Mutual fund ratings systems get a 'C,' for confusing

February 21, 1993|By David Conn | David Conn,Staff Writer

Mutual funds were supposed to make life so easy. They were a refuge for the woman without enough money to limit risk by diversifying investments, or for the man without enough time to research a universe of stocks.

But now that the number of mutual funds is fast approaching the number of stocks, investors face a daunting array of rating systems, newspaper articles and "Annual Mutual Fund Top Picks!" magazine editions that purport to spotlight the best funds.

There's just one problem: The criteria used for such ratings differ widely that almost any grade can be attributed to any fund at any time. Consider Fidelity's Limited Term Municipals fund, whose ratings run from A, right through C, to E.

"A lot of [mutual funds] are receiving a lot of phone calls from shareholders who are confused," said Erick Kanter, spokesman for the Investment Company Institute, the mutual fund industry association. "I think the real question is, does the average person see all of [the ratings] and do a careful study of them. . . . I think most people are just so busy that they don't have time."

Of course, saving time was a large part of the original appeal of mutual funds, whose assets have grown from $300 billion to more than $1.5 trillion in a decade.

Today, there are more than 4,200 stock and bond funds. That's four times the number a decade ago, and far more than the number of stocks on the New York and American stock exchanges combined. There are specialty funds investing in everything from the U.S. leisure industry to the Singapore stock market, and issuers from the AARP to Zweig.

This explosion in funds triggered the need for a system to judge performance, an attempt to simplify the decision-making process for mutual fund investors. Lipper Analytical Securities Corp. of New York, Chicago-based Morningstar Inc. and CDA Investment Technologies Inc. of Rockville have emerged as the main providers for such performance data.

But from those three systems, America's financial media have created a virtual Baskin-Robbins of fund ratings -- except that there are twice as many rating systems as ice cream flavors.

The latest entry is the Wall Street Journal, which this month introduced a set of charts that change each weekday. Using data supplied by Lipper, funds receive a letter grade based on their total return compared with their peers, and on a time frame that changes Tuesday through Friday. On Tuesdays, for example, funds are ranked on their one-year performance; Wednesdays through Fridays show three- , four- and five-year numbers.

There are plenty of other variables among the rankings.

Some systems, including those of Money and Business Week, adjust the five-year numbers to account for risk factors; others, such as USA Today's, exclude funds whose management changed hands recently. Some adjust performance data to account for commissions, or "loads," and management fees; some don't. Some look at one-year performance, or three years, or five or 10; a few only rank funds that have been through both an up and a down market.

And Financial World magazine recently created a ranking system that attempts to forecast the future performance of stock funds, by evaluating the prospects of their holdings.

(The Sun, no stranger to the field, lists 16 categories of mutual funds each Sunday, and ranks them according to three-year returns, with no adjustment for risk.)

That's why Legg Mason Inc.'s Special Investment Trust, for instance, can be rated among both the best and the worst-performing funds, notes Tal Daly, vice president and director of marketing for Baltimore-based Legg Mason's 11 mutual funds.

"In Morningstar we're the highest, in the latest edition of (P Business Week we're [next to] the lowest, and in the Wall Street Journal we're a B," he said. Likewise, Legg's U.S. Government Intermediate bond fund, rated a D by the Journal for its five-year performance, earned four out of five stars from Morningstar.

The two most important factors influencing a fund's grade are the time frame being evaluated and the definition of the fund's investment objectives. For example, is it a growth fund or an aggressive growth fund?

A few systems mark a distinction only between stock and bond funds; Lipper is able to divide funds into as many as 72 categories, including about 22 different "single-state" tax-exempt bond funds.

Many in the mutual fund industry criticize the Wall Street Journal's ratings because the newspaper uses only 10 categories. For instance, the Journal lumps all municipal bond funds together, regardless of maturities, and makes no distinction between funds that are exempt from all taxes in a state.

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