Investigations into mutual fund misdeeds have multiplied since we addressed the issue in September. The funds we recommend have not been implicated nor do we expect that they will be. However, more than a dozen fund families that market conventional open-end mutual funds have now joined the list of alleged participants in improper trading practices.
Conventional open-end funds are vulnerable to a variety of nefarious trading practices by their managers. Some of these include:
• Market Timing—(not illegal per se) or in-and-out trading to make fast profits. This hurts the fund’s long-term investors, because the profits are earned on all of the fund’s assets, even though the in-and-outer’s stake is never invested. Managers who allow this may receive kickbacks from the market timers.
• Late Trading—is the same thing, except that the in-and-outer’s trades are made after the fund has been priced for the day. Late trading is illegal.
• Front Running—purchases for the manager’s own account in advance of purchases for the fund, which can push up the price of a stock.
• Scalping—purchasing a stock for the fund that the manager already owns.
• Cloning—maintaining a separate (and secret) brokerage account for managers engaged in the foregoing to avoid detection.
These work against investors’ interests and a variety of regulatory measures are being weighed to address the problem. We should note that the losses to investors from these practices are dwarfed by the excessive fees and expenses charged by many funds. The latter get by the regulators as long as they are “fully disclosed,” but this does not make them any less harmful to the investor.
It is this emphasis on “full disclosure,” rather than the costs and risks relative to alternative investments that led E.C. Harwood to identify the Securities and Exchange Commission as one of the “greatest swindles of all time.” In any event, the market itself offers a solution in the form of exchange traded funds (ETFs) such as those we recommend on page 88. ETFs are priced continuously throughout the day (rather than only at the market’s closing price)—their prices always reflect all currently available information. This means that ETFs do not offer the opportunity for timers to gain at the expense of longterm investors, not only because they are continuously priced, but also because a buyer’s invested dollars are not invested in underlying shares but instead flow directly to the seller of the ETF (for a full explanation of ETF mechanics, see the November 2001 INVESTMENT GUIDE). Trades in ETFs are subject to brokerage fees, but these are clearly evident to the investor. In addition to transparency, ETFs have other attractive features. Most ETFs eschew stock picking strategies in favor of tracking market indexes, and their expense ratios are typically below even those of conventional index mutual funds. All of our recommended asset classes are available through ETFs except for gold, and we expect gold ETFs to be introduced soon.
Also in This Issue:
Giving That Keeps On Giving
Medicare Bill – Dollars to Donuts
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
To access the full article, please login or subscribe below.
Already a Subscriber?
Log in now
Get full access to the Investment Guide Monthly.Print + Digital Subscription – $59/Year
Includes 12 Print and Digital Issues
Print + Digital Subscription – $108/2 Years
Includes 24 Print and Digital Issues
Digital Subscription – $49/Year
Includes 12 Issues
Digital Subscription – $98/2 Years
Includes 24 Issues