Thanks to SEC, fund shareholders given more data to evaluate holdings


November 14, 1994|By JANE BRYANT QUINN

NEW YORK -- How well is your mutual fund doing, compared with others you might own? Is it good enough to keep?

Those are always hard questions. But it's easier to answer them today, thanks to the new information published in the funds' shareholder reports.

Under rules established last year by the Securities and Exchange Commission, your fund now has to explain in detail why its share price went up or down. If you own a bond fund, you'll learn how changes in interest rates help or hurt your investment. If you own a stock fund, you'll discover which stock picks were wild successes and which ones failed. A series of these reports can amount to a minicourse in how markets work.

Just as interesting to investors is another SEC rule: that the funds compare their short- and long-term performance, after expenses, with the performance of a standard market index. For example, a stock fund might compare itself with Standard & Poor's 500-stock index, which charts the progress of leading stocks. A bond fund might compare itself with the Lehman Corporate Bond Index. These charts show you quickly whether your fund has done better or worse than the market as a whole.

The industry doesn't much like this rule. For one thing, it puts the mutual funds at a disadvantage. All funds have costs -- for overhead, money management and brokerage fees. But there are no costs in a price index. Even a fund whose investment performance exactly matches the market will fall short after subtracting fees. Funds also keep a cash stash in case you want to redeem your shares, and in some years that lowers performance, too.

But from an investor's point of view, the comparison works just fine. Some funds do better than the market, even after fees; other funds do worse. If your fund consistently does worse, you should ask yourself whether it's worth its price. Maybe you should switch to a fund with lower fees.

A second controversial issue is how the funds pick the index they compare themselves with. A renegade fund could cheat investors by picking an easy target to beat. A small-stock fund, for example, might compare itself with a big-stock index like the S&P 500. That tips the comparison in its favor, because small stocks do better than big stocks over long periods of time.

But the SEC's Robert Plaze, assistant director of the investment management division, thinks this isn't much of a problem. Tattling competitors are quick to complain about a fund that's playing games. Furthermore, the game might misfire. If the index buys different types of securities, it might, at some point, make the fund look bad instead of good. A fund is allowed to change the index it compares itself with, but for one year it has to disclose both the new index and the old, Plaze says.

For some funds, no comparable index exists -- for example, a balanced fund that owns stocks and bonds. Such a fund might solve its problem by comparing its performance both with the S&P 500 and with a Lehman bond index. Generally speaking, its own performance should fall somewhere between the two, says money-manager Kurt Brouwer, president of Brouwer & Janachowski in San Francisco. Other funds compare themselves with both small-stock and big-stock indexes.

International funds have the hardest time finding a good standard for comparison, according to Vanguard Group Chairman John Bogle. The most commonly used market index is heavily weighted toward Japanese stocks. It will perform differently from a fund that avoids Japan.

Morningstar Inc., which tracks mutual funds, compares the past performance of the funds it covers with 10 to 13 standard market indexes, to see which one best fits each fund. But many funds compare themselves with the S&P 500, even if it's not ideal, because that's an index people know, Morningstar Editor John Rekenthaler told my associate, Louise Nameth.

Surprisingly, that may work to your advantage. The more the fund has to explain why its performance differs from a market average, the more an investor is going to learn.

I'd add just one thing to the disclosure. The shareholder reports give you the fund's average compounded returns over one, five and 10 fiscal years (or the life of the fund, if it's younger than that). But you're not told how well the market did over those same periods. Including it would make the fund's record even easier to evaluate. For starters, I recommend that you pay attention to the information you've got.

Jane Bryant Quinn is a syndicated columnist. Write to her at: Newsweek, 444 Madison Ave., 18th Floor, New York, N.Y., 10022.

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