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Fund Fee Disclosure Gets a Facelift

Understanding mutual fund statements should be a heck of a lot easier now that federal regulators have okayed new disclosure rules that would spell out more clearly the fees imposed on shareholders.

The SEC recently adopted a series of amendments that aim to clear up the confusion surrounding fund costs, portfolio holdings and investment performance. The new rules come at a time when investor confidence is decidedly shaken as a result of the wave of impropriety that has been uncovered at some of the nation's top fund shops.

Fund companies will have four months to make the necessary disclosure adjustments. Many of them already comply with some or all of the requirements outlined by the SEC., so it is likely that these requirements are achievable under their existing cost structures.

"I think the SEC stance on increased disclosure is a step in the right direction - more disclosure on expenses and holdings is important," said Phil Edwards, managing director of global fund research at Standard & Poor's.

Edwards particularly applauded the requirements to provide investors with a means of comparing expenses across a number of funds and a graphic representation of holdings. Still, he noted there could be some problems presenting the information in a way that is meaningful to investors.

"While the more frequent disclosure of holdings is good, I think it will be difficult for investors to deal with this level of detail, especially in mid-cap, small cap, international equity and fixed income funds, Edwards said. "So a tabular or graphic representation will be useful."

Perhaps the most significant change is the enhanced disclosure of expenses in shareholder reports, a move the Investment Company Institute has always supported, but only if it meant meaningful disclosure. The amendments will require mutual funds to reveal the cost in dollars associated with an investment of $1,000 based on the actual expenses for that particular period. In addition, funds must include a second number that incorporates the cost in dollars associated with a $1,000 investment based on its actual expense ratio and an assumed return of 5% per year.

The first number would enable investors to estimate the costs related to owning the fund while the latter number would allow them to compare the fees and expenses of different funds. The expense disclosure will also include the fund's expense ratio and the account values for an initial investment of $1,000 at the end of each reporting period.

Another key rule change is the quarterly disclosure of portfolio holdings, which ultimately would give investors a firmer grasp of what stocks the portfolio manager is buying and how close it is sticking to its stated investment objective. Portfolio holdings would have to be filed with the Commission each quarter and made available to the public through its EDGAR service.

Fund shops would be permitted, however, to file a summarized version of its portfolio holdings in its semi-annual reports provided they file the complete schedule with the SEC and make it available to shareholders upon request, free of charge. This abridged version must include the fund's 50 largest holdings and every stock that represents more than 1% of the fund's net asset value. The intended goal of this amendment is to provide a snapshot of fund assets in a simpler format that is easy to understand.

Consistent with that concept is requiring fund reports to display a table or some sort of graphic representation that illustrates a fund's asset allocation by certain categories. For example, a fund could break it down into identifiable categories such as industry, geographic region or credit quality.

Another requirement under the new rules is the inclusion of Management's Discussion of Fund Performance (MDFP) in the fund's annual report. At present, funds can put the MDFP either in the prospectus or the annual shareholder report.

"I suspect that it will only require a minor tweaking of computer systems," said ICI spokesman Chris Wloszczyna when asked if funds would have trouble making the transition.

Money market funds will be exempt from the new portfolio disclosure requirements because they behave differently than other funds. Detailed information about their portfolios is not necessary because their investments are covered under the 40 Act, typically high-quality and have shorter term maturities.

"Improving disclosure has been difficult because of the potential for litigation in our society. On one side, the fund sponsors want to leave as much room as possible to limit the opportunity for litigation. On the other, the investor wants more to make an informed decision," Edwards said. "At the end of the day we'll have to see how the fund groups implement these regulation to determine if they are meaningful."

Copyright 2004 Thomson Media Inc. All Rights Reserved.