Rules Offer Some Help on Shopping for Funds

If you’ve been confused by misleading advertising claims by mutual funds, or about what fees your fund charges, some relief is near.

Starting Sunday, the first set of new Securities and Exchange Commission regulations to standardize and improve advertising and disclosure of fund performance and fees is scheduled to take effect.

But don’t jump too high for joy. You still need to do your own homework when picking funds. And the new rules don’t address some questionable sales pitches practiced by fund salespeople.

The new rules have two major components.

The first, set to take effect Sunday, requires funds to display sales commissions or “loads,” management fees and other expenses in a standardized fee table near the front of the prospectus.

The prospectus also must show how fees and expenses would affect a hypothetical $1,000 invested in the fund with an assumed annual return of 5%. The example must show the amount of those fees and expenses if shares are sold at the end of 1, 3, 5 and 10 years.

The rule addresses frequent investor complaints that fee information is often buried in a prospectus or shrouded in legalese that few investors understand. Funds often may obscure certain controversial fees, such as annual 12b-1 charges for marketing and advertising expenses that generally run about 0.25% to 0.50% a year but in some cases run as high as 1%.

Fees Can Vary

But while such tables will be useful, don’t be misled by them either. Fees can vary depending on the amount of money you invest, the size of the fund and where you place your fund shares. For example, fees and sales charges are often lower if fund shares are held in individual retirement accounts.

Also be aware that annual expenses such as 12b-1 fees and management fees are already factored into yield and total return numbers stated by funds, says Burt Berry, editor of NoLoad Fund X, a San Francisco newsletter.

So while you should generally seek funds with lower fees, don’t reject a fund with consistently high performance just because it charges a 12b-1 fee or has a higher-than-average management fee, Berry says.

The second major component of the new rules, to take effect July 1, requires all funds to use a standardized yield formula if they choose to advertise yields. Now, only money market funds have been required to use standardized formulas (they use a seven-day yield). The rest of the funds will be required to use a standardized 30-day yield.

These funds--particularly bond funds--have been using widely different formulas and accounting methods, making it difficult for investors to accurately compare performance of different funds. These accounting methods have been so different that the fund industry requested, and got, an extension of the rule’s implementation to rework their computer systems. The rule had originally been set to go into effect May 1.

The new rules also will go further. If yield is cited, a fund must also disclose--with equal prominence--its cumulative total return for the past 1, 5 and 10 years. (This rule goes into effect Sunday, unlike the yield rule, which was postponed.) The total return will compute what you got as an investor, adding in rises or falls in the value of securities in the portfolio.

Read Numbers Carefully

The inclusion of total return numbers should show how bond funds, particularly those investing in long-term bonds, are volatile and can even lose money over certain time periods. Many bond-fund investors still mistakenly believe that their funds are “safe” from price fluctuations and losses of principal.

The numbers should demonstrate how higher-yielding funds often carry higher risk and volatility and aren’t necessarily the best investments for conservative investors.

But be careful not to be misled by such numbers. Total returns for the past five years for many bond funds are likely to be stunningly attractive, largely because falling interest rates sharply boosted bond prices in that period.

Numbers for the past year, however, might show some funds actually losing money or posting minuscule gains because interest rates rose sharply during the spring and late summer of last year, pummeling bond prices.

“You can’t view the last five years in any way as a reasonable expectation of future returns,” says Steven Norwitz, spokesman for T. Rowe Price Associates, a major mutual fund company.

Experts also caution not to buy funds just from looking at advertisements. “The ads are just giving you a few facts; you should read the prospectus” for further detail, says Matthew P. Fink, senior vice president and general counsel for the Investment Company Institute, the chief trade group for the fund industry.

Unfortunately, this new rule--by governing only written sales pitches--may affect only a minority of funds. Three in four funds rarely advertise in print, instead selling to investors through verbal pitches of stockbrokers or other salesmen whose conduct isn’t generally covered in the new rules.

Investors often complain that they are misled by fast-talking salespeople who sugar-coat performance records of funds while minimizing risks.

Perhaps the best advice when shopping for a fund is to spend the time to compare the performance records and fees of many of them. You also should find out how much risk a fund takes to achieve its given return, and find out if the portfolio manager responsible for an impressive past performance is still there.

Services that provide in-depth information on fees, performance and risk include:

- Wiesenberger Investment Co. Service, an encyclopedia-like reference providing extensive listings and performance records of funds. Often regarded as the bible of the fund industry, it is available at most libraries.

- The Individual Investor’s Guide to No-Load Mutual Funds ($19.95, available through American Assn. of Individual Investors, 612 N. Michigan Ave., Chicago, Ill. 60611).

- Handbook for No-Load Fund Investors ($38, P.O. Box 283, Hastings-on-Hudson, N.Y. 10706).

- Donoghue’s Mutual Funds Almanac ($23, Box 540, Dept. A-1, Holliston, Mass. 01746).