Despite SEC Scrutiny, Names Can Be Misleading

The Holy Roman Empire was a classic misnomer. As Voltaire noted, it was “neither holy nor Roman nor an empire.” The mutual fund business has its own examples of Holy Roman Empires--oddly named funds that might confuse investors who don’t really understand what they’re buying.

The Securities and Exchange Commission keeps an eye peeled for misleading titles. Just last October, the agency objected to the use of “guaranteed” or “insured” in the names of funds that invest in U.S. government obligations. Such wording might lead some investors to conclude that their shares would be protected against market losses, the SEC complained.

In reality, while Washington promises to pay interest and repay principal on the underlying bonds when due, there’s no assurance against possible market losses caused by rising interest rates. “Anything with a government backing is sometimes misconstrued as protection for safety of principal,” says Steve Norwitz, a vice president for T. Rowe Price Associates in Baltimore.

Esther Berger, an account vice president with Paine Webber in Beverly Hills, says “government plus” funds have been another source of investor confusion. These portfolios typically hold Treasury bonds and sell options in an attempt to boost yields or hedge against volatility.

Unfortunately, the approach increases costs and might also boost risk--a consequence not apparent from the name. “The funds are marketed as government paper, but the options strategy makes them more aggressive,” Berger says.

Last year, four government funds dropped “plus” from their names, according to Lipper Analytical Services, but more than a dozen others still cling to the term. Of roughly a dozen “government guaranteed” funds, three got rid of the latter word in 1990.

The SEC looks for misleading nomenclature as part of the process of registering new funds. “This kind of scrutiny is a good thing that helps explain why the mutual fund industry is as clean as it is,” says Michael Hines, a vice president of marketing for Fidelity Investments in Boston.

Sometimes, the agency requires name changes for funds that are already up and running. In 1988, for example, the Strong Tax-Free Income Fund had to change its title to the Strong Municipal Bond Fund because it held a fair number of bonds whose interest was subject to the alternative minimum tax.

But even with the SEC’s vigilance, some potentially confusing names have slipped through the cracks. Consider the case of “value” funds.

Value investors typically buy cheap, neglected stocks, such as those selling at low price/earnings or price/book value ratios. Although there’s no widely accepted “value” category for mutual funds, many fall within the growth and income camp. However, Royce Value is classified as a small company fund, while Dreyfus Capital Value is an asset allocation portfolio that holds bonds, cash and gold mining shares. Schield Value, a growth fund, invests in stocks trading at fairly high P/E multiples while it tries to time the market.

Then there’s the Dean Witter Value-Added Market Equity Fund. It had such a bad year in 1990 (losing nearly 12%) that Mutual Fund Values, a research publication based in Chicago, suggested a name change to “Value Subtracted.”

Dozens of funds have a geographical reference in their names, often with little or no correlation to the underlying investments or where they’re managed.

For example, the New Jersey Pride Fund is based in Pennsylvania, the Pennsylvania Mutual Fund is located in New York and the New York Venture Fund is run out of New Mexico. The Philadelphia Fund has its headquarters in Florida, while the Delaware Fund is based in Philadelphia. Only one of these funds (New Jersey Pride) actually restricts itself to investments in a particular state.

Needless to say, you shouldn’t invest in a fund based on its name alone. “You can’t expect the name to be the entire disclosure of the fund,” says Hines.

The prospectus outlines the fund’s objective, investment approach and other facts and figures, including fees and past performance. But as legal documents, prospectuses can be tough to wade through. Besides, they generally don’t reveal other key information, such as the fund’s current holdings, who the manager is or how the fund stacks up against rivals with similar objectives.

If you’re not sure what you own, Berger recommends calling the fund company and posing a few questions. On a stock portfolio, she says, your queries should include the following:

What are the five biggest holdings? This will give you an idea of the type of companies in which the fund invests.

What is the basic investment approach? Equity funds run the gamut from highly aggressive to conservative. Some primarily seek capital appreciation, while others focus on dividend income.

Who is the portfolio manager? Find out how long this person has been on the job and how well he or she has done.

What’s the portfolio turnover? “This tells how aggressively the fund is managed and indicates the costs it will accrue,” Berger says. Turnover of 100%, for example, suggests the manager replaces each security in the portfolio once a year on average. Aggressive growth funds recently had a rather high average turnover of 145%, reports Mutual Fund Values, while the number was just 85% for growth and income portfolios.

Bond funds require some different questions. Berger suggests that you focus on the quality of the holdings (lower-rated securities carry a greater risk of default) and the portfolio’s average maturity (longer-term bonds are more volatile). Also, she says, find out if the fund holds much “premium paper”--bonds that sell above their face values (at a “premium”) and will drop in price as their maturity date nears.

Clearly, many investment terms don’t carry precise meanings. That’s why you should look beyond a fund’s name and evaluate its objectives, approach, volatility and other factors. “In a recession, there’s always more business risk,” Berger says. “Now’s a critical time to understand what you own.”

The names of dozens of mutual funds include terms that are euphemisms or otherwise have imprecise meanings. Some examples:

Term: High yield Real meaning: Fund invests in lower-rated or junk bonds. Term: Insured (Muni bond funds) Real meaning: An insurance company guarantees interest and principal, but there’s no federal insurance and no protection against market losses. Term: Plus Real meaning: Fund uses options or futures to boost income or hedge against volatility, at added cost. Term: Small company Real meaning: Fund invests in medium-sized firms. The thousands of truly small companies draw scant interest from mutual funds. Term: Special situations Real meaning: Fund invests in companies facing “unusual” circumstances. In reality, there’s often little difference from what other funds buy. Term: Strategic Real meaning: Nothing. Term: Value Real meaning: Usually means fund buys “cheap” stocks selling at low price/earnings ratios and the like, but it’s a loosely used term.