Sometimes `good' leaves much room for improvement

YOUR FUNDS

Your Money

November 13, 2007|By CHARLES JAFFE | CHARLES JAFFE,MARKETWATCH

In the town where I live, the motto of the local high school is, "If better is possible, good is not enough."

In the community where most Americans invest - the mutual fund world - the motto seems to be, "If good is possible, why make it better?"

That's not a statement on performance - though it could be in many fund shops - but rather an indictment of the industry's steps toward improving fund governance.

The industry proved the point again last week by giving itself a big loud pat on the back with the release of a joint survey by the Investment Company Institute, the trade association for the industry, and the Independent Directors Council that details "increased commitment" to shareholders.

The study shows that over the past 10 years, fund boards have "increasingly adopted practices that benefit shareholders. Further, they have often adopted these practices in advance, or in absence, of any regulatory mandate to do so."

In short, the fund industry has done its homework without being threatened with detentions; it hardly means the business is making the honor roll.

Specifically, the study found that by the end of 2006, independent directors made up three-quarters of boards at nearly 90 percent of fund firms and that 75 percent of all fund companies reported having at least one board led by an independent chairman or an independent lead director.

By comparison, in the mid-1990s less than a quarter of fund complexes had an independent trustee leading the board.

The study also showed that 90-plus percent of fund firms now have separate legal counsel to serve their independent directors, up from about two-thirds of the firms in 2000. And "a vast majority" of funds now claim a financial expert as part of their audit committee; by rule, a fund doesn't actually need a financial expert on its audit panel - go figure - it simply needs to say if it has one on there.

"Fund boards have always taken their duties to shareholders very seriously," Robert W. Uek, chairman of the Independent Directors Council, said in the news release trumpeting the findings.

"Clearly, fund boards have increased the depth of their oversight as the industry has grown and the issues affecting funds have continued to become more complex. This report indicates that shareholders should be confident that directors are keeping a close watch on their funds."

Bzzzzzt, wrong.

Funds have taken a journey toward improvement that they should have made long ago. While they did it without legislation or rules forcing the changes, many of the current "best practices" were part of proposed industry reforms and were adopted in many cases by firms figuring that they would just beat regulators to the punch.

There's no cause for glad-handing here.

Fund firms have done the bare minimum for what the public should have expected or demanded from a board of directors.

Yes, it's an improvement. No, it doesn't go far enough to make shareholders happy.

What you haven't seen in the past decade is those boards standing up regularly to management practices that are bad for investors. Plenty of funds have retained mediocre or lousy managers year after year, have pushed through fee increases, or have failed to push management to close a fund to new cash after passing the ideal size for the strategy they employ.

On the governance front, you have seen no steps by the big fund firms to set up multiple boards, so that a director serves no more than, say, 25 funds. A director can only be so "independent" working for dozens of funds run by the same firm.

While boards have been marginally more active in dismissing sub-advisers - outside hired guns brought in to run money - they appear no more interested in jettisoning in-house managers. They may be independent, but boards aren't firing insiders.

Fund directors say investors have the proxy of their feet, and can take their money elsewhere, which is why they don't want their boards to interfere with management.

While that's true, it's not necessarily realistic; many investors are locked into retirement plans with limited selections, or they have longtime holdings that will generate huge taxable gains if they make a change.

Investors deserve activist boards that defend their best interests. That's a few steps beyond having a financial guy on the audit committee, or even having an independent chairman.

Says Geoff Bobroff of Bobroff Consulting, who also serves as a director of the Matthews Asian Funds: "To some extent, boards have risen to the occasion of taking more control of the process. They're in more control than they were, but it's still not full control. Not even close, especially on fees and performance issues."

In short, better is possible. So while the progress the fund industry has seen in the past 10 years is good, it's not nearly enough.

cjaffe@marketwatch.com

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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