitate the regular purchases or sales by long-term buy-and-hold investors. Hedge funds and speculators shouldn’t be allowed to fish in these waters.
The best solution to recover from the worst mutual fund scandal in 50 years is to put into place a series of reforms aimed at returning the mutual fund industry to its roots — that of serving the best interests of ordinary investors in the best possible way. In this way, investors will continue to invest with confidence.
John T. McCarthy is founder and president of McCarthy Grittinger Financial Group LLC, Milwaukee.
