Select Funds Raise Questions of Conflict
November 15, 1999
In the past two years, wirehouses like Bear Stearns, Morgan Stanley and PaineWebber have introduced mutual funds that invest in stocks that are recommended by their firms' equity analysts.
Some mutual fund analysts question whether the funds are compromised by the fact that these wirehouses are also involved in investment banking. And financial planners say that the funds lack a clear-cut investment style.
The newest addition to this group is the Strategy Fund of PaineWebber of New York. The fund, which was introduced on Oct. 4, invests in companies in PaineWebber's highlighted stocks list, a list of about 25 stocks.
The highlighted stocks list, which was developed in 1988, is compiled by the firm's equity research department and is drawn from those companies that have a "buy" or "attractive" rating. So far, the fund has done well in attracting assets, said Paul Schubert, treasurer of the fund. He declined to disclose sales figures.
The Focus List Portfolio, of Bear Stearns of New York, invests in the top 20 stocks in the firm's focus list. It was opened in January 1998, and has done well recently, said Barry Sommers, head of mutual fund marketing for the firm.
It had $30 million in assets as of Sept. 30. In the 12 months ending Sept. 30, it returned 37.69 percent. It has returned 48.83 percent since inception, Sommers said.
The advantage of holding this type of fund is that the task of watching analyst's recommendations of individual stocks is done by the fund manager rather than by the individual investor, said Sommers.
Another selling point is that it is easier and cheaper to buy the fund rather than to purchase individual stocks of the list, Sommers said. The fund has a minimum investment amount of $1,000.
An investor could not buy all the stocks in the fund, individually, for as little as $1,000, he said.
Morgan Stanley of New York opened the Morgan Stanley Competitive Edge Best Ideas Fund about two years ago, said John Diat, a firm spokesperson.
Analysts look at 2,000 stocks from all over the globe and winnow them down to 40 to 50 best picks for the fund. The stocks tend to be large-cap, Diat said.
Merrill Lynch, Goldman Sachs, and JP Morgan, all of New York, do not have such funds, said spokespersons for those firms.
A major reason some wirehouses might not offer these types of funds is that they try to keep the asset management and brokerage sides of their businesses distinct, said Geoff Bobroff, president of Bobroff Consulting of East Greenwich, R.I.
"The [wirehouse] firms themselves are investment bankers for many of these companies, so they have to be careful about what they do and don't say in their analysis," said Bobroff. "From that standpoint, there's a bias, there's a conflict. And I hate to say it, but other than one or two situations, the street recommendations haven't been embraced warmly in the marketplace, because they haven't always meant positive results for investors."
Wall Street analysts' recommendations can seem to be compromised, said Russ Kinnel, a mutual funds analyst for Morningstar of Chicago.
"I think it's tricky basing a fund on wirehouse recommendations," he said. "Wire recommendations are influenced by the investment banking business. Less than one percent of wirehouse recommendations are sells.' But, it [the method] could still work if the manager has a fairly wide latitude in how he applies the rankings."
None of the wirehouse "best picks" funds have existed long enough to get a star rating from Morningstar, Kinnel said.
Financial planners also are wary of these funds.
"We consider these funds to be what I call a story sale,'" said Harold Evensky, principal of Evensky, Brown, Katz & Levitt of Coral Gables, Fla., a financial planning firm. "People like it because it seems to be a good story rather than a good investment idea. It doesn't really meet any particular need, or address any asset class or style. How does this fit into a particular investment category? It's just stocks the analysts like."