SEC's Levitt Crashes Mutual Fund Industry Party
WASHINGTON--Mutual fund companies got chastised this morning by Arthur Levitt, the leader of the industry's long arm of the law. His directives: cut fees, educate investors, and push fund directors to earn their paychecks.
Just yesterday, during the Investment Company Institute's annual conference, we witnessed the industry's two camps, whose division line is clearly forming: the executives who want to build fund assets without decreasing their fees, and the fund managers, who land squarely on the side of investors.
As chairman of the Securities and Exchange Commission, Levitt has taken the side of the investors, and the crowd of more than 1,000 industry representatives sat quietly as he issued his directives.
"The financial literacy of Americans," he said, "has not kept the pace with the growth of fund investments or of investor's satisfaction. They also have totally unrealistic expectations about how their money is going to grow. A recent survey found that mutual fund investors anticipate returns of more than 20% a year for the next decade. That's dangerous."
But investors aren't to blame.
Levitt first attacked the industry's broad-based use of a fund's performance as a sales tool. "You also jeopardize the fund industry's future when you sell performance. The average equity fund was up more than 24% in 1997, and almost 12% in the first quarter of this year alone. Those numbers contrast sharply with long-term market returns of 10-11% a year. You also do a real disservice to investors when you encourage them to chase short-term goals."
He also criticized the increasing complexity of fees and expenses charged by mutual funds. "People don't know or understand what kind of expenses they're paying," he said. "Our own research shows that less than half of these people realize that expenses are deducted on an ongoing basis. Only 8% say they completely understand their expenses that their funds charge. We can only guess whether they actually do."
A 1% fee, he says, will reduce an ending balance of a mutual fund account by 17% on an investment held 20 years investment.
"You've got to do a better job of making sure those who sell funds explain the cost of investing," Levitt said. "You're setting yourselves up for trouble down the road when you ignore risk and expenses. How do you expect investors to understand the alphabet soup of A,B,C,D,I,Y and Z shares, front-end loads, CDSCs, 12b-1 charges, commissions and who knows what else they're paying?"
In a later session Friday, mutual fund executives got another dose of reality by Steve Case, founder of America Online [AOL]: the growing popularity of individual stock investing. He predicted the Internet will help stock trading become a more competitive force with mutual funds, as the ease and speed of trading stocks online improve and lure those investors who previously may have been turned off from stocks because of the barriers to entry (read: brokers).
Levitt also emitted candid remorse for the misdirected use of the SEC's approval of profile prospectuses and push for plain-English writing in the legal documents. "A number of funds have heeded our call for better communication. But now its time for the whole industry to carry out the promise of our efforts. We're chagrined to hear that some of you intend to make only a few cosmetic changes and mostly leave your prospectuses as they are; in the same dense legalistic presentations that investors don't want, don't understand and don't read."
Mutual funds' boards of directors are also under the gun for improvement. Levitt said directors need to more actively oversee a fund. While they don't have to guarantee that a fund pays the lowest rates, he said they should ensure the fees fall within a reasonable range.
Levitt proposed the beginnings of a solution on the fund governance issue: a roundtable in the fall of investor advocates, fund managers, directors and academics, "to air the issues and work toward a consensus on whether changes are needed in the current system."
--Valerie Putchaven is a reporter on Morningstar.Net's news team. She can be reached at firstname.lastname@example.org.