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More light needed for mutual funds


As mutual funds have become the primary mode of investing for a large segment of the U.S. population, shareholder advocates have argued that investors aren’t getting the full story from their funds about the actual cost of ownership. On Jan. 24, 2004, an event was held on the campus of the University of Mississippi that could change the face of investing for the better.

The so-called Mutual Fund Summit, hosted by the university’s law school and an organization known as Fund Democracy, was sponsored by the Zero Alpha Group (ZAG), the National Association of Personal Financial Advisors and the Financial Planning Association.

Fund Democracy is a non-profit shareholder advocacy firm founded by Mercer Bullard, an attorney formerly with the U.S. Securities and Exchange Commission. The ZAG is a consortium of eight fee-only investment advisory firms from across the country that collectively manage about $3 billion.

Foster Group, a West Des Moines-based firm, is a member of this organization. Also participating were industry notables John Bogle, founder of The Vanguard Group; Don Phillips, managing director of morningstar; Harvey Goldschmid, commissioner of the U.S. Securities and Exchange Commission; and Barbara Roper, director of investor protection, Consumer Federation of America.

The purpose of the summit was to assemble a group of participants to engage in an open discussion about the major issues facing the mutual fund industry and mutual fund investors today.

In conjunction with the summit, the preliminary results of a ZAG-commissioned study into the hidden costs of fund ownership were released by the authors of the study, Edward O’Neal of Wake Forest University, and Miles Livingston and Jason Karceski, both of the University of Florida.

Myself, Bullard and Jeff Buckner, president of PlanCorp, a St. Louis-based ZAG firm, also participated in the media event. This study of the top 30 retail mutual funds based on total net assets as of Dec. 31, 2001, found that for every dollar of cost identified in the fund’s expense ratio, another 43 cents on average is spent on portfolio transaction costs hidden from investors’ view. In some cases, these hidden costs ranged as high as $4 for every $1 of disclosed cost.

The summit and study participants are not suggesting that investors stop using mutual funds. To the contrary, they agree that mutual funds are the only practical way to achieve proper diversification and manage risk for most investors. They believe, though, that better disclosure and investor education is needed to ensure that mutual fund investors get a true picture of the cost of owning their funds.

Why do we think this cost issue such a big deal? Because these hidden costs are borne directly by investors. The expense of trading the underlying holdings of the fund comes directly from fund’s gross return. In other words, they’re subtracted before the fund passes through its return to its shareholders.

We support the work of the Fund Democracy organization and its mission of advocating for shareholder rights and serving as an information resource to the investing public. We are strong proponents of full disclosure to the investor and we have no hidden costs in our client relationships.

We believe the fund industry should follow a similar business model and that complete cost disclosure is necessary. If a fund family and its managers are accountable to shareholders by making their true cost information easily accessible in a format the average investor can understand and use, market forces will bring pressure to bear on any fund that is not treating shareholders fairly. If an investor knowingly chooses to own an expensive fund, so be it. But the industry owes investors the information they need to make a truly informed decision.

Mark Stadtlander is president of Foster Group.  

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