Mutual denigration

The dirty secret about your mutual fund. One company comes clean.

By Steve Bodow

Published June 20, 2000 7:00PM (EDT)

Buy a can of soup and you'll know every last ingredient. Buy a typical mutual fund and you may never discover exactly what you own.

Most funds disclose their holdings just twice a year. Few tell anyone how often they trade, which can seriously impact after-tax returns. The result: Mutual fund investors get left in the dark, says Don Luskin, an investment industry veteran of more than 15 years and co-founder of a company called MetaMarkets.

But slowly, fund companies have begun to crack open their books.

MetaMarkets' OpenFund (which trades under the symbol OPENX) lives up to its name. This maverick operation makes its entire portfolio open for inspection.

No other fund flirts with so much disclosure, though others have started moving in the same direction. Montgomery Funds markets its brand-new Stock Solutions portfolios to "today's savvy investor" who wants good returns and a little insight into its manager's investment decisions. Other smaller funds, including Munder NetNet and Firsthand Funds, also offer Web updates of their holdings.

Compared to other relatively candid funds, the tech-heavy OpenFund is a flagrant exhibitionist. OPENX, which has performed roughly in line with its aggressive-growth peers since its inception last August, lists every trade on its home page moments after it happens, along with a nugget of color commentary. Last Friday, when chipmaker Rambus (RMBS) was up 50 percent on news of a deal with Toshiba, anyone could go online to see OpenFund taking some healthy profits on its RMBS shares. On Monday, Luskin weighed in with a broader analysis of the Rambus deal and what it meant for the market.

Other unique features: Investors critique the day's buys and sells on MetaMarkets' discussion boards, and anyone can make suggestions about what to trade next. The boards' contributors -- an unusually knowledgeable group -- get peer-rated, so an investor with a run of good ideas can catch the fund managers' attention. Luskin says the fund routinely researches little-known companies mentioned on the boards, and even has made a couple investments based on discussion-board discoveries.

More disclosure, openness and better-informed investors certainly sound like benefits. But while Luskin and his band of self-proclaimed financial libertarians lobby to bring fund holdings, trading patterns and other key stats out of the closet, some of the industry's biggest names profess a different take: Don't ask, don't tell.

"I work in this business 12 hours a day, six days a week," says Vanguard spokesman Brian Mattes, "I have a huge portfolio, and I could not begin to tell you what specific stocks are in there. It's not a productive use of my time."

Fund selection, Mattes says, shouldn't hinge on the specific equities a manager holds, but on the fund's overall approach, philosophy and performance. In fact, he and other defenders of the status quo say more disclosure ends up hurting investors.

Their argument? Fund owners usually reap bigger gains when they hold shares for a long time. Releasing blow-by-blow trading data would divert investors' focus to the short term, and possibly encourage them to buy and sell mutual funds like fund managers buy and sell stocks -- that is, often.

More insidiously, Mattes says, frequent disclosure would sap managers' ability to trade effectively. Say a fund manager wants to add eBay to his portfolio. The market trades about $200 million worth of eBay shares a day. To have eBay become a meaningful part of his $1 billion in overall holdings, he would have to buy a big chunk -- maybe $20 million worth.

What he shouldn't do next is buy $20 million of eBay in one gulp. If he hits the market with such a huge buy order, traders will see that there's a motivated buyer and rush in to buy the same stock. It's known as "front running."

Instead, hungry funds should play things close to the vest -- nibbling anonymously over several days or even weeks. Ten thousand shares here, 15,000 shares there. Really huge funds, those with more than $10 billion in assets, may need many months of fine-tuned trading to build or liquidate significant positions.

And there's the rub. If Fidelity Magellan or Vanguard Windsor told the world exactly what they owned at the end of each day, it wouldn't take a Harvard MBA to figure out what they were buying, or to take advantage of those stocks' rising prices.

Yet, that doesn't entirely excuse the secrecy. Morningstar research director John Rekenthaler says that 99 percent of funds could publish their holdings monthly without exposing themselves to front-running risk.

Luskin dismisses the financial establishment's anti-disclosure arguments as having less to do with protecting investors than with an old-vs.-new money cultural bias. Big brokerages and fund families, he says, believe buy-and-hold strategies aren't just bottom-line better than day trading; they're ethically superior. "There's this almost moral tone to what people say," Luskin says. "How often have you seen articles explicitly comparing day trading to gambling? There are all these charged words with religious connotations."

He attributes this attitude to a benign paternalism -- an assumption that most investors don't know what they're doing and need rules to protect them from themselves. This thinking inspired much of the Investment Company Act of 1940, which was written in the wake of the Great Depression and still is in effect, and which closed riskier investments such as hedge funds to everyone but "accredited," i.e. wealthy, investors.

This well-intentioned if patronizing stance still informs much of what the old-school financial community believes. Vanguard's Mattes, for example, says fund managers employ complicated hedging strategies where they buy stocks that seem to superficially go against common sense. "Will the average investor understand that? I would suggest not."

Mattes isn't a snob; funds are legitimately complex. But such complexity doesn't excuse secrecy. When the Securities and Exchange Commission established disclosure standards decades ago, compiling and mailing fund data was far more time consuming and expensive. The Web has changed the equation, making it relatively simple to keep investors informed.

The question now is whether investors want to bathe in as much data as OpenFund pours out. Most probably won't. (A few sports fans read box scores while the majority just glance at the standings.) But investors are grown-ups; they should at least have the choice. OpenFund has taken a step in the right direction.

Steve Bodow

Steve Bodow is a writer in New York who has contributed to New York magazine, Wired and Feed.

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