Mutual fund companies can’t guarantee great results, but they could give shareholders honest and clear disclosure that helps investors properly use and understand the funds they own or are interested in.
Which is why I wish the fund industry would treat investors better. My holiday wish list is filled with ideas that most industry insiders scoff at, right up to the point when performance lags or there’s an industry scandal, at which point they get re-packaged as “mutual fund reform.” Yet I expect that one day, most of these fund wishes will come true:
1. Electronic documents as the default choice for shareholders:
Recently I proposed personalized prospectuses where investors could choose the presentation order for the items they consider most important — something much better than the current traditional or summary prospectus because it can include items those documents bury.
Fund companies already deliver documents electronically, but consumers have to opt-in to get it. Sadly, studies show that shareholders barely read fund documents; regulators should let fund companies save paper and expenses and make electronic delivery the default.
Defaulting to electronic delivery would be a big improvement. Folks who aren’t computer-savvy can stick with paper, but the time has come for authorities to make this change.
2. Better disclosure of potential capital gains:
Capital gains distributions are made on the trading profits a fund accumulates; by rule, funds pass-through those gains to investors, who then are responsible for any taxes due.
Gains must be distributed annually, whether a fund has had a good or bad year. Right now, gains numbers are up thanks to years of the bull market. But at some point in most market cycles, the investment world takes a turn for the worse, fund managers lock in profits or trade positions, and investors get socked with capital gains pain on top of a fund’s losses.
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The next market downturn will bring that nasty problem back to the fore. But fund companies do a horrible job of telling potential investors that they are buying a potential tax headache. Part of that is because today’s potential gains may not be realized for years, or could be offset by future losses.
Investment research firms such as Morningstar Inc. calculate potential capital gains exposure, but funds should put their own math where investors can’t miss it, helping investors decide if a fund is appropriate for a taxable account. A simple shaded box, right next to performance, would do the trick if it said something like: “Results have created potential future tax liabilities, currently estimated at (dollar amount per share), that may someday result in large taxable distributions.”
3. Clear statements of what makes a “smart beta” fund so smart and what an “alternative fund” does that is so alternative:
Smart-beta and alternative funds are the buzz of the industry, and come in many shapes and sizes. Yet investment objectives for alternative and smart-beta funds offer no specifics and rely on traditional boilerplate.
There’s nothing alternative to “the fund seeks a long–term positive absolute return,” or smart about “the fund seeks to replicate the return of the index.”
Investors need to know what they’re getting into with these funds, and most don’t. While alternatives, technically, fall outside of stocks, bonds and cash, there must be some standardized definition to tell investors what they are getting; the same applies to smart-beta, which is more than just a means of refining, improving or rebuilding an index.
4. Easy-to-find statements of how much money a manager has in the fund:
A manager’s stake in their own fund is buried in a fund’s “Statement of Additional Information,” the second part of the prospectus, which shareholders only receive on request or if they look online. As a result, few investors know if managers eat their own cooking.
Managers with skin in the game perform better, according to most studies. Thus, investors learn something important from a disclosure like “Joe Manager has no money invested in the fund.”
Funds should be required to add a line to the manager bio in Part 1 of the prospectus, disclosing the manager’s ownership range right after giving tenure, background and other details.
5. Comparative fee information:
Funds should compare fees to benchmarks and peer groups, just as they do with performance, so that investors can see how expense ratios measure up.
Adding columns to a prospectus table — comparing fund expenses to averages for active and passive funds in the same category — would pressure management to keep costs in line.
6. An indication of whether sister funds play nicely together:
Fund firms know when issues within the family are substantially similar; investors should be told. When fund siblings consistently have 20% or more overlap, shareholders should be told that they could be concentrating a portfolio rather than diversifying it.
7. Fewer funds:
Too many investors accept fund mediocrity, but fund companies accept a regular stream of fees when they allow uninspired, flawed, high-cost and weak-minded funds to survive.
Shareholders deserve a fund company’s best ideas, not to be stuck with its dullards. If a fund isn’t meritorious, management should close it down. Merging a laggard into something better puts investors into a firm’s most worthwhile issues.