THE FREE AND CLEAR PRESS

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Intellectual Ammo
Debating firepower from the team

By Dave Nadig (rating 3.84) on 11:58 05.17.00
This week the entire mutual fund industry meets in Washington DC at the Investment Company Institute to discuss the critical issues of the day. The ICI helps determine policy for the entire mutual fund world, yet unbelievably, disclosure is not on the agenda. We at MetaMarkets.com, in conjunction with some of our colleagues and competitors, feel compelled to advance this issue, and have thus wrote this letter to the President of the Organization. Representatives from Morningstar, IPS Millenium, the National Association of Investment Clubs, and On24 have joined us. As always, we appreciate your comments.


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May 17, 2000

Mr. Matthew Fink
President
Investment Company Institute
1401 H Street, NW
Washington, DC, 20005

Dear Matt:

This year, as we come together at the ICI's General Membership Meeting to celebrate the sixtieth anniversary of the establishment of the mutual fund, our industry is entrusted with the care of $7 trillion invested in over 10,000 funds. Even as we marvel at this tremendous long term success, we should also feel a sense of shame that investors, advisers, and third-party watchdogs have only a pittance of information available to them if they are interested in knowing exactly what fund managers are doing with this huge pool of assets.

According to TheStreet.com, an astonishing 18 of the top 25 fund management companies only allow outsiders - including their fund shareholders - to examine the full composition of their funds a meager two times per year. And what are shareholders actually shown? A report with information that is often several months out of date by the time it reaches their mailbox. In today's wired, information-rich world, this is unacceptable.

The existing system puts investors at a strong disadvantage in two ways:

Inadequate information makes for poor investment decision making

Shareholders relying on outdated information to make investment decisions are shooting blind. This is true also for the advisers, reporters, and rating companies that shareholders trust to help guide them to appropriate investments - how can these professionals lend accurate, useful insight when their data reflects weeks or months-old information? Portfolios can change rapidly and radically in terms of holdings, risk exposure, cash position, and sector weightings in today's swift moving markets Yet there is little means for the shareholder to learn of the dynamic state of his or her funds beyond checking a price in the morning paper.

Inadequate disclosure invites misleading portfolio management activity

The industry should take pride in its reputation for strong self-regulation and the absence of major scandal, but the fact remains that current policies leave mile-wide cover for misleading activity. Certainly the largest fund companies, with millions invested in their powerful brands, have much to lose if scandal erupts. But as recently as September 1999, one of the largest fund companies was fined by the SEC for failing to disclose the impact of aggressive portfolio strategy and IPOs on the performance of a fund in the early days of that fund's life - an all-too common strategy that would be difficult to obscure if more frequent disclosure were the rule.

And what of the hundreds of smaller fund companies purveying product in our industry? No reporters are calling them to inquire about portfolio moves, and rating companies are physically unable to dig beyond their stated semi-annual data - what resources does the individual have to make sure for themselves that their investments are appropriate? So-called "window dressing" is well known to be the result of money managers' desire to obscure their true strategy. Why is the fund industry not acting pro-actively to address this hot-button issue now through more aggressive disclosure policies?

Clearly, if abuses exist, they are not pandemic in the fund industry. But what message are we sending if we are unwilling to consider change that will help minimize the possibility of such activity?

The existing disclosure policy, which only mandates full exposure bi-annually, is a fund industry anachronism that is overdue for retirement. In 1940 (or even 1985), when ordinary mail was the only means available to send information to shareholders, infrequent disclosure was a practical necessity to keep fund expenses under control. But today, the rise of the Internet as an investment, research, and connectivity tool for individuals has rendered this policy obsolete.

Unfortunately, the industry has been sluggish in its recognition of the potential of the Internet to facilitate more open disclosure, apparently choosing instead to wait until regulator or shareholder pressure forces a change. Below are the most commonly voiced arguments against more open disclosure:


"Shareholders don't want or need more detail."

This paternalistic attitude results from the sad fact that, until recently, no one thought to actually ask shareholders their opinion. Montgomery Funds did - their 1999 survey of 2,500 online investors found that 97% would be interested in a fund that provided more up-to-date portfolio information. An ongoing poll by TheStreet.com has found that 76% of respondees favor the idea of funds releasing portfolio holdings more often.

