Don't let crooks manage your money
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Get your money out now and invest where management isn't selling out its investors. Look for funds with financial independence and managers who are shareholders.
By Timothy Middleton
I’m happy to say I don’t own any mutual funds sponsored by companies implicated in the brazen trading scandal unearthed by Eliot Spitzer, New York's attorney general. If I did, I would sell them instantly.
Here's how much loyalty you owe a mutual fund: none. The industry is awash in high fees, managed like a celebrity golf tournament and overseen by the attention deficit disorder-afflicted Securities and Exchange Commission. Moreover, with so many funds to choose from, there’s no excuse to entrust your money to crooks.
David H. Diesslin, a financial adviser in Fort Worth, Texas, says he has several criteria when making investments, but the first one is, “I want to make sure the guy at the top is ... a solid individual.” If there are doubts on that score, “you don’t want to deal with it.”
Neither do I. “If a fund company is cutting deals, it’s obviously looking for an aggressive means to boost profits,” says Daniel Wiener, publisher of the Independent Adviser for Vanguard Investors newsletter. “It would certainly hurt my confidence in the company that they had to go out and play these games.”
A matter of trust
So if I owned funds sponsored by the families named in Spitzer’s complaint -- Janus Capital Group (JNS, news, msgs), Strong Financial's Strong Funds, Bank One's (ONE, news, msgs) One Group and Bank of America's (BAC, news, msgs) Nations Funds -- I would dump them. None offers a single portfolio that couldn’t be replaced with something just as good, or better.Money 2004.
Smarter, faster and easier
than ever.
And when I went shopping for replacement funds, I would place the reputation and financial independence of the fund family at the very top. This would immediately rule out funds run by banks, and it would rule in Vanguard Group and Fidelity Investments, both of which specifically have fought the abuses of which these others are accused. (Spitzer reportedly also subpoenaed trading records of many large mutual fund companies, including Vanguard and Invesco, but gave no indication they're suspected of improper trading.)
It would also rule in funds whose managers are my fellow shareholders. The principals of Davis Funds, Clipper, Longleaf Partners and Tweedy, Browne, among many others, have substantial assets in the funds they manage.
“When you get up to a stake like that, you know that salary and bonus aren’t going to come close” to coloring their judgment against shareholders, says Russ Kinnel, director of fund analysis for Morningstar.
The dirty details
Spitzer on Wednesday announced a settlement with a hedge fund, Canary Capital Partners, connected to Edward J. Stern, scion of the Hartz Mountain family. Canary agreed to pay a $10 million fine and $30 million in restitution in connection with two similar frauds known as late trading and a form of market timing.
Canary allegedly placed some so-called “sticky assets” with the four fund companies, from which they garnered fees, in exchange for violating prohibitions in securities laws, and often, guidelines spelled out in the funds’ own prospectuses.
Some of the companies, notably Bank of America’s Nations Funds, allowed Canary to buy fund shares as late as 6:30 p.m., and even 9 p.m. in one case, at the funds’ 4 p.m. closing net asset value. The hedge fund knew the exact holdings of the funds. So when it saw big jumps by any of those stocks in after-hours trading, it could buy at the 4 p.m. price, which hadn't factored in the stocks' increases. Then, the next day it could sell and pocket the gain, clipping risk-free profits from funds’ long-term shareholders.
In the market-timing instances, the funds allowed share purchases before changes were factored into the net asset value. For instance, for funds that trade in foreign securities, there can be a lag before market moves overseas are calculated into a fund's net asset value. So again, the hedge fund could jump in at a lower price and sell at a higher price.
In every instance, “the gains the hedge fund was earning came directly at the expense of long-term shareholders,” says Jason Greene, professor of finance at Georgia State University, who has studied the impact on fund performance of maneuvers such as these.
According to Spitzer’s complaint, the hedge fund delivered returns to its investors of 49.5% in 2000, 28.2% in 2001, and 15% in 2002.
Among the funds specifically cited in Spitzer’s complaint are Nations International Equity (NIIAX), One Group Diversified International (PGIEX), Janus Mercury (JAMRX) and Strong Advisor Mid Cap Growth (SMDCX).
All four companies said they were cooperating with Spitzer’s investigation. Janus said it had market-timing assets of as much as $750 million in 2002 and 2003 and would make restitution to shareholders for any economic harm. Bank of America also said that it will reimburse fund shareholders who lost money because of improper trading, Reuters reported.
'The biggest fraud'
“This is the biggest fraud in the fund industry since federal regulation began in 1940,” says Mercer Bullard, chief executive of Fund Democracy, a shareholder-advocacy group.
Bullard, a former Securities and Exchange Commission lawyer, penned a series of articles for TheStreet.com laying out the issues Spitzer acted on. “I wrote them specifically to get the SEC’s attention,” Bullard says.
On Thursday, one day after Spitzer's action, the SEC said it was sending letters to major mutual funds asking for information about trading in their shares.
While the regulators dig, you can and should act. Dump these fund companies in favor of those with clean records. While you’re at it, take a hard look at all your high-expense funds from companies that are beholden to Wall Street’s quarterly earnings estimates, which includes virtually any fund sponsored by a bank, insurance company or brokerage firm.
The two most outstanding candidates for fresh investments are Vanguard and Fidelity. Both firms have explicitly banned the kind of market timing to which Canary hasn't admitted, in the curious legal dance securities lawyers perform, but has agreed to make restitution for. Both fund families have also acted aggressively against late trading.
Another giant fund company immune to stock-market pressure is American Funds, whose sponsor, Capital Research and Management, is privately owned. So is Fidelity, and Vanguard is mutually owned, meaning it's owned by its shareholders.
Obvious choices
The other obvious choices for your money are funds whose principals have consistently treated their fellow shareholders well. The Wasatch funds are good examples -- nearly all are closed to new investors in the interest of their existing shareholders, even though the company itself would reap higher fees if it kept them open.
Another example is funds with a high percentage of insider ownership. Kinnel cites the Davis Selected Advisors series of funds. “Chris Davis has generations of Davis family money in there, and the directors have a lot of money there,” he says. “If somebody came to him to make a fast buck, they wouldn’t get too far.”
Kinnel says other funds in which management is a major shareholder are those of Longleaf Partners, Tweedy, Browne and Clipper, which manages one of its funds under the PBHG brand.
Funds like these are also good to own on general principles. The Canary scandal only highlights how callous profit-driven fund managers have become, how derelict crony-capitalism fund directors have been and how slovenly the SEC has overseen the fund industry.
Legally, mutual funds belong to their shareholders. In practice, they are often treated as the personal fiefdom of their sponsors. You’re a sucker to be a serf. |
