Each year at this time, I take a crack at predicting the big fund-industry stories of the coming 12 months. I am confident that we’ll see the following in 2007:
In 2006, Bisys Fund Services revealed that it had been paying kickbacks to some of those funds in order to get and keep the accounts. Shareholders funded the kickbacks through heightened expense ratios. When it becomes clear that this was a more-widespread practice, investors may figure out that the real problem is that asset managers were the ones requesting the paybacks, effectively telling the service providers to skin shareholders. When investors wake up, reputations will be ruined.
Fidelity Investments recently agreed to pay more than $42 million to its funds, reimbursing the funds for improper gifts and gratuities accepted by some of its traders. It took this step even though an independent review produced no conclusive evidence that investors were harmed when traders violated company policy and accepted travel, entertainment, gifts and more from firms courting Fidelity’s business. Fidelity was not the only one accepting gifts (the brokerage firms aren’t buying luxury boxes at sporting events to leave them empty); expect several fund companies to disclose similar problems – and make big-dollar, fast-and-easy settlements – in ’07.
The year 2001 is off of five-year track records, 2002 is out of the three-year records, the Dow Jones industrial average is at record highs and even the funds with middle-of-the-pack results have numbers that, on both a historical and an absolute basis, they can crow about to draw attention from investors. Performance sells, and fund companies will use it as their big selling point this year.
I made this same call a year ago and was just a bit early and optimistic; several new funds based on “semi-active” tactics passed regulatory muster and hit the market. The next step in the evolution of ETFs – which traditionally act like an index fund but trade like a stock – is an offering that is actively managed. It may be an ETF flavor of your favorite mutual fund, but more likely will follow an aggressive, tactical-allocation strategy.
Recent mutual-fund reforms have amounted to new disclosures that average investors typically don’t understand or ignore. That said, regulators and legislators keep looking for ways to make funds more transparent. One idea that might gain populist support in the Democratic Congress would force fund companies to say on every customer’s statement just how much – in dollars – a shareholder paid in fees. So while the fund might post an expense ratio of 1.35 percent, its customer statements would include a line saying, “Your account gained (or lost) X dollars this year; you paid management Y dollars to achieve that performance.” Ironically, Congress is likely to be looking for something to help investors in retirement plans, and those investors don’t have the free-and-easy ability to say, “Look at how much I paid for that terrible performance!” and then move unfettered to another fund.
Reasonable mutual fund tax-reform proposals drew bipartisan support from dozens of lawmakers, but didn’t get out of committee in ’06. It will be more of the same in ’07; the best hope for this legislation is that it becomes an election-year enticement for voters in 2008.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com.
