Mutual fund shareholders benefit greatly from the commingling of address stocks or fixed-income securities in diversified pools of investments.
Even a fund that simply throws darts at a newspaper page of stock listings can provide the single greatest attribute of fund investing.
Nonetheless, in today's jittery market climate, investors should be asking a different question: Do you want to be commingled with other investors in a mutual fund?
Just as stocks and bonds present an array of performance characteristics, fund shareholders exhibit a variety of investment behavior -- from long-term, buy-and-hold strategies to short-term, market-timing strategies.
Who pays the increased trading costs and suffers the diminished investment performance caused by trigger-happy investors jumping in and out of the fund you bought for the long run?
When stocks advanced 30 percent a year, as they did on average over the past three years, few fund shareholders cared about who was swimming in their pool, or whether splashes from their cannonball dives and springs to the sidelines lowered the water level for all.
But with the average equity fund in the negative column this year, losses attributable to the fund itself -- management fees, marketing expenses and trading costs -- may exceed investment losses.
Forward Funds, a family of five no-load funds scheduled to debut in October, says it has found one answer to the problem. The San Francisco-based organization plans to charge a "purchase fee" equal to one-quarter of 1 percent of each investment.
The fee is intended to cover the cost of putting new money to work, so that other shareholders do not bear a cost they did not voluntarily incur.
The fee is not a sales load, which represents a commission to the fund or a broker, but is applied against the cost of trading -- a cost hidden from shareholders in most funds.
"The person who is cheated in the commingled process is the long-term investor, who ends up paying for all the buys and sells of the fund," said Carl Katerndahl, executive vice president of Forward Funds.
"If I'm a market timer, I'm not going to use a fund that charges a quarter-point purchase fee. We're willing to say 'no thanks' to that segment of the market."
So far, Forward does not plan to impose an exit fee, but all its funds, except the small-cap fund, pledge to keep turnover to less than 30 percent -- a third of the rate of the average actively managed fund. Lower turnover means lower trading costs.
Ronald Pelosi, president of Forward Funds, says his company's concept represents a departure from conventional fund marketing, from an emphasis on investment performance and convenience to an emphasis on getting what you pay for and only what you pay for.
Roger Edelen, an assistant professor at the Wharton School of Business at the University of Pennsylvania, has studied the "costs of providing liquidity" in mutual funds.
Fund managers automatically find themselves behind when they must buy and sell securities to accommodate the fund's customers' desires to acquire and redeem fund shares -- a significant cost that passive market indexes do not face.
"The very act of providing a liquid entry position to investors arguably the primary service of an open-end mutual fund, generates a return that is on average less than the return of an unmanaged benchmark," Edelen wrote in a recent paper.
The cost of providing liquidity -- keeping the pool full despite splashes over the side caused by rambunctious investors -- can be especially onerous when managers, fearful of holding low-yielding cash in a stock portfolio, find themselves buying stocks at peaks and selling to meet redemptions during slumps.
Forward Funds will levy separate charges on shareholders who demand special services, such as check writing and money transfers.
"Our per-use fees may be on the high side," said Alan Reid Jr., also a Forward executive vice president, but the funds pledge to keep expenses -- charged to all shareholders -- below industry norms and to lower expense ratios as assets under management increase, a promise virtually unknown in the fund industry.
Pub Date: 9/27/98