SEC Cooking Up a New Batch of Mutual Funds
In the near future, mutual fund buyers may have to pick more than just investment style when they shop for a fund. Like bank CDs, funds may soon come with three-, six- or 12-month terms.
The Securities and Exchange Commission on Tuesday formally proposed allowing investment companies to create a series of hybrid mutual funds, a change that could dramatically alter the face of the $1.5-trillion fund industry.
Taken to extremes, the proposal could be viewed as a bulldozer plowing down walls that now protect many individuals from wandering into the quicksand of high-risk securities: By allowing funds to require that investors stay in a fund for a minimum time period, the SEC’s idea is to make it easier for funds to own little-known securities that are tough to trade.
And those typically are stocks or bonds issued by smaller, more speculative companies.
Providing small businesses easier access to capital has been one of the principal--and most controversial--goals of SEC Chairman Richard Breeden, as well as that of his boss, President Bush.
In practice, the SEC proposal won’t mean that the nation’s biggest mutual funds will suddenly come with early-withdrawal penalties. Most funds, in fact, will stay exactly as they are. What you’ll eventually see is a crop of brand-new funds aimed at the long-term investor.
Indeed, most intriguing about the SEC’s idea is that it represents a new federally engineered attempt to goose individuals down the path of long-term investing--at a time when many people still cling to their 3%-yielding money funds, afraid to take a chance on longer-term securities such as stocks and bonds.
The SEC’s new proposal would create two principal types of hybrid funds:
* An “interval” fund, which would allow investors to take money out only on dates fixed in advance--say, once a quarter, or every six months.
* A “payback delay” fund, which would accept investor redemption requests at any time, but would also allow fund managers to honor those requests over a set period rather than all at once.
Currently, the vast majority of stock, bond and money market funds are “open-ended”--that is, on any given day an investor may buy or sell shares in the fund at the market price. That’s no minor point: investors’ confidence that they can pull their money at any moment is one of the reasons the fund industry has been so enormously successful.
But that quality also can be a handicap for fund managers. There are many interesting small stocks or other securities that funds might like to own but can’t, simply because the securities couldn’t be sold quickly if fund investors rushed for the exits.
“It’s the cash flow into and out of a fund that wreaks the most havoc” with fund managers’ long-term planning and performance, argues Eric Kobren, whose independent Fidelity Insight organization tracks the mutual funds of Boston-based giant Fidelity Investments.
Thus, an interval fund or payback-delay fund could offer investment companies a way to better manage their cash flows. That, in turn, could give them the option of boosting the number of illiquid, small-company securities that they own, with the idea of scoring at least a few huge gains in those high-risk securities over the long term.
“If a manager has the desire to start a fund that would hold less-liquid investments, this would seem to be the way to do that,” says William Lyons, senior vice president at the 20th Century mutual funds in Kansas City, Mo.
The question is, do individual investors--via mutual funds--really want to boost their collective role as financiers of small businesses?
The idea has emotional appeal nowadays. With many banks and traditional venture capitalists turning their backs on small businesses, the $1.5 trillion in mutual funds may appear to be the national pot of gold, ready to finance the future.
More important, selling mutual fund investors on the concept of locking up their money for the true long haul should in theory be easier than ever: Look at the incredible growth of mutual fund IRA assets since 1982, to $169 billion now. That’s bona fide long-term money.
Promise those investors a sexier return over time in small-company securities, and many of them may decide their inability to cash out of those funds in the short run may be unimportant.
That possible sales pitch worries some state securities regulators. In particular, they have a problem with SEC Chairman Breeden’s cheerleading of the small-business-finance issue.
“It’s strange the SEC finds itself in such a promotional guise,” argues Barry Guthary, Massachusetts’ director of securities management, and president-elect of the North American Securities Administrators Assn. “They’re actually getting into product design now,” he contends.
The NASAA, representing state securities regulators, is arguing vociferously against some of Breeden’s other proposals to allow smaller companies to issue stock more easily. Guthary and many of his peers worry that by making it too simple for small companies to raise money from the general public, the SEC would open the door to rampant fraud, costing individual investors dearly.
Breeden, however, argues that state regulators are overdramatizing. Still, it’s worth noting that the Bush Administration does have every reason to push heavily for new business-financing ideas in an economy woefully short of jobs.
Should you worry that your mutual fund is about to leap into something ridiculously risky under the SEC’s new fund proposals? Nope. Most won’t. But if you begin to hear about new funds that promise dramatic returns in the long run if you just stay put, take a good look at what’s inside.