Regardless of whether or not the average shareholder actually pores meticulously over portfolio holdings (and there are many that do), freer access to information is still badly needed. The community that utilizes this information is much wider than just the individual shareholder - the media, rating companies, regulators, and financial advisers all rely on it to rank fund performance and risk characteristics. What use is an analysis that is assembled on the basis of stale or incomplete information? The potential for nasty surprises is huge, and it creates an open opportunity for lawsuits and an environment of distrust.

"If given too much up-to-date information, shareholders will adopt a short term trading mentality that is antithetical to the long-term holding periods commonly associated with mutual funds."

Similar arguments were put forth in the 1980s by those who opposed giving 401(k) plan participants more information about their investments, as well as daily access to trading between those investments. Actual experience has now shown that 401(k) participants tend to trade less when given more information, even if they also have more opportunities to trade.

"Frequent disclosure will give away my strategy to my competitors, and opportunistic traders will be able to guess my next move and profit by 'getting in front' of my trades."

This contention is true for a certain sector of the industry, particularly for big funds that invest in small companies. Large block trades can move stock prices, creating opportunities for "front-running" if certain strategies are revealed too early. However, we must find a better balance between the legitimate need for short-term anonymity and the rights of shareholders. The industry may not be ready for full real-time disclosure, but quarterly disclosure is surely a reasonable first step.

In the words of John Rekenthaler, Morningstar's research director, "Quarterly online [disclosure] is a reasonable idea. Relatively few funds have massive turnover from quarter to quarter. [But] the reality is that for 99% of the fund managers out there, you could have the information monthly."

Today in our industry we have examples of funds that reveal their holdings at least daily, including one that reveals its trades and holdings right up to the minute. Why is there no serious discussion on an industry level to see how these innovations can be applied more widely? Compared to this level of openness, twice yearly exposure is absurdly conservative.

"The extra administration costs involved in reporting the information will increase fund expenses and create extra costs for investors."

In the age of the Internet, this argument no longer holds water. Almost every fund company has a website on which detail could be made broadly and cheaply available as often as they chose. Since not everyone is yet online, the industry could continue to mail twice-yearly to shareholders to keep costs down, while revealing more frequent disclosure online. Indeed, many fund companies have adopted individual policies for the disclosure of top holdings at set intervals, and have thus already been bearing the costs. The incremental cost of this strategy would be practically nothing, yet a consistent, industry wide policy would yield immediate benefits for the investor and the watchdog community.


Where Do We Go From Here?

In view of the obvious potential benefits for investors, as well as the very real danger of an erosion of trust in the industry if the open disclosure issue is not addressed head on, the ICI should establish a committee immediately to examine disclosure policy, focusing on the following points:

What is an acceptable minimum portfolio disclosure standard for the entire industry? Are we ready for monthly full holdings disclosure, or is quarterly the best first step?
What exactly should be disclosed and with what time-lag should it be revealed?
How should this disclosure be carried out (printed or online), and what format should it take?
What will the timetable be for rolling out this new policy?
Today's shareholders are evolving rapidly in terms of the level of information and access they expect with their investments. We need to make the choice now to evolve along with them or fail to serve their needs into the future. Investors have been wise to trust mutual funds as their investment vehicle of choice for meeting their long term wealth-building goals, but we must continue to earn that trust by having the confidence to show our hands more openly. If we have nothing to hide, we should not hide. We should demonstrate our integrity to shareholders by committing as an industry to pushing the disclosure envelope pro-actively as hard as we prudently can.

In the final analysis, we can never forget that it is the shareholder's own money that we are managing, and it is therefore their right to have as much information as possible about how it is being cared for. It is the industry's duty as the guardian of these assets to discard its traditional policy and immediately put serious consideration into what new level of disclosure is feasible today.


Sincerely,

Donald L. Luskin
President, CEO, and Co-Founder
MetaMarkets.com H. Davis Nadig
Executive VP and Co-Founder
MetaMarkets.com

Co-Signers:

John Rekenthaler
Research Director
Morningstar, Inc. Robert Loest, Ph.D., CFA
Portfolio Manager
IPS Funds

Thomas O'Hara
Chairman, Board of Trustees
National Association of Investment Clubs
Mitch Ratcliffe
VP, Editor-in-Chief
On24, Inc.

Glenn Tanner
Managing Director
General Manager
LionShares.com, a Division of Worldly Information Network

http://metamarkets.com/disclosure/07_harris_summary.pdf


http://metamarkets.com/disclosure/0529_harris_advisor_exec_sum.pdf