Keep an Eye on Unsteady Mutual Funds

Physician's Money Digest, March31 2004, Volume 11, Issue 6

In the late 1990s, in the midst of astreak that saw the New York Yankeeswin three consecutive World Seriestitles, team manager Joe Torre was askedabout the importance of a manager's roleon a baseball team. In response, heexplained that managers receive too muchcredit when teams win, and too muchblame when they lose.

InvestmentNews

Recently, in an interview with (www.investmentnews.com),Don Phillips, a respected mutual fundauthority and managing director atMorningstar Inc, noted something similarwhen assessing the mutual fund industry."Ten years ago, people had overestimatedhow good the fund industry was. I think,today, people overestimate how bad theindustry is," Phillips said.

Active Management Needed

Phillips' comments illustrate just howgreat a state of flux the mutual fundindustry is in. He explains that it's a frustratingtime for investors, because if theychose to move their money from one ofthe fund families under scrutiny, theycould be moving it to one that will be inthe headlines the following week.

With the November elections looming,Phillips believes that more than a fewpoliticians will use the mutual fund scandalsto "position themselves as defendersof the small investor" and introduce legislationaimed at increasing regulatory oversightof the mutual fund industry. Thechange is needed, Phillips readily admits,but the quickness with which the legislationis passed "may or may not be the mostreasoned response."

Phillips notes that John Bogle, founderof The Vanguard Group Inc, says the recentmutual fund scandals are yet anotherargument against active management andfor index funds. The thought here is thatwith an index fund, it's easier to detectwhether or not shareholders' best interestsare being compromised.

But Phillips argues that while thepractices of a dozen or so mutual fundcompanies have been brought into question,that's a small percentage of themore than 600 fund management companiesin existence. As such, he doesn'tbelieve investors will exercise an extremeresponse to the scandals and removetheir money from funds.

Optional Approaches

New York Times

Phillips adds, "There's no obvious alternativeto mutual funds." True, but accordingto an article in the ,there are other approaches that fundmanagers can take, particularly duringthese uncertain times. And those approachesprovide alternatives for investors.For example, the article points out thata growing number of managers are holdinga large percentage of their funds'assets in cash. They say that stocks havebeen in a mini-bubble, and that the marketis headed for a big fall.

Times

According to the article, as of lastOctober, the average mutual fund had just4.5% of its assets in cash. However, theClipper Fund, a large cap value fund, hasmore than 26% of its $6.5-billion assets incash. And the Needham Small Cap Growthfund holds more than 44% in cash. Withthose holdings, the Needham fund was upmore than 60% as of mid-December 2003.

Times

The article notes that holding alarge amount of cash is considered heresyin the world of stock mutual funds. It mustalso give some investors cause for concern.As one chief investment officer notes,stock fund managers should pick stocks,allowing investors or their financial plannersto determine how much cash theywant to hold in their portfolios.

InvestmentNews

One thing is certainly true, as Morningstar'sPhillips notes in his interview. The mutual fundindustry "is going to get the most thoroughscrubbing it has ever gotten in itshistory." The result, he explains, "is thatwhen the dust settles on the mutualfund scandal in 12 to 18 months, it'sgoing to be very clear who violated yourtrust and who did not."