Creating Mutual Fund Transparency: The Elimination Of Deceptive Communication

Abstract

While the SEC debates the overall merits of forming mutual fund company boards with an independent chairman to go along with 75% make-up of independent board members, I question how this is going to create more transparency for the individual investor.  The real culprit is the flexibility given to mutual fund companies in allowing them to set fees as permitting trading within funds has confused the true cost to the consumer and has added insult to injury.  Dr. Edward O’Neal at Wake Forest states that “the average fund managers cannot recoup these expenses in the form of better performance.”  Gaspar, Massa and Matos (2006) brilliantly show that mutual fund families tend to charge various levels of fees on its member funds, forcing different funds to contribute unequally to the total profit.  They found that during the January 1991 to July 2001 time period, high value funds (i.e., high fees or high past performance) are favored inside fund families by 6-28 basis points of extra net-of-style performance per month (.7% - 3.3% per year) relative to the low value funds (i.e., low fees or low past performance), based on the criteria they used (i.e., fees or past performance).  How can all these deceptive practices be eradicated?  The author proposes a five-step “absolute” process in order to create mutual fund transparency:  the elimination of all soft dollar arrangements; creation of a mutual fund separateness statue to eliminate what Gaspar, Massa and Matos (2006) call the strategic Cross-Fund Subsidization; terminate all 12-B1 fees; eliminate all “rolling performance periods” by forcing one-year calendar performance periods with mandatory fee return to investors if the manager underperforms; and outlaw all front-end and back-end loads, thus forcing marketers to charge a direct commission.  The goal of any transparent system is to protect the consumer, and the individual investor can only be protected by implementing “absolute standards” that will allow no “wiggle room” for mutual fund companies.