When Christopher Cox got in front of the Senate Banking Committee late last month and said that improving mutual fund disclosure is the “central focus” of the Securities and Exchange Commission, there was a scary and disappointing sense of deja vu.
Improving disclosure has been a big issue with the last five chairmen of the SEC, so Cox is hardly alone in pandering to fund investors. The enormous chunk of the investing (and voting) public that owns funds.
And yet for the last 15 years, every attempt at improved disclosure has failed to deliver the meaningful results that regulators and lawmakers have promised. Every time the SEC tries to require that fund prospectuses be written in “plain English,” the end result remains a document that has enough cover-your-assets language to let down a legion of investors.
So if Cox is serious about improving disclosures, here are a few things he might consider:
Give an assessment of how funds work together.
Money managers are loathe to offer anything that even hints at investment advice, yet they know that investors are not well served when they buy several funds with significant overlap.
Management knows which combinations of funds would create a false sense of diversification; they could do the analysis and issue a warning whenever funds are one-quarter identical.
All that’s needed is a simple statement like this: “(Management company) believes that diversification is important; investors buying this fund should be aware that it historically has had significant overlap with the following funds run by (management company). Owning funds that invest in the same kinds of securities can reduce the diversification effects normally associated with buying multiple funds.”
Discuss whether a fund belongs in a taxable account.
Funds are now required to show after-tax returns, which would be sufficient if investors actually paid much attention to that part of the prospectus.
Big capital gains distributions each year can create tax headaches for fund investors; management may be mostly worried about gross income, assuming that investors would recognize the potential tax consequences and hold the fund only in a tax-advantaged account.
That’s a lousy assumption. Instead, management should make a statement suggesting whether – due to past tax experience – the fund is appropriate for a taxable account. That’s the kind of consumer-friendly disclosure Cox should be encouraging.
Require personalized disclosures in fund statements.
If fund companies can calculate individual fund returns, they can tailor an investor’s costs and expenses.
This is information that should go into the regular statement, not the prospectus, so that the fund shows investors their profit or loss over a certain period of time, followed by a line showing investors how much they paid during the period for that gain or loss.
While past disclosure changes have improved the way fees are reported, showing the precise amount an investor has paid right next to the performance they have received would make smart investing a lot easier.
Bring back the profile prospectus, and make its use mandatory.
In the mid-1990s, the fund industry created the “profile prospectus,” a summary document that answered 11 critical questions. Those questions covered the fund’s objective, what the fund can invest in, who it is appropriate for, the fund’s costs and fees, past performance, how someone buys and sells, and more. This was supposed to be an easy-to-read supplement, so that someone who ignored the heavy paperwork still had good details to work with. It never caught on.
A two-page summary of these key points would give investors at least the bare minimum they should know out of the paperwork.
Highlight prospectus changes, don’t hide them.
Fund firms change their operating rules all the time, sometimes to make it easier on management, other times to help investors or to save money and in some cases to make sure they won’t be rung up by regulators.
Firms should give up-front details of changes made and explain why they were necessary. Then, in the body of the prospectus, changes should be in special lettering so that shareholders know something new is in place.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.
