What's ahead in 2002?A look into crystal ball

Your Funds

Dollars & Sense

January 06, 2002|By CHARLES JAFFE

LIKE MOST investors, I find it hard to describe a break-even year as a good one. And when it comes to my annual predictions for the fund industry, 2001 was a 50-50 proposition.

Each year at this time, I predict fund developments that will make headlines. Started in 1995, it's an exercise in which I was always solidly in the black until last year, when I broke even.

For example, I was wrong about a liquidity crisis and about a resurgence among international funds. I correctly called the rebound in value funds and the heavy pace at which fund firms killed off their weakest offspring.

Like fund investors, I'd like my performance to return to historic norms this year. If that happens, at least five of the following predictions will come true. Here's what my crystal ball suggests we'll see in 2002:

A fund-renaming frenzy.

Thanks to a new rule requiring funds to put at least 80 percent of their money into the assets they're named for (meaning a tech fund shouldn't buy gold stocks), look for a spate of name games. Meaningless names like "Explorer" that don't actually describe the fund will be particularly en vogue.

If you get a name-change notice, take it as a warning. Any fund that must change its name to comply with the rule (the old rule required only 65 percent) probably isn't doing precisely what you expected when you first bought in.

Funds sued for assets that don't necessarily fit its name.

This is about how some stocks fit into the name rule.

Most funds, for example, considered Enron to be an energy company, though it was more of a broker than a traditional utility. As a result, any "utilities fund" that blew up after Enron's corporate implosion is likely to face investors questioning whether the stock was appropriate for the fund.

Many stocks are similarly miscategorized. Sharp plaintiffs' lawyers will allege that funds violated the spirit of the name rule by buying into companies that aren't a picture-perfect fit.

Fund directors sued for not firing managers.

The industry's most interesting development last year hardly will be noticed. It's a rule forcing a fund's directors to say - in the fund's "statement of additional information" (SAI) - why they retained management. Presumably, this will be boilerplate "it's all good" stuff, ignored by investors.

But the first time directors from some big-but-lousy fund pass off a below-average manager as doing a job worthy of renewing the management contract and increasing expenses, the class action plaintiff's attorneys will jump into action. Here's hoping they not only file one of these suits, but also win it.

A decline in the number of funds.

Throughout the bull market, everyone wanted into the money-management business. Mom-and-pop shops opened and thrived, and big firms filled every imaginable crevice with products.

Even in 2001, the proliferation of new funds - partly caused by new share classes of existing issues, which are counted as separate entities - was enough to outweigh closings and mergers.

This year, that trend will change. Boutique firms will shutter tiny funds or postpone new openings, while big firms will kill off as many bad track records as possible, leading to the first contraction in the industry in years.

Money market mutual funds that lose money.

With interest rates dropping to levels not seen in decades, any money fund with an expense ratio above 1.25 percent is in jeopardy of going negative, having expenses outweigh the yield they can produce. They'll break that barrier when rates drop again (and they will) unless they start to waive expenses.

If you bought a money fund as an ultra-safe, no-lose investment, make sure your fund is not in this group.

After-tax returns being virtually ignored by the public.

This is the first year funds must disclose after-tax returns, showing in their prospectus and in ads how an investor in the top tax bracket would have fared after paying Uncle Sam his due.

Tax-efficiency can save an investor big money. But it won't be a big deal in 2002 because the huge losses at many funds from 2001 will be used to offset gains for the foreseeable future, bringing a measure of tax-efficiency to funds that otherwise might have suffered on that score.

Shareholder tax relief moving forward in Washington.

The idea of a tax break for fund investors has been kicked around for the last few years, popular with investors but not going anywhere in Congress. While I doubt that any relief measure will get passed this year, the issue should move close enough to the front burner for a shot at passing in 2003 or 2004 as things move back into presidential election mode.

Chuck Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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