Hunt for Top Returns Keeps Fund Industry in Check
February 17, 2003
If you are looking for corporate integrity, check out the mutual funds. In our lifetime, we have seen major scandals or collapses of the banks, savings and loans institutions, the life insurance industry, big businesses - even religious organizations.
But not the mutual funds industry.
That's because the experts who manage the funds, the financial advisors who market the funds and the investors who own the funds are all sitting on the same side of the table. We all want the same thing: Good performance.
Whether the money comes from shareholders of great wealth - big companies or endowment funds - or with little wealth - such as a single mom funneling a mere $50 a month into her 401(k) - the same portfolio managers manage the very dollar the same way.
Mutual funds have teams of highly educated, brilliant and focused analysts who specialize in different industries and who funnel their research to the portfolio manager.
"How do you know when management is lying?" Fortune magazine asked Sallie Krawcheck, the former CEO of Sanford C. Bernstein who recently made headlines when she took a top research job at Citigroup. "Their lips are moving," Krawcheck replied.
She was one of a large group of analysts Merrill Lynch flew to Japan to showcase an investment-banking client. Wow, the company looked busy. The parking lot was full of bicycles and cars. Phones were ringing, people dashing, top executives combing and currying - but it all still didn't feel quite right to Krawcheck.
Excusing herself to use the restroom, the research sleuth instead went to some of the other floors, where she found empty cubicles and unconnected phones.
Was Merrill Lynch was doing a good job for their client? Absolutely. Hired to showcase this IPO, they were putting on a show worthy of the Academy Awards.
But because of their conflict of interest, they were not doing as good a job for their brokerage customers - including mutual fund portfolio managers.
Not every analyst can find each skeleton in a company's closet, but overall, an analyst's objectivity, ability to ask penetrating questions and knowledge of his or her industry gives a layer of protection to fund shareholders that is unavailable to an individual investor.
Funds are well diversified because federal regulations mandate they cannot have more than 5% ownership of any one company. Because the money is spread over so many companies in one fund, if a company pulls an Enron and collapses, losses are minimal.
Mutual funds also have clout because of all the money they have invested in Corporate America. As an example, funds are leading the way to restoring dividend yields.
Ralph Wanger, lead portfolio manager for Liberty Acorn Fund says his firm believes the dividend payment should be a noticeable percentage of a company's free cash flow.
Even in the "pirate capitalism" era before 1935 (pre-SEC), when the world was quite accustomed to sketchy or deceptive accounting, companies paid out a high percentage of their earnings in dividends and stocks. They were valued by their dividend yield. From 1960 to 1994, companies paid out 43% to 64% of their earnings as dividends. By 2000, only 31% of earnings were paid to shareholders. Dividend yields had been 3% to 5% for many decades, but collapsed to a derisory 1.2% in 2000.
What would make a company restore its dividends? Wanger believes fund analysts and portfolio managers have the power to make that happen - and should make that happen since dividends give investors confidence.
Wanger believes that when CEOs begin hearing this refrain from the powerful mutual fund community, they will ask their boards of directors to consider making the important change.
Mutual funds have not had corporate scandals because they do not have a conflict of interest. The portfolio manager, the analyst, the mutual fund marketer and the shareholder all benefit if the fund does well. On my visits to many of the largest funds in the country, I've never talked to a portfolio manager, an analyst or a wholesaler who did not have most of their personal money invested in their own funds.
In sum, these are the reasons mutual funds are the answer to the lack of corporate ethics.
Thinking an individual can outperform mutual funds by trading his own stock portfolio is like thinking the Gretna, Neb., high school football team can beat the Denver Broncos. Today's investors need a big kahuna on their side to sort through the misinformation from Corporate America.
Cella Quinn is president and founder of Cella Quinn Investment Services, an Omaha, Neb.-based financial planning firm that focuses on mutual funds. She can be reached at CellaQ@aol.com.
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