Getting Accurate Price Quotes Getting Trickier
It has been said that close counts only in horseshoes and dancing, but a third activity could be added to the list: pricing mutual-fund shares.
One of the nice features of mutual funds is that their prices are easy to obtain. People can find out what their shares are worth by looking them up in the newspaper or calling the fund company. Investors rely on the reported prices as being accurate, and most of the time they are.
But mistakes and misjudgments happen. And when they occur, investors could wind up paying too much for shares or receiving too little when selling.
Inaccurate pricing isn’t deemed to be much of a problem at the moment, despite an embarrassing if harmless gaffe committed last year by Fidelity Investments, the nation’s largest mutual fund family, on the price of its flagship Magellan Fund. As a rule, stocks and bonds that trade regularly don’t present problems.
But as portfolio managers make greater use of derivatives, obscure small stocks and investments in Third World markets, they could face a tougher time measuring what a particular holding is worth.
“For many exotic securities, pricing is largely a matter of judgment, because there is no correct price,” said Gene Gohlke, an associate director of the Securities and Exchange Commission, during a conference in Palm Desert last week sponsored by the Federal Bar Assn. and CCH Inc., a San Francisco publisher of tax and legal information.
“Sometimes, you can’t price to market because there is no market,” added Robert Kopprasch, senior vice president at Alliance Capital Management in New York.
Instead, Kopprasch said, fund managers must use some type of pricing mechanism. On a simple level, this might mean deriving a price for an obscure municipal bond by analyzing how similar types of bonds fared. If the holding is a complex derivative instrument, a price might have to be estimated by calculating how the derivative would behave under numerous scenarios.
On certain derivatives purchased by bond funds, the yields or maturity values aren’t known, which makes it hard to estimate their current worth. A derivative’s price could change in hard-to-predict ways, dependent on movements in some underlying commodity, interest rate or asset.
In addition, pricing difficulties can crop up on mainstream investments during market traumas. For a short period after Orange County’s financial problems surfaced last December, a bond issued by the county briefly was quoted at $600, a huge drop from its $1,000 face value, Kopprasch said.
Since mutual funds generally must value their holdings at the most recent transaction price, if available, this could have caused muni funds holding Orange County bonds to devalue their holdings to the fire-sale price.
As it turned out, no Orange County bonds actually traded at that price, so the affected mutual funds were spared. But if even one investor had panicked and sold, it could have forced a huge devaluation, Kopprasch said.
Another example of pricing difficulties concerns so-called Brady bonds--IOUs issued by Latin American governments for which Washington has guaranteed the principal repayment and up to three periodic interest payments. Prices here can be difficult to measure because the investments reflect the values of both U.S. Treasury securities and bond prices in the appropriate foreign market, Kopprasch said.
As problematic as pricing can be, you shouldn’t lose sleep worrying that fund companies misstate values intentionally. It would be difficult to maintain a ruse for long under the scrutiny of federal regulators, competitors and the fund’s own independent accountants.
Even if a company succeeded in fabricating prices--and thus performance--for one quarter, it would have to maintain the sham or the following quarter’s performance would suffer by comparison.
“You would have to keep building a bigger and bigger lie,” said Michael Lipper, president of Lipper Analytical Services, a Summit, N.J., company that compiles fund performance numbers.
A fund’s board of directors, management company and accountants share responsibility on the pricing issue, and all three could be forced to reimburse shareholders for any errors.
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So how big a problem does inaccurate pricing represent?
Joseph Antonellis, senior vice president for State Street Bank & Trust in North Quincy, Mass., said the daily prices reported by mutual funds are “99.8% accurate.” And of the roughly 140,000 investment holdings tracked for fund clients, only a small number each week look suspicious, he adds.
But you can reduce the already-minuscule odds further by steering clear of certain types of mutual funds. This list would include portfolios that dabble in derivative instruments, obscure U.S. stocks and bonds or Third World markets.
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Shareholders could see their mutual-fund operating expenses drop by a few cents a share if Republican leaders in Congress succeed in removing certain “unnecessary regulations.”
Rep. Jack Fields (R-Tex.), the new head of the House telecommunications and finance subcommittee, said he plans a “good old-fashioned housecleaning” of laws affecting the tightly regulated fund industry.
Speaking at the Palm Desert conference, Fields said money could be saved if shareholders did not need to ratify a fund’s choice of auditors and if directors did not have to vote in person on certain issues.
He also cited liberalized advertising rules and a “top to bottom review” of the Securities and Exchange Commission as being on his agenda.
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Morningstar Inc. of Chicago has unveiled its annual list of “forgotten funds” that have achieved solid track records but remain small, with assets of about $100 million or less.
The list consists of Berwyn Income ((800) 824-2249), Franklin Equity-Income ((800) 342-5236), Loomis Sayles Bond (800) 633-3330), Sit U.S. Government ((800) 332-5580) and Wasatch Aggressive Equity ((800) 345-7460).
All are no-load funds except for Franklin Equity-Income, which levies a maximum 4.5% sales charge.
