The law requires mutual fund advertisements to tell new investors to "read the prospectus before investing." But is that enough? No -- not if you really want to know where the fund invests your money, and don't want any unpleasant surprises.
One investor recently said she planned to complain to the Janus Twenty fund after belatedly discovering the presence of Philip -- Morris, a major tobacco and food conglomerate, in its portfolio. She had already invested in the fund on the recommendation of a financial planner. But there was no listing of its stocks in its prospectus, the reader complained, and because she abhors tobacco companies, she now plans to sell her shares.
Before doing so, however, the investor plans to write the fund to express her displeasure with this stock. She and other investors may wonder if letters like hers have any effect on stock purchases by a portfolio manager. They also may want to know the best way for investors to learn ahead of time whether a mutual fund holds stocks of which they do not approve.
Chrissy Snyder, spokeswoman for Janus in Denver, said a letter from an investor complaining about a certain stock in a fund's portfolio will be passed on to the portfolio manager -- but will
have "almost no effect."
The goals of most stock mutual funds are too broad to incorporate subjective opinions of certain companies. Janus Twenty, for example, seeks growth of capital from companies with strong financial positions. Because that's the goal investors expect from that fund, "we don't make ethical or moral decisions" about the stocks the fund buys to achieve it, Ms. Snyder says.
At the Vanguard Group in Valley Forge, Pa., fund managers are partly compensated based on the performance of their funds. "If we start to tell fund managers, 'You can't hold Philip Morris, but if you underperform we won't pay you as much,' that wouldn't be fair," says Brian Mattes, a Vanguard spokesman. "We have to leave it to the portfolio manager's discretion."
However, executives of some mutual fund companies have deliberately designed their funds to be "socially conscious" and avoid stocks in companies that make cigarettes or weapons, or companies that pollute. That's spelled out in the prospectus. Investors know that the choices of those portfolio managers are more limited, which can and often does affect performance.
In any event, new investors can and should ask for more than just the prospectus before investing, if they really want to see what stocks the fund buys and how the company operates.
New investors can ask for the last semiannual or annual report. (Some funds publish quarterly reports, though it is not required.) These reports, sent to all current shareholders, list all the stocks in the fund's portfolio as of a given date. While the portfolio may have changed a little since then, the report gives a pretty good idea of the kinds of companies the fund buys.
New investors can also ask for copies of recent newsletters, special notices and other material that's gone out to shareholders lately, Ms. Snyder said. Morningstar Mutual Funds, major newsletter, evaluates the completeness and clarity of shareholder reports for thousands of funds.
A prospectus contains information about the fund's investment criteria, strategy and expenses, but "if you really want to know the fund, get the annual report and read it from cover to cover," Mr. Mattes recommends.