Wall Street Journal

It's Time for Straight Talk From Mutual-Fund Firms

There are more assets in mutual funds -- more assets in Fidelity Investments, in fact -- than there is gold in Fort Knox and the New York Fed combined. There are, additionally, more people in funds than there are homes with personal computers, more interest in funds than in the Jacksonville Jaguars and, rather remarkably, two stock funds today for every three listed New York Stock Exchange stocks.

This is why the coming Securities and Exchange Commission proposal to redesign and simplify fund prospectuses will have more practical effect than anything else the SEC does in Arthur Levitt's tenure as chairman. It may not be literally true that investors do less research for a fund than they do for a dishwasher, but the prospectus is still the one and only piece of paper that all of them see.

The SEC has in mind a much-shorter, plainly worded "profile" prospectus that could be used as a selling document instead of the jargon-filled and virtually unreadable prospectus in use today. (The long form would still be available on request, but it, too, would be shorter.) Just as important, the SEC says it wants fund issuers to convey the risks of their funds in more specific and pointed terms.

Those two goals -- more readable and more informative -- aren't incompatible, but whether the SEC lives up to both will bear watching, particularly as the fund industry is breathing down its neck. The industry has drawn up (for the agency's consideration) a four-page prototype of a "profile" prospectus that an investor could read over a cup of coffee.

For fund promoters, shorter has always been better. It wasn't many years ago that Fidelity was dreaming of selling funds off a newspaper coupon. Funds now have religion, and piously declare the importance of disclosure, and some of them may mean it. Still, it's important to remember that when Mr. Levitt started this drive in 1994, it was because prospectuses were going unread, and perforce weren't educating anyone about the funds' risks. He then challenged the industry to drum up a more readable document. Making it shorter was a means, not the sole end (otherwise you could cram the prospectus onto a postcard).

The mock profiles done up by various fund companies have some fine features. They are indeed simpler, and their format would make different funds easier to compare. In particular, there is much to be said for Fidelity's idea of presenting a fund's return for each of the past 10 years pictorially, in bar-graph form.

One small drawback is that the industry notion of letting each fund compare its returns with "an appropriate benchmark" would destroy comparability. The same two yardsticks should be used for all: the risk-free return on Treasurys and the Standard & Poor's 500.

A more serious problem relates to the narrative discussion of risk-supposedly the heart of the new profiles, and what investors told the SEC interested them most. Samples offered by fund companies are generalized to the point of irrelevancy. ("Stocks can go down; you can lose money; it may rain.") The descriptions of the funds' strategies suffer from the same handicaps.

Companies protest that it's hard for them to be more specific. But actually, they do it all the time. When portfolio managers give the low-down to their sales reps, they are plenty specific. ("We're playing the techs;" "We're into cyclicals," etc.) And when I called Gary Pilgrim, the frank devotee of high-wire stocks at PBHG, he boiled down the essentials of his fund into two blunt sentences. ("We're pursuing high-growth companies to try to achieve above-market returns. That pushes us in the direction of higher P/E, less liquid companies concentrated in a few industries.")

As the equally frank fund-company lawyer Julie Allecta notes, such risks and such candid presentation of style rarely get conveyed to investors.

What's the best way to beef up the new profiles and prospectuses?

Require that funds include their 10 biggest positions as of the end of the previous quarter, with a warning that all are subject to change. Include management's discussion of what affected the fund during the previous calendar year. (This plainly worded talk now appears in annual reports. Funds have the option of putting it in the prospectus, but virtually none do.) Disclose the average holding period for each security. Disclose any tendencies that enhance risk, such as high P/Es or industry concentration. And disclose who the manager is and how long he has been there. If the profile winds up six pages instead of four, so be it.

Yes, I know all this will tell you only how funds behaved in the past. If we knew what would happen in the future, we wouldn't need a prospectus. But barring clairvoyance, the past is the best possible guide.

A repeated rebuttal from industry reps: The new profiles would tell people where else they could get all that other information, so why clog up the profiles? Because, the short profile, if adopted, will be all that most investors ever read. The fund companies have been saying they are sick of jargon and long to talk straight to their investors. The SEC should take them up on it.


1. Why is there a trend towards more disclosure on the part of mutual funds? What implications does this have for the maturation of the mutual fund industry?

2. What are some of the items that the author of this article believes should be disclosed by a mutual fund in its profile? As an investor, would you find this information useful? If so, why? If not, why not?