Managers need clearance to sail your ship into safety

Your Funds

Dollars & Sense

April 27, 2003|By CHARLES JAFFE

IN HIS book What About Mutual Funds? author John A. Straley recalls a panel discussion at a Mutual Fund Dealers' Conference in which a member of the media asked: "Does a decline in the securities markets mean that you face a difficult public relations job?"

The answer, which Straley says brought applause from the audience, was: "No. If the investor understands what he owns, after a declining market, his feeling will be, 'Yes, my shares are lower in price, but I know that the management of my fund, with the same amount of money over the same period of time, has done a great deal better job for me than I could have done for myself."

That less-than-humble reply came approximately four decades ago. I found a second edition of Straley's book, dating to 1966, on my parents' shelves during a recent visit.

Today, few fund industry executives would spew such arrogant poppycock, but the truth is that they still think it.

It's time that thinking changed, or that managers did something to earn that kind of self-confidence.

Much of Straley's book is timeless. Methods for selecting a fund have improved, there are infinitely more choices and participants and the 8.5 percent sales charge has gone the way of the Model T, but the fund business justified its existence four decades ago by offering diversification and professional management at a reasonable cost.

Straley's basic premise was that investors with neither the dollars to hire personal managers nor the expertise to effectively trade stocks on their own need to be in mutual funds to get exposure to the market while leaving the actual investment selection to an expert.

But he stressed the value that shareowners would get for their investment dollar, and most investors having lived through the bear market would feel a bit cheated.

In fact, the advent of style-specific funds that stick to a certain benchmark, Morningstar style box or tightly defined investment objective has removed a lot of management's toughest decisions from play.

There are few "go-anywhere funds" today, few managers who look at their investment horizon and say "This market [stinks] right now, I'm outta here."

Yet that is precisely the kind of management Straley and the old-time fund industry were talking about.

Today, the vast majority of managers stay fully invested because their job depends on it. They fear losing clients if they move out of, say, small-cap stocks in favor of cash; financial advisers who put clients in funds want those issues to remain true to a promised style.

But the always-be-fully-invested philosophy actually takes some measure of professional management out of funds.

Moreover, it ignores a segment of fund investors who believe that management should be "protecting the shareholder" through smart decision-making.

A recent article in Barron's talked about how managers should be freed from the shackles of style. While I would not go so far as Barron's to say that style boxes and SEC rules should be trashed, I would suggest that fund companies owe investors one basic management judgment that they have been unwilling to make in recent years: Decide whether the asset class is worth owning.

If, for example, the manager of a tech fund can't find good investment options or doesn't believe in the sector based on market conditions, he or she should be allowed to move more money to cash without fear of running afoul of regulations stating that 80 percent of a fund's holdings must be in the asset class for which the fund is named.

Fund management should tell consumers and financial advisers they might cash out, so that investors can decide if they want to be in a fund that could morph temporarily into an expensive money-market offering. (Mind you, the Barron's suggestion would let the manager of a tech fund head into gold or real estate or anything; I'm simply suggesting management have the option to NOT own their asset class by moving some or all of a portfolio into cash.) And when the manager goes to cash, the fund ought to stop taking new investments.

If fund firms would allow managers to play to these basic instincts - and I have talked to plenty of fund managers who believe that if they followed their gut to a 30 percent holding in cash they'd lose their job for it - the industry might again be able to say with a straight face that it feels confident it has done a better job managing money than the average investor.

Without that judgment, fund performance - good or bad - will rest almost exclusively on the asset class a fund invests in, rather than on any brilliance from management.

Chuck Jaffe is senior columnist for CBS Marketwatch. He can be reached at or Box 70, Cohasset, Mass. 02025-0070.

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