Steps for making mutual fund guides more helpful

The Baltimore Sun

There's a difference between what an investor needs to know before buying a mutual fund, and what he or she wants to know.

But if the fund industry is serious in its quest to alter the prospectus - effectively replacing the thick booklet of jargon with a thin "quick-start guide" that it supplements by putting the traditional document online - management should be required to provide consumers with both types of information.

Any effort to reform the prospectus - this column discussed last week the move to do just that - should be focused on giving consumers better, more useful decision-making materials. Behind the scenes, industry leaders seem to be more focused on their cost savings than on the wealth of information they can provide in new and different ways.

Remembering that investors will still have access to the full prospectus online, any proposed summary prospectus should have four categories of data: nuts and bolts, basic information, statistics and wishful thinking. True reform won't be possible until that last group becomes a reality.

Nuts and bolts: Because a prospectus is a legal document between the investor and the fund, it has to include a skeleton just beneath the real meat. This information won't help consumers pick a fund, it will just help them work with the fund once it has been picked.

No summary prospectus would be complete without telling investors how to buy and sell shares, how distributions are made, what other services the fund company offers shareholders, and what rules - such as short-term redemption fees or limits on quick-turnaround trades - the customer has to live with.

Basic information: If funds can eliminate the jargon and legalese and state in plain English their goal, investment strategy and significant risks, investors will get a clearer picture of what they are buying.

Funds describe for whom they are appropriate, but it would be hard for any investor to read those disclosures and not see themselves, because management tries not to turn anyone off. One nice addition would be a disclaimer from management saying whether the fund is equally appropriate for taxable and tax-advantaged accounts; investors sometimes save a bundle by owning only a tax-inefficient fund in an account where Uncle Sam doesn't pocket a big chunk of returns.

Throw in information about the managers, including their record at other funds - because a manager who gets lucky with one fund out of five is a different breed of cat from a manager who runs one fund extremely well - and you have the underpinnings on which an investor can make a decision.

Statistics: Funds should provide a comprehensive performance chart, including benchmarks against an index representing the appropriate asset class, and against the performance of the average fund in the category. Annual performance should be shown - so investors can see what the fund has done in its best and worst years - as well as showing the growth or shrinkage of a $10,000 investment over time.

Next, investors need the numbers on fees and expenses, not just on a percentage basis but in real dollars, so they can decide if they are paying a fair price for the returns they expect to get.

Finally, a table showing portfolio turnover, and the fund's past tax efficiency, would be a welcome addition, helping investors break ties that exist when they try to winnow down the fund universe into one or two selections.

Wishful thinking: While my ideal summary prospectus steps up the performance disclosures, it would require only a few significant additions to make fund-shopping significantly easier.

Start by requiring funds to provide current ratings - no more than six months old - from three independent research firms (think Morningstar, Lipper, Value Line, etc.). If the fund industry wants to create a "quick-start guide," the managers should include the information that most investors actually use to get the ball rolling.

Next, management should have to say if the fund works well with any sister offerings, providing a chart showing which siblings have a portfolio with at least 20 percent of the same underlying holdings. A chart showing the fund family's offerings and showing where potential duplication of holdings could reduce diversification would be a plus.

Finally, management should have to lay out its own expectations for the fund, including a list of targets that define "disappointment," so that the investor knows that the fund hasn't just lagged behind a benchmark, it has gotten to the point where management agrees you would be justified to sell.

If the idea is to create a "quick-start guide," then fund companies should provide some guidance. Forcing management to define future disappointment would turn the prospectus from a sales document into more of an owner's manual, which would be a welcome change.

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

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