Four mutual fund families under a cloud

THE BALTIMORE SUN

Walt is a 59-year-old retiree from Newton, Mass., who moved some of his money into Janus Growth & Income a little more than a year ago.

The fund got a five-star rating from Morningstar Inc., had an experienced manager in David Corkins, and had beaten its large-cap growth peers during both the bull and bear markets.

It was a time when many investors were leaving Janus funds, tired of suffering the losses the firm endured when the stock market's 1990s party came to a crashing end.

"I knew what was happening with some of the other Janus funds, but I looked and saw a high-quality fund," says Walt, who called my radio show recently.

All of the conditions that first attracted Walt to the Janus fund still exist today. Same manager, same star rating, same performance, same everything.

But there's one big additional circumstance: Morningstar recently came out and told investors to back away from Janus, Strong, Banc One and NationsFunds, the four fund families named in the complaint that New York Attorney General Eliot Spitzer filed against a hedge fund accused of illegal trading activities.

Now Walt is like millions of investors wondering what to do next.

He has a fund he likes, one that he believes was not touched directly by the alleged bad actions of the parent company, and one that has not been proven guilty of any wrongdoing.

"None of the bad news about Janus in general would lead me to believe my fund would be a problem," he says. "Morningstar is saying 'Three strikes and Janus is out,' but none of those three strikes directly affected my fund. Nothing is shouting out 'Stay away from this fund.' It looks like the Salem Witch Hunt right now, and now I am wondering if I will panic, or if I might be the victim of everyone else panicking."

Walt's worry is a common one.

The Spitzer case touches mostly on a market-timing strategy known as international fund arbitrage, and the allegations seem to center on the funds at each firm that invest in foreign stocks. Essentially, the firms are alleged to have broken rules designed to stop market-timing trades in some of their funds, in exchange for a big chunk of cash parked in their bond or money-market funds.

The point Morningstar's top analysts make in advising investors to shun the four tainted fund firms was that top management at each company may have shown a willingness to put corporate interests ahead of shareholders, an action that can rightly be considered intolerable.

The Morningstar analysts were quick to point out that their recommendation might hinge on circumstances - selling a long-term holding and generating a big tax bill is different from dumping something purchased in 2001 where the investor might get tax benefits from selling at a loss - and they did not rule out a fast change of heart if the firms are exonerated and can prove they have mended their ways.

To further compound the decision of investors such as Walt, they also praised some managers at the firms, including Corkins. But even as it warns investors to avoid the four firms, Morningstar continues to rate and track the funds.

And with investors gravitating to performance - well over 90 percent of all money invested in funds goes into issues that carry Morningstar's top two star ratings - there's little reason to believe most investors will want to bail out of the top-rated funds from any of the companies.

"I have no doubt over time that Janus, Strong, Banc One and NationsFunds will demonstrate to the public that every shareholder gets treated the same, but until that happens, we think the investor is better served being at another firm," says Don Phillips, managing director at Chicago-based Morningstar.

"An investor might decide to wait to see how widespread this is before taking action - and that might prove to be a fine decision - but if an investor leaves today, they are leaving because they think governance is an important contributor to performance, and they believe they might be hurt by sticking with companies that have governance issues."

The media has had a field day with Morningstar's first-ever blanket recommendation to avoid some fund families, but the truth is that the data-tracking firm didn't have the mechanism to make such a suggestion until it allowed analysts to make picks and pans a few years ago.

Critics have pointed out that Morningstar didn't take a similar action against other fund firms that have gotten into trouble.

In October 2000, the Heartland funds had three junk muni-bond funds blow up based on questionable pricing actions; class action lawsuits were filed and the Securities and Exchange Commission put the funds in receivership - something it had not done to any fund in ages - and liquidated the remaining assets. But no one said to avoid Heartland's other funds.

In fact, the Heartland shareholders had been badly damaged, with the cost being easy to calculate. And there was no restitution from the funds.

Three of the firms in the Spitzer case - Strong being the exception - have already said that if they can calculate a cost to investors from their actions, they will pay back those monies to shareholders.

Morningstar's warning is, at least, well-intentioned. It's like advising someone to lock their car doors when driving into a dangerous neighborhood.

But acting on it will wind up being an individual decision, and there's a remarkably easy way to make that choice in this case.

Ask virtually any financial expert how they would evaluate selling a long-term investment, and they will tell you to include the following question in the analysis: "Would I buy this again today?"

Chuck Jaffe is senior columnist for CBS Marketwatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.

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