For Fund Investors, a Time to Take Stock

Times Staff Writer

Should I stay or should I go?

That's what many mutual fund investors may be asking themselves as the oil slick created by the fund industry's worst-ever scandal continues to spread.

Indeed, the revelations that have come to light so far -- that many mutual funds allowed favored customers and some fund managers to enrich themselves through improper trading techniques -- may be just the tip of the iceberg. The fund industry is rife with conflicts of interest that can harm fund investors, John C. Bogle, the retired founder of Vanguard Group, the No. 2 fund company, told a gathering of financial journalists last week.

"The recent scandals are but a midget manifestation of the problem," Bogle said. "The spotlight that shines on the scandals perpetuated by the bad apples of the mutual fund industry reflects the frequent willingness -- nay, the eagerness -- of fund managers to build their own profits at the expense of the fund owners whom they are honor-bound to serve."

Does this mean that investors should flee mutual funds completely? Hardly, Bogle said.

Particularly for small investors, mutual funds still provide numerous benefits. They give investors the ability to easily spread their money among a variety of assets, such as stocks, bonds, real estate and international securities, providing vital diversification for portfolios big and small.

But it does mean that fund investors need to look more carefully at what funds they choose, Bogle noted.

Much of the information investors need is spelled out in fund annual reports and proxy statements. What investors should look for:

Fees and Expenses

The inverse relationship between fund fees and fund returns has been proved in study after study, Bogle said. In other words, the higher the fund fees, the lower the returns to investors.

Fund proxy statements spell out fund expense ratios, which are expressed as a percentage of assets under management. All other things being equal, the fund with lower fees is the better deal. As a rule of thumb, said Christine Benz, a fund expert at data tracker Morningstar Inc., expense ratios should be less than 1% for stock funds and 0.75% for bond funds.


This measure, expressed as a percentage, tells how much trading a mutual fund manager does -- the higher the percentage, the more trading being done within the fund's portfolio.

High turnover can be attributed to fund managers who like to trade a lot, shifting holdings rapidly in a search for short-term profit. Or it can be due to a large number of redemptions by shareholders fleeing a fund. If too many shareholder exit in a short time, the fund managers may have to sell holdings to raise cash to pay off the exiting shareholders.

High turnover can hurt investors in two ways: It can generate capital gains -- and therefore, capital gains taxes -- and it can boost a fund's trading costs, which then are passed on to shareholders in the form of higher expenses.

How high can turnover rates be? Fred Alger Management equity funds, with total assets averaging about $2 billion in 2002, reported redemptions for the year of about $9 billion, for a 440% redemption rate, Bogle pointed out. Bank of America Corp.'s Emerging Markets Fund had a 295% redemption rate, and Janus Capital Group Inc.'s Janus Adviser International Growth had a rate of 372%. All three companies have been cited by regulators for allowing improper trading activity in at least some of their funds.

Total Assets

Keep an eye on your fund's asset level. Fees and expenses generally are calculated as a percentage of assets, so a sharp drop in assets -- caused, say, by a mass exodus of shareholders from a scandal-tainted fund -- can stick the remaining shareholders with a large increase in fees.

Asset Growth

When money is pouring in at a rapid clip, managers sometimes have difficulty investing it effectively, Bogle said. As a result, shareholders should consider it a good sign when a fund closes its doors to new investors. That's a signal that the fund company is putting its personal interest of gathering new fee-generating assets below the interest of shareholders' getting the best return on their money.

Unfortunately, such closures are rare. Only 137, or about 4%, of the current 3,363 domestic equity funds are restricting new investments, Bogle said.

Bad News

Pay attention to the names of the fund companies that have been tainted by the current scandal. Although these companies may be attempting to clean up their operations, much of what goes on within a fund remains virtually invisible to investors.

Consequently, any sign of ethical breaches within a company should be taken seriously, said Brent Kessel of Abacus Capital Management in Santa Monica.

"There are so many things that go on behind the scenes that investors cannot possibly know," he said.

"If you see something that smells funny, the chances are good that there is more that you don't see."

Kathy M. Kristof welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or

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